You make your regular morning dial-up to the bank, expecting to find a fat bank account as a result of that clever, new banner-ad campaign that you just put into place yesterday. Instead, you find a big shock. Not only do you find that the balance has not increased as you expected; you find that your account has been cleaned out. And then you find out you can't obtain merchant processing anywhere else. What happened?
What happened is what has generated more turmoil in this industry than almost anything since it was born: Too many chargebacks garnering termination of your merchant privileges. And, as everyone already is painfully aware, this gets you on the terminated merchant file ("TMF"), so you will be unable to obtain bank card processing anywhere else. How can this be?
As has been oft-noted in this publication and elsewhere, the bank card processing system is stacked heavily in favor of the cardholder - $50 maximum loss exposure; cards issued to minors; cards issued to people with doubtful credit; the effectively unqualified right of the cardholder to cancel a transaction. Why? In case you haven't noticed, interest on credit cards is the highest a bank can ever command. It's a loan-sharking windfall. Almost everybody charges more stuff on credit cards every month than they realize, thereby regularly paying off less than the whole balance. The issuing banks have a scandalously lucrative deal.
And, if you haven't been reading about it, the banking lobby is down in Congress trying to eliminate or at least drastically curtail personal bankruptcy so they can collect their usurious interest. Remember, bankruptcy is not a right; Congress is allowed but not required under the Constitution to implement a bankruptcy system.
But what about the merchants? Credit cards cannot survive without merchants, right? Wrong! It's the other way around: Merchants no longer can survive without accepting credit cards. Proof is found in the fact that almost every merchant now accepts American Express, despite the heftier amount that it lops off the top. Yes, in the final analysis, consumers can survive without credit cards; merchants cannot.
So when the banks establish the VISA and MasterCard rules, the merchants take it in the shorts. The banks want everyone to have all the credit cards they can, despite the fact that credit cards probably represent the single most significant cause of consumer financial woes.
One other significant bit of background, involving chargebacks, is this. Chargebacks are in one sense akin to insufficient-funds checks. Suppose that someone writes a check that bounces but, upon learning of this event, runs right over to the payee with a bag of greenbacks sufficient to cover the check. No harm done? Hardly. The bouncing check has caused inconvenience - which translates into costing money - both to the payee and to the banking system. The banking system has to re-route the bounced check, and perhaps other checks that bounced because of the domino effect of bounced deposits. Hot checks throw sand into the gears of commerce. Chargebacks also do so, and in a very similar way.
As explained earlier, a chargeback causes a banking nuisance. In fact, it is much akin to the nuisance caused by a hot check. So, not surprisingly, merchants who cause chargebacks are treated the same way as check bouncers - a fee is imposed, coupled with increased penalties and, in the worst cases, privileges are revoked (although one wonders whether the banking industry has fallen short when it comes to policing check bouncers).
So, against that background, here are the legal principles that are in place that put e-merchants into the predicament which they now find themselves:
Using VISA as the example, the whole thing starts with the contract between the acquiring bank and the merchant via the ISO - the "merchant agreement," in VISA parlance. The terms of the contract are governed by the VISA operating regulations; sort of an "omnipresence in the sky."
Even before the merchant account can be established, the acquiring bank compares the merchant to the minimum "merchant qualification standards" so as to determine whether there will be a merchant account in the first place. And a key item in the equation is what category of merchant you are, especially if you fall into a suspect category, such as "high-risk telemarketing merchant" or an "electronic commerce merchant."
If you establish a merchant account, you may come to wish that you hadn't. MasterCard maintains a file, currently known as "MATCH," that identifies merchants - and principals of merchants - that acquiring banks have terminated for specified reasons. The regulations mandate that acquiring banks must add a merchant and its principals to this so-called terminated merchant file if terminated for enumerated reasons, most significantly including excessive chargebacks.
The acquirer is on the hook for adding or deleting a merchant from the TMF; it has to defend itself and VISA. But if a merchant is wrongfully tagged with TMF status, likely any dispute about it will be subject to the arbitration provision in the merchant agreement, and arbitration rules generally specify that the parties each pay half of the arbitration costs (which are substantial) - so you are stuck with your own attorney's bill and half the cost of the arbitration.
An acquirer, by virtue of the regulations to which it agrees to conform, "is responsible for and indemnifies and holds harmless VISA against any and all claims arising from failure to terminate a merchant." This leaves the acquiring bank on the hook to the whole system for the problems created by a merchant that should have been terminated. A merchant can be deleted from the TMF only by the bank that put it there.
Getting TMFs is mandatory. In particular,
"An acquirer must add a terminated merchant to the [terminated merchant] file as soon as possible, but no later than the close of business on the day following the date the merchant is notified of the intent to terminate the agreement. An acquirer must list the merchant [on the TMF] if terminated for one or more of the following reasons:
"Acquirer received an excessive number of chargebacks due to merchant's business practices or procedures."
The VISA regulations include what is called a "merchant chargeback monitoring program" which includes monitoring of the percentage of consumer dispute chargebacks, called CDCs (although not in VISA vernacular). A CDC is a chargeback where the cardholder either denies participation in the transaction or is "dissatisfied with the goods or services purchased with the card." The ongoing firestorm of controversy, of course, comes from the fact that VISA and MasterCard are ratcheting down their chargeback thresholds from 2.5% to 1%.
When a merchant meets or exceeds the applicable chargeback ratio, VISA U.S.A. sends the acquiring bank a warning notification for the first three appearances of a merchant on the report. The VISA Operating Regulations specify assessments of fees, charges and fines for excessive chargebacks over enumerated periods (for example, four of five consecutive months and the subsequent two months). And,
"If the merchant outlet continues to meet or exceed either of the applicable chargeback ratios beyond the periods specified... Visa, U.S.A. may
"Permanently prohibit the merchant from participating in the Visa program and
"Add the terminated merchant's name and those of its principals to the merchant performance reporting service as a prohibited merchant."
All of those VISA U.S.A. Operating Regulations control your merchant agreement, which explains how you can get clobbered. You agree that the bank can put the money directly into your account through the automated clearing house, but you also agree that the bank can suck the money right back out as a reserve for chargebacks and keep it for six months or so. You agree to abide by the VISA U.S.A. Operating Regulations, even though it is nearly impossible for you to obtain a copy of them. By doing that, you agree to pay fines and penalties if you have more chargebacks than whatever VISA decides is too much. You further agree to be put on the TMF if your chargeback problem continues. You agree that you cannot obtain merchant processing anywhere else if you are on the TMF because the Operating Regulations dictate that no VISA acquirer can open a merchant account if the merchant or any of its principals are on the TMF.
So, VISA might say, "You agreed to all of this, so how can you complain about any of it?" And they would be technically correct. If you don't like their business arrangement, don't agree to it. If you don't like the way Coke does business, drink Pepsi. If you don't like the way Ford does business, get a Chevy. If you really find Microsoft objectionable, you probably can get a Mac.
If you don't approve of the way VISA or MasterCard do business, however, that obviously is a different story. Long before the 1980s when the Government broke up AT&T, Lilly Tomlin did a sidesplitting persona on Laugh In of Ernestine, the telephone operator. "If you don't like it," she would say, chortling, to the complaining phone company subscriber on the line, "try a Dixie cup and a thread." There was no other phone company in those days; and these days there is no viable means of collecting money in e-commerce other than the Big Three - the VISA/MasterCard "cartel," American Express and Discover. (Ever since Diners Club and Carte Blanche were eaten by Citibank, they haven't seriously been in the picture.) But that is how things are going to operate in the foreseeable future, so get accustomed to it and learn to deal with it. Antitrust, however, is another topic; this is credit cards.
In the meantime, you can just picture Ernestine calling from the office of the acquiring bank saying, "Don't worry about this little TMF problem; just take cash."
(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.)
