Virtually all online industry is financed by credit cards. No credit cards, no industry - it's that simple. Have a pay site? You live or die by your merchant account. Have a free site? Your banners go to pay sites and/or AVS sites that similarly live and die by their merchant accounts. None of this is news.
If you have or are contemplating having a merchant account and are not familiar with the concepts of chargeback reserves and terminated merchant files (TMF), this series of articles will be a much better forum for becoming familiar with them than the dizzying experience of one day finding out that your merchant-processing privileges have been discontinued, the next day finding out that your processor has sucked all the money out of your bank account, and the day after that finding that you have been TMF'd and are unable to obtain merchant processing privileges anywhere else. As this topic is of such importance to this industry, it is worth starting from scratch and going off on several tangents.
Like every other topic, and particularly legal topics, a little history is necessary to put things in perspective. After all, stories about the home run races between Mark McGwire and Sammy Sosa make no sense to someone oblivious to Babe Ruth and Roger Maris. So, rewind a couple of hundred years.
Consumer credit was unheard of until we became an urbanized country, causing people the need to purchase housing, rather than simply building another house on the family farm. Of necessity, the mortgage was born, facilitating the concentration of a number of people sufficient to staff a factory. The factory, in turn, allowed its workers a regular stream of income sufficient to pay off mortgages. But everything else was cash. Home mortgages represented the very first phase of what would be a consumer credit revolution.
From there, the growth of technological apparatuses for the consumer market arose - items which were so costly that they could not be widely distributed without some kind of credit mechanism, yet sufficiently durable that the product itself was respectable collateral. Perhaps the first such product was the sewing machine, said to have been invented by one Isaac Merritt Singer around 1850. In 1856, Singer's Edward Clark originated the "hire-purchase plan," which Singer (the corporation, not the man) now claims was "the prototype for all installment selling or time payment purchases." Singer's then-unique credit plan was the beginning of a profound cultural revolution. Remember, in those days borrowing money was considered nearly sinful.
Singer's insightful 19th Century launch of the second phase of the consumer credit revolution is ironic in light of the fact that, on September 13, 1999, The Singer Company filed voluntary petitions to reorganize under Chapter 11 of the United States Bankruptcy Code, in which bankruptcy it is still mired.
As popular attitudes changed such that borrowing money no longer was considered, in most circles, quite so immoral, purchase of durable goods on credit became more popular, and developed into the concept of revolving credit. Consumers began doing what businesses had long been doing, sort of a "net 30" concept, which fit neatly into the steady stream of income which was becoming more prevalent in an increasing industrialized society: revolving credit. On a small scale, the general store would allow its customers to "run up a tab," so to speak, and pay at the end of each month.
The third phase of the consumer credit revolution began in the 1920s, when the idea of revolving credit was not lost on larger companies with many outlets, such as gasoline stations and hotels. And brand loyalty could be reinforced if those customers could be provided an easy method to run up revolving credit. So the companies, starting with gasoline-station chains and hotel chains, began issuing to their premiere customers little identification cards that would facilitate the use of the customers' revolving-credit accounts. The credit card was thereby invented. This was marketing wizardry! Frequent travelers, for example, might have a card for a particular hotel chain. Using it would reduce the amount of cash he (women didn't travel alone then) needed for a trip. (Remember, no ATMs and no branch banks back then; all hotels had safes and the guests all used them).
After World War II, revolving-credit charge cards flourished, catching on with chains of department stores, clothing stores and others, fueled by the rapidly growing radio and television advertising industries and the first booming consumer economy in over 15 years. GIs were returning in droves; the Baby Boom was on, and everyone needed automobiles (and gasoline to put into them), furniture, refrigerators, washing machines and more. And after a depression and a war, consumers were not about to wait much longer to begin living normally again. So, when places like department stores got into the act, revolving credit began to be viewed differently. It not only had become a necessity to compete in the marketplace, it became a money-maker to the point that, for example, some department-store chains eventually found themselves as much or more in the credit business than in the hard-goods business. And they found themselves in a position to charge higher prices because they accepted credit cards while other sources for the same products did not.
From a legal standpoint, however, the consumer-credit and credit card revolutions to this point were very simple. The consumer was simply purchasing something from a company on credit, whether it was a sewing machine, an automobile, a tank of gas, a night in a hotel, or a suit of clothes. It was simply a financing agreement between a company and an individual.
Like any flourishing consumer activity, big companies invariably got the upper hand on consumers with respect to this flourishing consumer credit; consumers complained about being helpless to negotiate with them, government heard the complaints, and government responded. Accordingly, it was not long before federal and state governments started regulating consumer credit. And the regulations have increased significantly over the years.
World War II shrank the United States dramatically. The Northeast quadrant of the country (i.e., bordered by the Atlantic Ocean, Canada and, roughly, the Mississippi and Ohio Rivers) had become crisscrossed with railroad tracks, facilitating efficient passenger rail service. And air travel was born: DC-3s were converted from military to civilian use, and the technology from the B-29s that bombed Japan quickly begat the DC-6, which could hold a lot of people; the DC-7, which could go coast-to-coast nonstop; the Constellation, which could go fast (at least for a propeller aircraft); and later, the DC-8 and 707 jets, which could go really fast. And these trains and airplanes were all loaded up with businessmen (business women wouldn't come about in significant numbers for another decade or two) who all needed to stay in hotels and eat in restaurants.
Necessity is the mother of invention. In 1950, Diners' Club produced that invention: a charge card that was good at many establishments, not just one company. This was a jarring commercial revolution. Diners' Club was a finance company. It didn't sell anything, but it wasn't a bank, either.
A creditworthy consumer, which often was a corporation, would be charged an annual fee in exchange for a card. Cooperating merchants - then primarily hotels and restaurants - would hang a little Diners' Club sign outside of the front door, or wherever, proclaiming that these little plastic cards were welcome; no cash needed! As the waiter brought the after-dinner coffee and the check, the customer would produce his (or his company's) Diners' Club card. The waiter, in turn, would crunch the credit card on that little machine, write in the amount, present the card to the customer who - only after, hoped the waiter, adding a tip - would sign the carbon-paper set and take the "customer copy" with him. At the end of the day, the merchant would separate the carbon-paper sets, mailing in the pile labeled "original" and keeping the pile labeled "merchant copy." Soon thereafter, a check would arrive in the mail from Diners' Club representing the total, less Diners' Club's cut. Each month, the customers would all receive their Diners' Club statements, which were due and payable in entirety upon receipt.
Some places still operate this way - carbon paper and mail - but remember that this was 1950. Computers had vacuum tubes; it would be nearly 20 years before ArpaNet (which would later become the Internet) was started; 30 years before modems reached just 300 baud; and Air Mail cost extra then.
While all of this seems so pedestrian and archaic now, it was in fact revolutionary. Diners' Club, the first major "Travel and Entertainment Card," was mirrored in 1958 by American Express, which ultimately won the T&E Card Derby by eight lengths and going away. (Technically, Diners' Club was not the first third-party card; it was preceded by a few years by the Air Travel Card, which was issued to companies to facilitate purchase of airline tickets.) Still, as America entered the 1960s, use of credit cards was for the most part limited to business travel and purchases from department stores. Cash was still king, but writing checks was becoming more commonplace.
Another component of the Diners' Club Revolution was that the card issuer became a near-deity. By the mid-1960s if your restaurant in Downtown Philadelphia, Chicago or Detroit could not accept the T&E cards, survival was problematic. Moreover, cardholders represented an excellent marketing opportunity - the dream market segment, consisting of nothing but business travelers who were coming to town to spend other people's money. No merchant that marketed to business travelers wanted to get on the wrong end of a dispute with either of the T&E Card outfits.
All of that set the stage for the real credit card revolution. In 1959, Bank of America issued its first California BankAmericard. This was as revolutionary as the invention of the printing press, the cotton gin, interchangeable parts, the assembly line, the automobile, penicillin, jet airplanes, birth control pills or space flight. Yet it was nothing more than a combination of the Diners' Club concept of the third-party credit-card company and the department store industry's revolving credit system.
BankAmericard - which later became VISA (in fact, VISA still owns the BankAmericard trademark) was a revolution. It was an instant consumer loan; it was a mechanism to avoid carrying cash; it was the beginning of truly spiraling consumer credit as we now know it.
BankAmericard did not spread outside of California until 1966. But when it did, it grew like a fire on a Christmas tree. Around the same time, competitor Master Charge surfaced. There were also others around, such as Barclay's, which were comparatively short-lived. BankAmericard became VISA and Master Charge became MasterCard. The bank credit cards in the 1960s were as much a revolution as long hair, rock and roll music and the Civil Rights Act of 1964. It triggered a dramatic change in our society's habits.
Use of credit cards became increasingly prevalent. A substantial catalyst to the credit-card explosion was introduced in 1970 when Congress enacted 15 U.S.C. �1643(a)(1)(B), limiting the cardholder's liability for unauthorized use of his or her card to $50. The law goes on to say that the cardholder is not responsible for any charges once he or she gives notice of the missing card. And even if the consumer hasn't given notice, the $50 cannot be charged unless the card issuer has jumped through all kinds of hoops. As a practical matter, banks usually waive the $50 anyway; it is worth it to keep happy customers. The obvious significance of this 1970 legislation was to allow the masses to carry credit cards without fearing financial disaster if they were lost.
The credit card industry, and particularly the bank card industry, continued to thrive. Merchants could not compete unless they accepted credit cards, especially bank cards. Department stores, which were reluctant to accept bank cards because their own cards were so profitable, finally succumbed to the market forces and began accepting them. Sears, the behemoth of the department store industry, adroitly struck back with the Discover Card - if you can't beat 'em, join 'em.
Meanwhile, banks began retreating from the business of directly issuing VISA and MasterCard merchant accounts in favor of what are known as "independent sales organizations," or ISOs. These ISOs include the multitude of companies that constantly bombard most of you with spam telling you how favorable their rates are.
VISA is now the Coca-Cola of the credit card industry. And it rules its near monopoly with an iron fist. Visa U.S.A., Inc. is controlled by a dozen or so huge banks, and is affiliated with hundreds of associate banks. Visa U.S.A., Inc. has regulations - a two-volume set consisting of hundreds upon hundreds of pages; the Table of Contents itself is a couple of dozen pages long. Every VISA transaction, every VISA merchant account agreement, every VISA statement and everything else about VISA cards is governed by this two-volume tome. The Visa U.S.A., Inc. Operating Regulations undoubtedly is among the most important documents in commerce today, perhaps the most important document in e-commerce. Want a copy? Not!
"To order [The Visa U.S.A., Inc. Operating Regulations book]," the The Visa U.S.A. Member publications Subscription Order Form explains, "your organization must be a Principal-type or Associate-type Member of Visa U.S.A. All other organizations must submit their requests through their Visa sponsor" - there is a line item on the order form for your "Business ID" to prove as much. And the third line-item regulation (of hundreds upon hundreds) is "confidentiality." It violates the The Visa U.S.A., Inc.
Operating Regulations to disclose the contents of the confidentiality provision. The bottom line is an imponderable paradox: The agreement you signed when you applied for your VISA merchant account requires compliance with all of the VISA regulations - but you are not provided a copy, nor can you even obtain a copy, of the confidential regulations.
That summarizes the Yellow Brick Road that brought us all to the Land of Credit Card Oz. So should you just don your green glasses and pay no attention to the Visa U.S.A., Inc. Operating Regulations behind the curtain? Tips on how to avoid that pitfall will be found in Part II.
(Clyde DeWitt is a partner in the Los Angeles, California law firm of Weston, Garrou & DeWitt. He can be reached through AVN Online's offices, at his office at 12121 Wilshire Boulevard, Suite 900 Los Angeles, CA 90025 or over the Internet at "[email protected]". Readers are considered a valuable source of court decisions, legal gossip and information from around the country, all of which is received with interest. Books, pro and con, are encouraged to be submitted for review, but they will not be returned. This column does not constitute legal advice but, rather, serves to inform readers of legal news, developments in cases and editorial comment about legal developments and trends. Readers who believe anything reported in this column might impact them should contact their personal attorneys.)
