consumer protection

Daily Deal Providers May Be Violating Consumer Protection Laws

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Editor’s note:Guest author Rocky Agrawal continues his in-depth TechCrunch series looking at the daily deal industry. Agrawal is an entrepreneur who has worked on local products since 1995. He blogs at reDesign and Tweets @rakeshlobster.

Daily deal providers like Groupon and LivingSocial may be violating several key aspects of consumer protection law.

I’ve been looking into issues like gift cards, bankruptcy, sales tax, and alcohol regulations. These might all sound esoteric and not really worthy of discussion, but the outcomes can significantly affect the value proposition to the consumer, merchant and the deal provider. For investors in the daily deal companies, these can affect stock performance as well as legal liability.

I had a conversation with Ben Edelman, an assistant professor at Harvard Business School, about some of these issues. Ben and Paul Kominers of MIT published a paper yesterday on Consumer Protection in Online Discount Voucher Sales “. When I asked him if he has any conflicts, he says he hasn’t done any paid consulting in the industry nor does he have any other conflicts of interest.

Because daily deal vouchers are new, in some cases the specific handling is unclear. In others, the law is clear cut.

Gift cards

Everyone knows about gift cards. It’s a $90 billion business. Most people don’t think “gift card” when purchasing a daily deal from Groupon, LivingSocial, or the rest. But the law may see no such distinction.

The basic legal definition of a gift card varies by state, but generally has all the same requirements as a daily deal. It is prepaid, good for a predetermined value, and can be redeemed for goods or services at a specified business. Both Groupon and LivingSocial have already been sued under various state gift card statutes. One suit against Groupon was dismissed according to the Groupon blog.

Because the consumer prepays for the vouchers, daily deals may be considered a gift card. 27 states regulate gift cards. Although most daily deal vouchers have an expiration date, this may be against the law and the disclosures may violate state laws as well. (Some states require that expiration dates be printed in a certain font size, for example.) Many states have expiration dates that are significantly longer than the six months or a year attached to daily deals.

In Massachusetts gift cards are valid for 7 years and are based on the face value of a gift card. So 6 years after buying a $20 gift certificate for $10, the consumer could go to the merchant and redeem it for the full $20. Washington requires that consumers be able to use the remaining value on any gift card, which is something daily deal providers often prohibit. California requires that remaining value below $10 be returned to the consumer in cash.

Groupon puts expiration dates on its deals, online and in print. Groupon also sends out reminders when a Groupon is about to expire. In the fine print, it states that any expiration is subject to provisions of state law.

In the states Edelman and Kominers looked at, it is largely unlawful to “sell” gift certificates with the prohibited expiration dates. In that case, voucher services could also be liable years later.

In the U.S. and Canada, merchants benefit from Groupons that go unused. Elsewhere, Groupon benefits. Daily deal companies sell breakage on unredeemed vouchers as a benefit to merchants. (In fact, it may be the only way a deal becomes profitable.) But the merchant may be on the hook for redeeming the voucher long after the stated expiration date. Having to cash out residual value also makes the economics worse for the merchant. Because some merchants use daily deals as an introductory offer to build a book of business, they may not be inclined to offer the deals if the obligations extend for years.

Daily deal providers will generally refund the value of “expired” vouchers, even if the merchant won’t. If consumers become more aware of their rights regarding gift card expiration, this could hurt the deal providers’ bottom line.

Merchant bankruptcy

Running a small business is tough. Many of them fail. It’s important to know what happens when they do.

Groupon’s terms of service can be interpreted as the merchant is responsible for the delivery. The Groupon Promise is pretty wide open and seems to say that Groupon will cover such losses. Google Offers explicitly says in its terms of service that Google is not responsible if a merchant goes under.

I’ve been asking TechCrunch readers to share their experiences with closed businesses. (Send them to dailydeals@agrawals.org) There have been enough cases that this is clearly an important issue.

From what I’ve heard, Groupon and Living Social have refunded money when a business goes under. In some cases, they have been proactive and sent emails telling people that a business has closed.

That’s great for consumers. But it should be a concern for investors because of the risks inherent in small businesses.

Sales tax

What’s the correct sales tax on a $51 purchase with a $50 Groupon that someone bought for $25 in a state with a 5% tax rate? The possible answers are 5 cents, 68 cents, $1.30 and $2.55. That’s based on a taxable value of $1 (amount paid at point of sale), $13.50 (amount merchant actually gets), $26 (total amount consumer paid) and $51 (total face value of the transaction). I find that most businesses pick either extreme.

“It’s like Goldilocks and the three bears,” Edelman said. “It has to be just right.” Charge too little and states are deprived of much needed tax revenue. Charge too much and the consumer loses. Both are unlawful, Edelman said.

Edelman and Kominers reviewed state laws in several states, and found that many call for tax only on the amount the consumer actually paid. Edelman also wrote to the Department of Revenue of Massachusetts, which confirmed that “an online discount voucher is “the equivalent of a cash discount by the restaurant” since the restaurant itself funds the totality of the discount.

If tax isn’t collected correctly from the consumer, it can also affect the profitability of the deal for the merchant and they could end up paying taxes on money they never saw.

If you have a receipt from a deals transaction, please scan and send it to dailydeals@agrawals.org. If the state is not already printed on it, please write it.

Alcohol

27 states restrict discounting on alcohol and the rules vary by state. In Illinois, where Groupon is headquartered, merchants can’t discount alcohol to some patrons over others. Yet Edelman and Kominers found 87 Groupon vouchers in Chicago that mention “beer” in their descriptions and 252 that mention wine.

TechCrunch readers may think these are silly laws that shouldn’t be enforced (I would tend to agree), but this significantly affects the economics of the deal. It’s often hard to find discounts on alcohol; I was surprised to learn that I could use Groupons for drinks. I would buy them for bars where I normally wouldn’t eat. Enforcement of these rules would lead to lower sales. It would also create greater complexity for restaurants and bars in accepting vouchers. (But they would benefit from full price sales of alcohol.)

Summary

These are a few of the regulations and laws that the deal providers ignore. Edelman and Kominers track a few others such as escheat and accountability.

The deal providers have pushed the complexity of these laws onto the merchants and consumers. Groupons come with generic disclaimers in 5-point type. (Edelman checked.)

“Groupon asks individual merchants to figure out these questions for themselves,” Edelman said. He thinks that’s a bad approach: “By asking merchants to do the work, Groupon effectively guarantees that the work won’t be done at all.”

The ambiguity creates a bad customer-merchant dynamic. Jessie Burke’s story reached its boiling in a dispute with a customer who was trying to use an expired Groupon. She later tried to research Oregon law, but says, “The onus of responsibility shouldn’t be entirely on this little business that doesn’t know the laws in the first place.”

Edelman agrees. He believes that the deal providers are in a much better position to track these issues and educate the merchants. The work could be done once for each state. He’s already done a lot of the work for them in his paper.

Edelman would like to see more compliance with the laws and a clearer, more consistent message to the consumer. What the Groupon Promise gives with one hand, the terms of service takes away with the other.

“From one perspective, the Groupon Promise is basically illusory,” Edelman said. “Groupon is likely to argue that it’s just a statement of their customer service plan, not their actual obligation. Meanwhile their Terms of Service are much harsher and much less generous. That kind of difference is the stuff of consumer class action lawsuits.”

The consumers I’ve heard from have generally said positive things about the customer service from Groupon. One wrote to say that Groupon gave a refund for an unsatisfactory house cleaning. But merchants grumble that daily deal providers make them out to be the bad guys.