Early Termination of SAAS Subscriptions

A recent ruling in Mahlum v. Adobe Systems Incorporated in the Northern District of California should be of at least mild interest to lawyers who support internet service companies that offer services on a subscription basis.

Last week District Judge Lucy Koh dismissed plaintiff Scotty Mahlum’s claim that the early termination fee payable under Adobe’s Creative Cloud subscription agreement is an amount of liquidated damages, and, as such, prohibited under California Civil Code § 1671(d). According to the Adobe agreement, upon early termination, customers are required to pay 50% of the remaining subscription fees. A liquidated damage payment is defined under California law as an amount of compensation paid in the event of a breach of contract, the sum of which is fixed and certain by agreement. (See Chodos v. W. Publ’g Co., 292 F.3d 992, 1002 (9th Cir. 2002) (quoting Kelly v. McDonald, 98 Cal. App. 121, 125 (1929)).

Upon Adobe’s 12(b)(6) motion, Judge Koh found, as a matter of law, that when paid to Adobe the early termination fee is not liquidated damages, but, rather, an alternative to performance under the subscription agreement. According to the court, “where a contract for a specified period of time permits a party to terminate the agreement before its expiration in exchange for a lump-sum monetary payment, the payment is considered merely an alternative to performance, and not a penalty. (Citing Morris, 128 Cal. App. 4th at 1314 (citing Blank, 11 Cal.3d at 970)). Such a [payment], therefore, falls outside the scope of § 1671(d) and is not prohibited.” Case dismissed.