Groupon’s legal risks and hidden gift to merchants

By Felix Salmon
June 16, 2011
Benjamin Edelman and Paul Kominers have a fantastic post up about the various legal pitfalls facing Groupon and other coupon sites: there are more of them than you might think.

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Benjamin Edelman and Paul Kominers have a fantastic post up about the various legal pitfalls facing Groupon and other coupon sites: there are more of them than you might think. In many states, for instance, it’s illegal to offer discounts on alcohol, yet Groupon merchants do so anyway. In others, coupons need to have a 5-year expiration, rather than the much shorter ones found on most Groupons; it’s not enough just to offer the consumer’s money back for that long. Elsewhere, people redeeming coupons for less than the face value are required to get the difference back in cash. And it’s also quite common for merchants to need to hand over to the state any money they got from expired coupons.

And then there’s the question of sales tax. Let’s say I spend $20 for a $40-face-value Groupon at a restaurant. I rack up a $60 bill, before tax and tip, and the check arrives, charging me $65.32 after adding 8.875% sales tax. I hand over a Groupon and a credit card, and my card gets charged the difference, of $25.32; I then add a tip on the $60 amount. So far so normal.

But in fact, once I hand over the Groupon, the sales tax should be recalculated — this according to unanimous advice from various state authorities. Rather than charging tax on $60, the tax should be calculated only on the post-coupon amount of $20, and the check total should be $21.77.

This is in fact the amount of tax the restaurant pays — when doing its taxes, the restaurant adds up its cash receipts and calculates the total tax due. It doesn’t include coupons. So the extra tax — in this case $3.55, or 8.875% of $40 — is essentially a hidden gift which goes directly to the restaurant. (But not to the server! So don’t use this as an excuse to tip less!)

(Update: This gets complicated, I think I got this wrong. The restaurant should actually charge sales tax on the post-coupon amount plus the amount that the customer paid for the coupon. So in this case that would be $20 plus $20 makes $40. The restaurant is still charging too much sales tax, but only $1.77, or 8.875% of $20.)

Those sales-tax amounts quickly add up:

We value the principles of consumer protection law, and we hesitate to discard rights consumers have fought for years to obtain. Furthermore, the amounts at issue are substantial: Groupon’s S-1 anticipates selling $2 billion of vouchers in 2011. An extra 7% tax on that amount would be $140 million taken from consumers, and 15% nonredemption would cost a further $300 million.

The big picture here is that Groupon and other coupon sites are being unreasonably aggressive in trying to slough off legal responsibility for these issues onto their merchants. This bit is worth quoting at length:

Voucher services typically seek to cast themselves as mere marketing vendors that are not responsible for the conduct of the corresponding merchants. For example, Groupon’s Terms of Sale claim that “The Merchant, not Groupon, is the seller of the Voucher and the goods and services and is solely responsible for redeeming any Voucher you purchase.” On this view, a voucher service avoids liability for merchants’ shortfalls.

But a voucher service is the merchant of record for the charge to the customer’s credit card. As the entity officially responsible for charging the consumer, the voucher service thus faces increased responsibility to see that the consumer receives what was promised. Furthermore, the voucher service, not the merchant, writes the promotional text touting the merchant’s offering. As Rakesh Agrawal points out, Groupon’s financial disclosures even count the entirety of the consumer’s purchase price as revenue to Groupon. In this context, a consumer naturally looks to a voucher service for assistance if a merchant fails to perform. We think it is probably an unfair and deceptive practice, under the FTC Act and state equivalents, for voucher vendors to attempt to disclaim liability in such circumstances.

More generally, we are struck by Groupon’s attempts to push all responsibility to merchants. On every relevant question — discounting alcohol, honoring expiration dates, providing cashback — Groupon’s historic contract and current Merchant Terms of Service claim merchants are responsible. In our view, this approach invites confusion and non-compliance. Voucher services are far better positioned than merchants to determine what the legal system requires: Voucher services can research regulations centrally, once for each state in which they operate, then notify affiliated merchants of applicable requirements. In contrast, Groupon’s current approach asks each individual merchant to conduct its own research. If merchants actually conducted such research, it would be duplicative and potentially wasteful — thousands of small businesses re-researching the same questions. But in fact merchants typically ignore the questions, rationally concluding that these questions are too difficult for them to address on their own. Thus, by pushing merchants do to the work individually, voucher services virtually assure that the work is not done at all.

Importantly, the legal and regulatory questions flagged in this article are questions that arise distinctively in the context of discount vouchers: a merchant would never confront such questions were it not for discount vouchers. Having created the transactions giving rise to this regulatory complexity, we think discount voucher services should be expected to achieve compliance.

Andrew Mason, Groupon’s CEO, is the smiling face of customer service which exceeds expectations and keeps everybody — customers and merchants alike — happy. So it’s worrying to me that he’s set up his company in such a manner as to make it seem that these important legal issues are not his problem. Groupon is swimming in money these days: it should spend some of its millions on some decent lawyers and set a high standard in such areas for copycat sites to match. Otherwise its much-vaunted customer service looks as though it’s entirely cosmetic, and serves to disguise the fact that Groupon is helping merchants flout consumer-protection laws across the country.

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