In May 2011, Michaels Stores reported that “skimmers” using modified PIN pad devices in eighty Michaels stores across twenty states had gained unauthorized access to customers’ debit and credit card information. Not a pretty picture for Michaels. Lawsuits soon splattered on the specialty arts and crafts retailer, alleging a gallery of claims under the Stored Communications Act (“SCA”), the Illinois Consumer Fraud and Deceptive Business Practices Act (“ICFA”), and for negligence, negligence per se, and breach of implied contract.

Late last month, U.S. District Court Judge Charles Kocoras ruled on Michaels’s motion to dismiss. Some claims were dismissed, but others survived. The opinion presents a broad-brush survey of potential data security breach claims, with some fine detail and local color particular to this variety of criminal data security breach.

PIN pads aren’t a communications service under the SCA.

In dispensing with those claims that plaintiffs “artfully tailor[ed]” to the language of the SCA, the court ruled that Michaels’ provision of PIN pads enabling consumers to pay by credit or debit card did not amount to the provision of “electronic communications services” or “remote computing services” as contemplated by the SCA. According to the court, the plaintiffs failed to allege either that Michaels provided the underlying service that transported consumer credit and debit card data or that Michaels provided any off-site computer storage or processing services. Thus, the plaintiffs’ SCA claims failed.

Michaels didn’t deceive, but it may have been unfair.

The court next considered the plaintiffs’ claims under Illinois consumer law. The plaintiffs alleged that Michaels committed both a deceptive and an unfair trade practice by failing to take proper measures to secure access to PIN pad data.

The court rejected the plaintiffs’ deception theory because the plaintiffs failed to identify any communication by Michaels that contained a deceptive misrepresentation or omission. But the court went the other way on plaintiffs’ unfair trade practice claim, in part because Michaels is alleged to have failed to implement PCI PIN Security Requirements that might have thwarted the skimmers.

Relying principally on the First Circuit’s decision in In re TJX Cos. Retail Sec. Breach Litig., 564 F.3d 489 (1st Cir. 2009), but noting the potential relevance of the many decisions relating to Section 5(a) of the Federal Trade Commission Act, Judge Kocoras held that the plaintiffs’ assertion that Michaels’ failed to (a) implement industry standard data security safeguards and (b) promptly notify consumers of the resultant security breach sufficiently alleged a violation of the ICFA. (Without much analysis, the court allowed the latter to form the basis for an ICFA claim because “a disputed issue of fact exists” concerning both when Michaels first learned of the breach and whether Michaels permissibly notified individuals through substitute notice under the Illinois Personal Information Protection Act.) Specifically, the court explained that

Plaintiffs allege that the PCI PIN Security Requirements and the industry’s best practices obligated Michaels to implement procedures and practices to ensure that a legitimate device had not been substituted with a counterfeit device. Since Plaintiffs allege that the skimmers did, in fact, substitute legitimate devices with counterfeit devices, Plaintiffs’ allegations show that Michaels ignored its obligation to implement procedures and practices preventing the criminal conduct. Plaintiffs thus sufficiently allege that Michaels engaged in an unfair practice under the ICFA.

Although the court found that an unfair practice was sufficiently alleged, because ICFA claims require a showing of actual damages, the court went on to consider whether the harm plaintiffs claimed to have suffered (i.e., increased risk of identity theft, costs of credit monitoring and unauthorized charges on their accounts) supported their ICFA claims. Like other courts that have rejected similar claims, the court held that “Plaintiffs cannot rely on the increased risk of identity theft or the [voluntarily incurred] costs of credit monitoring to satisfy the ICFA’s injury requirement.” But the court nevertheless found that plaintiffs had adequately alleged a cognizable injury under the ICFA because they claimed that they lost money from unauthorized withdrawals and/or bank fees.

The economic loss rule bars the plaintiffs’ negligence claims.

As for the negligence and negligence per se claims, Michaels argued that these claims failed because the intervening acts of criminals severed the causal link between the retailer’s conduct and the plaintiffs’ injuries and because the economic loss rule barred the recovery of purely economic losses under a tort theory of negligence.

The court disagreed with Michaels as to the former theory because, in its view, Michaels’ failure to implement security measures that were specifically designed to minimize the risk to customer financial information created “a condition conducive to a foreseeable intervening criminal act.” As such, the skimmers’ reasonably foreseeable criminal actions did not sever the causal chain. Nevertheless, after considerable analysis, the court dismissed the plaintiffs’ negligence and negligence per se claims because the plaintiffs failed to show why the economic loss rule should not apply to bar these claims.

Michaels may have breached an implied contract to protect customers from a security breach.

Lastly, relying on the First Circuit’s “persuasive” reasoning in Anderson v. Hannaford Bros., 2011 WL 5007175 (1st Cir. Oct. 20, 2011), see our Anderson blog post, the court concluded that the plaintiffs’ allegations “demonstrate the existence of an implicit contractual relationship between Plaintiffs and Michaels, which obligated Michaels to take reasonable measures to protect Plaintiffs’ financial information and notify Plaintiffs of a security breach within a reasonable amount of time.” Notably, the notification obligation the court cites is nowhere to be found in the Anderson decision. But this is perhaps unsurprising since the obligation to notify individuals of a data breach is now a creature of statute in almost every U.S. state presumably because it is not an implied term of a relationship involving the exchange of information.

What does it all mean?

There’s a lot to digest here. The ultimate disposition of the case is not yet clear given the early stage of the proceedings. What is clear is that you don’t need to get creative to keep an identity exposure case afloat beyond the motion to dismiss stage – you just need some damages. This won’t surprise anyone who has been following this issue.

The plaintiffs’ allegations that they lost money through unauthorized charges got them over a hurdle that other data security breach plaintiffs have stumbled on. Indeed, they forced the court to confront some of the thorny issues that prior breach cases avoided due to the lack of any cognizable harm. The courts approach suggests, as the FTC has suggested many times in its Section 5(a) cases, that if you’re not implementing reasonable information security measures – including those mandated by applicable industry standards – you may be painting yourself into a corner where you’ll become the target of a government investigation or even a private lawsuit.

Think skimming can’t happen to you? In November, Lucky Supermarkets announced that hackers used devices called “sniffers” to record credit card numbers belonging to customers and employees who used the self-checkout kiosks in 20 stores in California.

If you’re not ready to thwart skimmers, then perhaps you should be ready for a lawsuit.