A California state court recently issued a preliminary ruling proposing to assess a statutory penalty against online discount retailer Overstock.com in the amount of $6.8 million for engaging in allegedly false and misleading discount advertising.¹ Overstock.com was alleged to have advertised discounted prices that were pegged to the company’s own uncorroborated estimate of undiscounted retail value, rather than on actual data. The case highlights the risk that both online and brick-and-mortar retailers face if they advertise “discounts” from “regular” prices that have never actually been offered in commerce, in violation of the Federal Trade Commission guidelines against deceptive advertising (“FTC Guides”). The case also signals a major new threat to retailers engaging in these kinds of marketing strategies, which are common in the industry.

The Overstock.com case began in 2010, when a group of California district attorneys filed a private action under California’s False Advertising Law, Unfair Competition Law, and Consumer Legal Remedies Act. Their complaint alleged that Overstock.com “routinely and systematically made untrue and misleading comparative advertising claims” by comparing its retail prices to “advertised reference price(s)” (ARPs) that were not the prevailing market prices for its products. The district attorneys claimed that Overstock.com instead used misleading internal formulas designed to “inflate the comparative prices and artificially increase the discounts it claimed to be offering consumers.” The complaint also alleged that because Overstock.com was no longer merely a reseller of distressed merchandise, but was now actively engaged in original design, production and sale of a wide variety of products, it could not possibly advertise a “discount” for such products that were never sold at an undiscounted price.

Using the FTC Guides as a key point of reference, the court agreed that Overstock.com’s pricing practices were deceptive and misleading. Among its findings:

• Overstock.com misled consumers because its ARPs were often based on inappropriate reference prices that were derived by either: formulas, rather than actual prices in the marketplace; the market price of similar products; or the highest price that could be found on the Internet, rather than the “regular” or “average” price.
• Because Overstock.com’s use of ARPs had been shown to drive increased sales, the misleading use of ARPs caused “consumer harm.”
• Surprisingly, Overstock.com was permitted to continue to advertise “free shipping” even though the cost of shipping was built into the price of the goods. According to the court, no reasonable consumer would think shipping is truly free.
• Additionally, even though the company had diversified its business beyond selling distressed merchandise, its purported claim to be a “liquidator” was not false advertising because it was not pervasive.
• Significantly, the court rejected Overstock.com’s statute of limitations defenses, effectively holding that retailers can face lawsuits no matter how long an allegedly offending business practice has been in use.

In crafting an injunctive remedy, the court did not ban Overstock.com’s use of ARPs altogether, but prohibited it from pegging ARPs to anything other than actual prices in the marketplace. The court also ordered Overstock.com to disclose when its ARPs are based on the highest available price or on the price of a similar product, as well as to take other steps to ensure pricing transparency—including qualifiers, disclaimers, and links to term definitions.

The court imposed civil penalties of $3,500 per day for practices from March 2006 through September 2008 and $2,000 per day for September 2008 through September 2013, but declined to order Overstock.com to provide direct restitution to its customers. Since no restitution remedy was awarded, one might expect to see follow-on class actions against the company if the tentative ruling stands.

The decision stresses the importance of advertising prices that are in compliance with the relevant FTC Guides. The advertising standards contained in such FTC Guides are technically voluntary, but are frequently incorporated into state law and can thus be enforced by state consumer protection agencies. For example, the lawsuit against Overstock.com may have been avoided through adherence to FTC’s Guide for Advertising Retail Prices Which Have Been Established Or Suggested By Manufacturers Or Other Nonretail Distributors (16 C.F.R. § 233.3), which recommends, among other things, that ARPs or “list prices” be pegged to prices that are “regularly charged by principal outlets in [a retailer’s] area.” The litigation also illustrates the collective power of California district attorneys, who have been aggressive in bringing consumer protection litigation within the state.

Although Overstock.com has announced its intent to appeal, this case should be watched closely by the retail industry (and discounters in particular), because the success of the case will likely embolden the district attorneys—and possibly other plaintiffs’ lawyers—to bring similar suits.

For more information about compliance with FTC Guides and avoidance of liability for false advertising, please contact the author of this post, or your regular Crowell & Moring contact.

¹ People of the State of California v. Overstock.com, No. RG10-546844 (Cal. Sup. Ct. – Alameda Cty.).