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The apps in question are known as “bait apps” and refer to children’s games that are available for free in the iTunes Store but that also allow players to buy virtual goods as in-app purchases while playing the game — anything from coins to fish to prizes.

Normally, an Apple user has to enter a password before they can buy a virtual good. But in the case of the “bait apps,” Apple allowed a 15-minute window after the game was downloaded in which players could buy what they liked without a password.

In practice, this meant that kids were able to rack up bills from $99.99 to $338.72  on their parents’ iTunes accounts. Apple has since eliminated the 15-minute window.

Last year, a federal judge in California consolidated a series of class action suits from parents which Apple then filed to dismiss.

U.S. District Judge Edward Davila responded to Apple’s request by upholding four of the parents’ five claims, including allegations that Apple violated consumer protection laws by falsely marketing the apps as free:

Contrary to Apple’s argument, Plaintiffs have alleged with specificity which misrepresentations they were exposed to, their reliance on those misrepresentations, and the resulting harm. Plaintiffs pled specific facts that Apple “actively advertis[ed], market[ed] and promot[ed] its bait Apps as ‘free’ or nominal .

The ruling was issued last week but didn’t attract attention until Seattle tech lawyer Venkat Balasubramani wrote about it on Eric Goldman’s Law and Marketing Blog.

The judge’s refusal to dismiss the case does not mean the parents will win, but it does increase the pressure on Apple. The company is relying on contract law arguments such as whether each in-app purchase was a transaction or (as Apple argues) whether the overall iTunes terms of service should apply to all the purchases. There is also a dispute about how contract law applies to minors.

Apple is expected to file its defense on May 24.

Apple’s terms of service say iTunes users are responsible for ensuring that their accounts aren’t misused by others.

The issue of children racking up in-app purchases has been a big source of frustration for parents, including our own Kevin Tofel whose step-daughter bought the family $375 worth of digital fish. (See his tips on how to handle this here).

Digital fish seem to be a particular hazard. Comedian Jon Stewart recently interviewed a man whose kids also racked up huge credit bills in the game Tap Fish in hopes of keeping their pets alive:

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Recently Flurry Analytics did some research on how much mobile gamers spend on and within Android and iOS games, the data showing that the average in-app purchase amounts to about $14 per transaction. On Tuesday Flurry gave a deeper dive into what those in-app transactions are for. Two-thirds of the items bought within an app are virtual goods that are consumable, as in they have no lasting value.

The firm looked at 57 million transactions and found the following:

The chart shows that over two-thirds of all items purchased in iOS and Android freemium games are consumable, goods that users deplete. Measured another way, approximately half of all real dollars spent within all apps are for game items consumers don’t keep.

That means, for instance, that most of the time people are buying fertilizer in a farm game or grenades in a war game as opposed to durable goods, such as a building or armor, which you don’t use up.

But the most popular consumable item people buy really shouldn’t be any surprise. It’s “premium” currency, which is usually a way to buy your way into advancing faster in a game. Game makers like it because it prevents players from abandoning games in frustration, but it also lines their pockets. Games that offer these consumable goods make a lot of money for developers, and they are “the best ROI” for game developers, according to Flurry.

For developers looking for the best investment, look no further than free games that offer virtual goods via in-app currency, according to Flurry.

 While the consumer is indeed purchasing virtual items that are most often consumable, what’s most important to understand is the psychology behind these games. In freemium games, consumers are experiencing compelling, immersive entertainment. They feel gratified when they progress, accomplish goals, create a unique world, and in some cases, show off to their friends. In exchange for this gratification, they are willing to spend real money, and lots of it.

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The American market for virtual goods will grow 31 percent to $2.1 billion in 2011, according to a new report from Inside Network. A huge driver of recent growth has been the social games sector, which “came out of nowhere” as co-author Charles Hudson put it. He said that virtual goods sold in social games are set to already account for 40 to 50 percent of the market, or at least $840 million in 2011, and that Facebook is responsible for “pretty much all of social.”

Many social game makers such the biggies – Zynga, CrowdStar, Playfish and Playdom – are transitioning to using Facebook’s Credits payments system, from which Facebook takes a 30 percent cut of all sales. Taking that rough math further, that means the social network stands to rake in $252 million in revenue from Facebook Credits for U.S. games next year. Facebook also has a second revenue stream from games from developers buying advertising on its site.

Hudson said that even with Facebook’s newly introduced tithing policy, game developers stand to benefit. As Facebook Credits are adopted, “The lift to conversion and monetization should offset the 30 percent,” he said.

What’s interesting about that market is that fewer than 5 percent of social game players ever buy anything, however, they account for the vast majority of the revenue from these free games. Virtual goods were worth $1.6 billion in the U.S. during 2010 and $1.1 billion in 2009, according to Inside Network. Hudson said that the Asian market for virtual goods is likely two-to-three times bigger.

Besides social games, Inside Networks included in its virtual goods market estimate virtual worlds, MMOs (massively multiplayer online games), console games, and mobile games.

Please see the disclosure about Facebook in my bio.

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I quickly changed my iTunes password, and unlinked my credit card from the account to stave off additional unauthorized purchases. Immediately following that, I opened three inquiries with my credit card company — one for each transaction. As of Tuesday morning, my credit card account has been credited back for all three. By the afternoon, I realized I would have to ask the card company to add those charges back on. It turns out my step-daughter made the transactions, courtesy of three in-app purchases, which touched off fireworks in my house rivaling any you might have seen over the holiday.

Clearly I can’t blame Apple or its iTunes Store for the purchases. And I can’t blame those iOS4 app developers reportedly hacking consumer iTunes accounts either. This financial debacle is the direct result of how I have the household iTunes accounts set up, along with the kids’ understanding of in-app purchases. Not only have I learned some better ways to manage iTunes, but this experience also shed light on what kids actually think about virtual goods and currency.

The free game that generated the costly transactions looks fun and harmless. It’s an aquarium on your iPhone that requires you to take care of your fish. You feed them, clean the tank and so forth. But you only get a few fish to start. If you want more or need additional items for your tank, you purchase them by spending real money to buy virtual pearls — or with gold coins accumulated through gameplay. And here’s where my step-daughter stumbled: She figured it was a free app and that both the virtual pearls and gold coins were freely available. So $375 later, I’m now the proud owner of a few thousand virtual pearls.

I’ll admit it can be confusing to have both free coins and paid pearls in a single app for purchases, and we’ve now discussed, as a family, the difference between virtual and real goods with the kids, so this sort of situation doesn’t happen again. Perhaps the most interesting development in all of this was my actual word-for-word reading of the Apple iTunes store terms of service. For privacy reasons, I’m not divulging my step-daughter’s name or age, but an iTunes account requires you to be 13 years old. Yet some of the games that support in-app purchases are rated for ages four and up. Again, I can’t blame anyone but my step-daughter on the $375 charge, but Apple’s age rating seems a bit inconsistent, no?

Preventing a similar situation may be common sense, but let me leave you with a few of my, ahem, pearls of wisdom gleaned from this experience:

• Don’t link a bank account, PayPal account or credit card to an iTunes account your kids have access to.
• Consider using the iTunes Allowance system that places $10 to $50 in an iTunes account on a monthly recurring basis.
• Give your kids iTunes Gift Cards to spend on apps, music or add-ons for their games.
• Explain the difference between virtual goods and real currency.
• Update: Set restrictions using the iOS4 parental controls found under Settings, General — you can limit actions such as in-app purchases or buying content over a certain age rating. Thanks to Lava for pointing this out.

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