New Jersey Attorney General Peter Harvey Friday said he has filed a lawsuit accusing Blockbuster Inc. (BBI), the largest U.S. video renter, of deceiving customers with its new "No More Late Fees" rental policy.

"Blockbuster boldly announced its 'No More Late Fees' policy, but has not told customers about the big fees they are charged if they keep videos or games for more than a week after they are due," Harvey said in a statement.

Officials in several other states, including Blockbuster's home state of Texas, were also keeping a close eye on developments surrounding Blockbuster's new movie rental policy, people familiar with the matter said.

A spokeswoman for New York Attorney General Eliot Spitzer (search) declined to comment.

In a statement outlining the complaint filed in Superior Court in Mercer County, Harvey accused Blockbuster of failing to disclose key terms of the policy and said some stores did not follow the policy but continued to charge late fees.

"Blockbuster's ads are fraudulent and deceptive," he added.

Blockbuster spokeswoman Karen Raskopf said the company was surprised that Harvey's office "never directly contacted us about this" before filing the suit. She said Blockbuster stood by its new policy and has done everything to explain to customers how it works.

"We are disappointed he took this action because we believe the end of late fees program is a terrific program, and we've received tremendous feedback from our customers and employees," Raskopf said.

Blockbuster — currently locked in a bitter takeover battle for No. 2 U.S. movie renter Hollywood Entertainment Corp. (HLYW) — unveiled the policy in December in an attempt to reinvigorate its business as competition escalates.

Blockbuster at the time had said that under the new plan customers would have a one-week grace period after a rental's due date. If a movie or game were not returned during that week, the customer would be charged for the purchase of the item. If the item was returned within 30 days, the customer would be able to receive an account credit but would be charged a restocking fee of $1.25.

Harvey said in some instances the restocking fee can be as high as $4.50. He said the state is seeking restitution for Blockbuster customers whose overdue rentals were converted to sales, were charged restocking fees or charged late fees by a nonparticipating store.

The state also seeks civil penalties of up to $10,000 for each violation of New Jersey's Consumer Fraud Act.

Tom Dougherty, managing director and senior strategist at brand development firm Stealing Share, Inc., said fallout from the new rental policy could tarnish Blockbuster's brand in the eyes of its customers if the company were to be found culpable.

Blockbuster, based in Dallas, has been facing increasing competition from discount retailer Wal-Mart Stores Inc (WMT) and online companies like Netflix Inc. (NFLX). Blockbuster in October had cut its fee for online DVD rentals, in response to a similar move by Netflix.

Its shares rose 8 cents at $9.16 on the New York Stock Exchange (search).