Credit Card Processing, Merchant Account and Merchant Agreement Details Important in Credit Card Litigation

Litigation involving credit card and debit card processing and merchant accounts or merchant agreements can be complex due to the fact that there are endless varieties of systems that can be cobbled together in order to process a payment from the time the purchaser’s credit card or debit card is swiped at a merchant’s business or entered into a merchant’s online website or given to a merchant over the telephone and results in the funds actually being transferred into the merchant’s bank account.

Notwithstanding the variety of systems that are available for processing credit card and debit card payments, there

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is an overall pattern to the process, and there are nationwide industry standard policies, practices and procedures that are important in banking litigation involving credit card and debit card processing disputes.

Merchant Accounts or Merchant Agreements

A merchant account or merchant agreement is an agreement between a business that accepts credit and debit cards for payment and a merchant acquiring bank for the processing and settlement of payment card transactions. A payment processor company, an independent sales organization (ISO), or a merchant service provider (MSP) can also be a party to a merchant agreement. A merchant agreement sets the terms, conditions, and responsibilities between the various parties whether the merchant enters into its merchant agreement directly with an acquiring bank or through another party such as an aggregator, and the agreement contractually binds the merchant to follow the operating regulations and requirements established by the card associations such as Visa, MasterCard, Discover, and American Express.

Steps in the Credit Card Process

There are four basic steps required in order to process a credit card payment

Step I. Authorization

1. Cardholder requests purchase from Merchant.
2. Merchant submits request to its acquirer, i.e., the Merchant Account Provider which typically is a bank or an ISO. This is the processing platform that provides a gateway to the card transaction processing system.
3. Acquirer (either a bank or an ISO) sends a request to the issuer bank that issued the card to the Purchaser. Sent through VISA or MasterCard, which are referred to as networks that connect issuers and acquirers.
4. If approved, the authorization code is sent from the issuer to the acquirer, and the funds are reserved from the available funds in the purchaser’s account.
5. Acquirer authorizes transaction to Merchant.
6. Merchant makes the sale.

Step II. Batching

1. Merchant stores authorized sales in a batch.
2. At the end of the day – usually automatically - or manually periodically throughout the day on as as-needed basis, the Merchant sends the collected batch of card sales to the acquirer for payment.

Step III. Clearing

1. Batch is sent through a card network – such as Visa or MasterCard – to request payment from the cardholders’ issuer banks.
2. The card network distributes each transaction to the appropriate issuer bank.
3. Issuer bank subtracts its Interchange fees (usually 2%-3% and which are shared with the card network), and transfers the amount due to the Acquirer bank through the card network. Then the acquirer bank pays the merchant the amount of the transaction minus both the interchange fee and an additional smaller fee – called a discount rate, add-on or pass-thru - for the acquiring bank or ISO. Essentially what happens is that the issuing bank gets paid interchange by the acquiring bank for each transaction. (The cost of interchange depends on the type of card that is presented. For example, a debit card, which is tied to your checking account, is a low risk, low cost interchange.)
4. Then the acquiring bank pays the merchant the amount of the sales transaction less both the interchange fee and an additional fee called alternatively a discount rate, add-on rate, or pass-thru, usually smaller fee for the acquiring bank or ISO.

Note: The fee payment process is reversed for cash withdrawal transactions at ATMs, the justification being that the fees are paid by the card-issuing bank to the acquiring bank in recognition of the acquiring bank’s costs of maintaining the ATM and the ATM network.

Step IV. Funding

1. Acquirer subtracts its discount fee (2%-3%) and pays the Merchant.
2. Merchant receives the payment minus the interchange and discount fees.

Online Debit System

The procedure for processing a debit card transaction is much the same as the process just described for processing a credit card transaction but with the added step that debit cards require electronic authorization for every transaction, and the debits are reflected in the cardholder’s account immediately. The transaction additionally may be secured with a personal identification number (PIN) authentication system, with some online debit cards requiring authentication for every transaction, basically performing like an enhanced automatic teller machine (ATM) card.

An additional complicating consideration when using online debit cards is the necessity of an electronic authorization device at the point of sale and sometimes also a separate keypad to key in the PIN, although this is becoming commonplace for all card transactions in many countries.

Online debit card systems are considered secure because of their real time authentication that eliminates processing lag on transactions.

Who Is Granting Credit?

It is important to note that the Visa and MasterCard networks are not the lenders and are not taking a credit risk on credit card purchases. The card issuing bank sets the terms under which it will grant credit. Accordingly, it is the issuing bank that earns the interest and fees on credit card purchase activities.

Basic Card Information Fraud Prevention

It is an industry standard practice that all processing companies encrypt card information that is captured and sent through the payment processing system. Trouble usually begins when a hacker gains access to the system long enough to find a hole in the security system that will allow the hacker to go around the built-in encryption protection.

Magnetic stripe information from the credit card, sometimes called Track 1 and Track 2 information and generally comprised of the cardholder’s name, account number, and expiration date, are read from the cardholder's credit card and sent from the point of sale to a processor, which then connects to Visa, MasterCard, American Express or Discover. As explained above, this information - along with information on the sale - is then sent to the card issuer - usually a bank - that ultimately authorizes the transaction. The actual payment and transfer of the money to the merchant occurs later, as explained above.

During the credit card or debit card purchase process, Track 1 and Track 2 data often is collected from the card. The minimum cardholder account information needed to complete the transaction is present on the two tracks. Track 1 has a higher bit density (210 bits per inch vs. 75 on Track 2), and is the only track that may contain alphabetic text such as the cardholder's name. This information has to be protected and should not be stored by the merchant since the account number and expiration date information could be transferred to the magnetic strip on a new phony card and then used illegally.

Conclusion

When pursuing litigation involving credit card or debit card processing issues, make sure that you have an expert examine all of the documents between the parties in order to determine who is responsible for what.

Understand the process before you get too deep into the facts of the case.

© 2012 by Don Coker. Serving clients worldwide from his Atlanta metro area office.

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ABOUT THE AUTHOR: Banking Expert Witness Don Coker
Expert witness and consulting services. Over 500 cases for plaintiffs & defendants nationwide, 120 testimonies, 12 courthouse settlements, all areas of banking and finance. Listed in the databases of recommended expert witnesses of both DRI and AAJ. Clients have included numerous individuals, 75 banks, and governmental clients such as the IRS, FDIC. Employment experience includes Citicorp, Ford Credit, and entities that are now JPMorgan Chase Bank, BofA, Regions Financial, and a two-year term as a high-level governmental banking regulator. B.A. degree from the University of Alabama. Completed postgraduate and executive education work at Alabama, the University of Houston, SMU, Spring Hill College, and the Harvard Business School. Called on by clients in 31 countries for work involving 61 countries. Widely published, often called on by the media.

Copyright Don Coker

Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.