Memphis, we have a problem

It began benignly enough, at least as legal matters go.

In February 2011, an immigration law firm in Alpharetta, Ga., filed a breach-of-contract suit against FedEx Corp. and its corporate support division, FedEx Services, alleging they misclassified commercial shipments as residential deliveries to extract higher surcharges from the firm, a FedEx shipper.

Nearly two years later, the case has broadened into a civil complaint filed under the federal Racketeer Influenced and Corrupt Organizations Act, more commonly known as RICO. In an amended complaint filed Dec. 12, 2012, in federal district court in Memphis, Tenn., attorneys representing the Atlanta firm and a law practice in Oakland, Calif., said Memphis-based FedEx defrauded customers over a number of years by intentionally mis-rating tens of millions of transactions as residential deliveries so it could collect millions of dollars in illicit overcharges.

According to the allegations, senior executives at FedEx and its Services unit did not stop the mis-rating practice despite receiving repeated internal warnings that it had become a systemic problem.

A sales executive at FedEx Services wrote in an August 2011 e-mail obtained by plaintiffs' attorneys that "we are choosing not to fix this issue because it is worth so much money to FedEx." The executive said he believed the company had "methodology available to us to verify commercial addresses and [to] not charge our customers for services that we do not perform."

The 170-page complaint also alleges that FedEx employees were encouraged to participate in the scheme through financial incentives. In one case cited in the complaint, FedEx levied about $142,000 in residential delivery surcharges to one customer for deliveries to nonresidential addresses. A FedEx Services employee then negotiated a $50,000 refund with the customer—which was not identified in a copy of the filing given to DC VELOCITY. The outcome allowed FedEx to keep more than $92,000 of the overcharges, according to the complaint.

For the work, the employee received an unspecified cash bonus and the company's "Bravo Zulu" award, a name taken from the Naval signal conveyed by flag-hoist or voice radio meaning "well done," according to the complaint.

Steven J. Rosenwasser, an Atlanta attorney representing the two plaintiffs, said FedEx employed various tactics to implement the overcharge scheme. For example, prior to 2012 the company had a policy of assessing the higher residential delivery charge on a shipment marked "residential," even if the driver making the delivery concluded that it went to a nonresidential address, according to Rosenwasser. However, if a customer indicated that a delivery location was not residential and the delivery still went to a residence, the customer's initial designation would be overridden and the residential delivery surcharge would be imposed, he said.

"FedEx followed its courier's designations only when it resulted in the imposition of a residential delivery charge but not when it would cause the removal of an improper overcharge," Rosenwasser said.

Because FedEx is not required to produce documents that existed before August 2008, it is impossible to know for certain how far back the alleged practice stretched, Rosenwasser said. Yet in one of the August 2011 e-mails, the FedEx Services sales executive said the issue had been "brought to the attention of many people over the past five or six years," a suggestion that it was going on before 2008.

Rosenwasser said he doesn't know if the alleged practice is still going on. Attorneys may get more clarity during the on-going "discovery" process, he added.

FedEx declined requests for an interview and had no comment other than an e-mailed statement from Sally Davenport, a company spokesperson. "We value our relationships with our customers, and these relationships are at the core of all we do," said Davenport.

Davenport added that the documents that were made part of the record in mid-December "do not tell the entire story of this case," and that the company "will continue to defend these allegations in a court of law and not the media." Customers with billing complaints can seek refunds through FedEx, she said.

For FedEx, the case is an unwelcome distraction as it works on an extensive revamp of its flagship FedEx Express air and international division, an initiative expected to reap $1.65 billion in annual savings over the next two to three years.

A parcel industry source said FedEx is likely to settle the case out-of-court rather than deal with the continued fallout from the release of additional potentially damaging documents. Rosenwasser declined comment on whether there have been discussions to that effect.

The attorney said a motion would be filed in the spring seeking class action status for a multitude of shippers allegedly harmed by the actions. He surmised the case impacts shippers of all stripes shipping from commercial and industrial origins.

If a civil action under RICO is successful, a plaintiff can collect so-called "treble damages," defined as damages tripling the amount of actual or compensatory damages.

Rosenwasser said plaintiffs' attorneys amended the complaint after becoming convinced that the misclassifications were not accidents that had been overlooked, but were a deliberate pattern of behavior that the company made no effort to halt.

THE SURCHARGE PHENOMENON
The dispute revolves around a band of surcharges imposed by FedEx on residential and commercial deliveries. The surcharge tab escalates as the deliveries are deemed to be more difficult and costly for the company to make. The surcharges on hard-to-reach residential locations can be as much as $1 more per shipment than the comparable commercial surcharge.

The delivery surcharges are just one of dozens of so-called accessorial fees that carriers tack on to the base rate to compensate them for a range of services beyond the pickup and delivery. The most well-known accessorial fee is a "fuel surcharge" levied to offset rising jet and diesel fuel costs.

Over the years, "accessorials" have become a larger part of a shipper's overall bill. Many chafe at the rising number of accessorials and their increased cost but continue to pay them. For example, in 2013 FedEx will bill shippers a basic $3.20 per-shipment surcharge for each residential delivery shipped by air and $2.80 for a residential shipment laded for ground delivery, according to Shipware LLC, a San Diego-based parcel consultancy. In 2012, those surcharges were $3 and $2.55, respectively, for air and ground services, according to Shipware.

Misclassifying delivery surcharges has a ripple effect on shippers because it also triggers the prevailing fuel surcharge on a more expensive delivery fee, parcel consultants said.

Carriers contend that surcharges cover a variety of value-added services that must be paid for and that many of these functions are performed to correct avoidable mistakes made by shippers. Parcel consultants note that FedEx and archrival UPS Inc. discount those fees for high-volume customers.

Parcel consultants—many of whom are former carrier executives and make a good living advising shippers on how to deal with rate, service, and accessorial issues—say the carriers admit that they make mistakes, that real-time information is available for shippers to audit, and that refunds will be made for legitimate overcharges. Shippers can get refunds if they bring solid evidence and push hard enough, according to the consultants. However, many lack the time or expertise to pursue them, they say.

"Few shippers do the investigations and questioning," said Jerry Hempstead, a former top parcel sales executive and now head of an Orlando-based consultancy bearing his name.

AN ART FORM
The application of surcharges is mostly an art form. As a general rule, the shipper is responsible for determining if a delivery is bound for a residential or commercial address. However, many shippers enter incorrect information, or are confused as to whether a destination is residential or commercial. Parcel consultants say many high-volume shippers tender everything as a commercial delivery knowing some shipments will ultimately be re-rated to a residential classification.

The driver makes deliveries based on the addresses shown on the package labels. If the delivery is to a residence, the driver checks a box marked "residential" on a handheld device. That action effectively overrides any commercial designation made at the time of manifesting and triggers a re-rate to a residential classification.

By checking the "residential" box on their devices, drivers are allowed to leave the package without a signature unless one was already required. Shipments delivered to a commercial address require a signature. FedEx and UPS often leave the ultimate application of delivery surcharges to the driver's discretion.

Both parcel giants receive customer complaints about overcharges relating to delivery misclassifications. However, a long-time parcel executive said there are fewer complaints directed at UPS because it is more proactive in adjusting the rate from residential to commercial when the situation warrants. UPS will reverse the charges on about eight out of 10 complaints, according to the executive. At FedEx, the ratio is one or two reversals for every 10 complaints, the executive said.

Hempstead of Hempstead Consulting believes that FedEx prizes its hard-won reputation for quality and integrity too highly to let this issue go unaddressed. "In the end, I believe this suit will result in a more accurate billing process," Hempstead said.

He added that FedEx will "get focused, put a Six Sigma team together, do root-cause analysis, and they will quickly put this issue behind them."

For those inside FedEx who sensed the coming storm well before it hit, the issue can't be in the rearview mirror soon enough. In one of the August 2011 e-mails, the FedEx Services sales executive complained that he repeatedly raised the issue as high up as the managing director level but received little or no response.

The clearly frustrated executive also made a comment that today seems eerily portentous: "My prediction is this practice is going to come back to haunt us in a very expensive way."