There are several reasons why retailers care about whether they may add surcharges. Those reasons have caused retailers to challenge California’s and New York’s surcharge bans. And now state and federal courts—including the U.S. Supreme Court—are chiming in on the debate.
In January 2018, the Ninth Circuit issued an opinion in one of these cases. It held that California’s surcharge ban was unconstitutional as it applied to the pricing schemes in that case. That decision highlighted this often overlooked but evolving issue that retailers would be wise to review.
California’s Surcharge Ban
Retailers impose a surcharges because credit card companies charge them fees of around 2-3 percent of the transaction cost when a customer pays by credit card. Retailers can recoup the cost of that fee by adding a surcharge unless a statute or contractual agreement prohibits them from doing so.
In 1985, California enacted Civil Code section 1748.1. That section provides that “[n]o retailer … may impose a surcharge on a cardholder who elects to use a credit card in lieu of payment by cash, check or similar means.” But the law permits retailers to “offer discounts for the purpose of inducing payment by cash, check, or other means not involving the use of a credit card, provided that the discount is offered to all prospective buyers.” Simply put, retailers cannot add a surcharge when customers pay by credit card, but they may offer discounts to customers who pay with cash. Willful violators are liable for three times actual damages, as well as attorney fees and costs in an action enforcing the ban.
In Italian Colors Restaurant v. Becerra, Case No. 15-15873 (9th Cir. Jan. 3, 2018), a group of California retailers filed an action against the state challenging its surcharge ban. The retailers alleged in part that the ban restricted commercial speech in violation of the First Amendment. A federal district court agreed and declared the ban unconstitutional. The district court issued an injunction permanently enjoining enforcement, and the state appealed.
The Ninth Circuit affirmed summary judgment but modified the relief. The court agreed that the surcharge ban was unconstitutional as applied to the retailers. Because the retailers presented an as-applied challenge, the court declared the ban unenforceable only as to the specific pricing practice that the retailers sought to employ. Nearly all wanted to charge lower prices overall and a higher price for credit card payers, expressing the difference as a surcharge or “percentage fee.” One retailer already charged a regular price and a discount price for cash customers but wanted to describe the difference as a surcharge.
The opinion in Italian Colors Restaurant offers compelling reasons for why retailers prefer to impose surcharges rather than offer cash discounts. First, surcharges more effectively convey to customers the high cost of credit card fees. Second, raising prices overall and then offering cash discounts makes goods and services appear more expensive. Third, research shows that a substantial number of individuals are more likely to change their spending behavior if presented with a potential loss than with a potential gain. One study suggested that 74 percent of consumers base purchase decisions on that perception.
The Ninth Circuit found that the surcharge ban regulated commercial speech because it applied to the communication of prices. Restrictions on commercial speech must survive intermediate scrutiny under the test from Central Hudson Gas & Electric Corp. v. Public Service Commission of New York, 447 U.S. 557 (1980). That test first asks whether the speech is misleading or related to unlawful activity. If it is neither, then the state must assert a substantial interest that the regulation aims to achieve. Finally, the regulation must directly advance that interest and cannot be more extensive than necessary to achieve that interest.
As applied to the retailers, the surcharge ban did not pass the Central Hudson test. The court found that the retailers’ desired pricing scheme was “no more misleading than calling the weather warmer in New Orleans rather than colder in San Francisco.” Moreover, the retailers wanted to communicate rather than conceal surcharges. Next, the court considered the state’s purported interest to “promote the effective operation of the free market” but found that there was “no evidence that surcharges posed economic dangers that were in fact real before enactment of Section 1748.1.”
Nor did the ban directly advance the state’s purported interest in protecting consumers from deception. Indeed, the ban undermined “truthful price information” because it kept retailers from conveying that higher prices were the result of credit card fees. Because there were more narrowly-tailored means available—e.g., banning only deceptive or non-disclosed surcharges—the ban was also more extensive than necessary.
In sum, the court held that the surcharge ban restricted the retailers’ non-misleading commercial speech in violation of the First Amendment.