Lily Case Highlights Compliance Obligations Under the Mail Order Sales Rule

While the FTC’s Mail Order Sales Rule pre-dates the Internet by decades, the Rule remains relevant with today’s online marketing practices, particularly for pre-orders. Companies that rely on pre-orders for a concept product need to take careful note of recent action filed by the San Francisco District Attorney against Lily Robotics, Inc. for false advertising and unfair business practices. After acquiring tens of millions of dollars’ worth of capital investment and pre-order revenue for a conceptual drone, the company repeatedly delayed release of the product in 2015 and 2016, and has since failed to produce a saleable product.

In the complaint, the District Attorney alleged that Lily’s promotional video, released in May 2015, portrayed “aspirational dramatizations” of what Lily anticipated they would be able to achieve in the future. The release of this video coincided with the announcement that consumers were able to pre-order the product. The District Attorney alleged that, Lily had not produced a product with all of the features appearing in the film, that the promotional video evidences Lily’s intentional goal to mislead potential consumers by inducing sale of pre-ordered product. Further, the shots labeled as “Lily Shot” were almost always immediately preceded by a user engaging with a Lily product, implying that the shots were taken from a Lily camera when that was not the case.

The complaint highlights that instead of pursuing a more traditional approach to raising capital through a crowdfunding site like “Kickstarter,” Lily chose to invoke a pre-order system whereby customers were required to pay for a product that was not yet available. As such, the District Attorney alleged that these pre-order transactions should be treated like “internet sales” and are therefore subject to certain consumer protection laws.

Of most relevance in this case, the FTC’s Mail Order Sales Rule governs mail, Internet and telephone orders through a series of regulations relating to the timing of fulfillment and refund obligations. The District Attorney alleged that Lily breached several requirements of the Rule. First, Lily allegedly did not have a reasonable basis for the stated shipping dates, a pre-requisite if a shipping date representation is made. Second, when it became clear that Lily was not going to be able to deliver on the stated shipping dates, Lily failed to obtain express consent from customers for the shipping delays, and then failed to cancel the existing orders and give automatic refunds to consumers. Further, the District Attorney alleged that Lily’s failure to comply with the Mail Order Rule was “willful, intentional and corrupt behavior.”

Lily has promised to refund all of the money paid in pre-orders, but if the District Attorney prevails, Lily will be liable for civil penalties amounting to $2,500 for each violation.

TAKEAWAY: When soliciting capital and pre-production orders, start-up companies should consider the differences in a “pre-order” model, as opposed to the more traditional crowdfunding approach. If a company chooses to engage in pre-orders, those sales may be affected by consumer protection laws, including the FTC’s Mail Order Rule. Further, when creating promotional materials for a product that is not yet manufactured, companies should be cautious in the way they portray purely aspirational product features.

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