Protecting the Foundation:
Strong Merchant Contracts   

by Holli Hart Targan          


THE FOUNDATION OF THE ENTIRE MERCHANT ACQUIRING INDUSTRY is the processorís arrangement with merchants. Merchants are the ďwho, what, where, when and howĒ of the acquiring world. And the contract you have with your merchants is the only way you can control the transactions presented by those customers. It is, therefore, vitally important to make sure that your merchant processing contract covers all of the bases. This article will highlight a few key merchant agreement provisions.

  • Does your merchant agreement adequately protect you?
  • Do you have the right to terminate a merchant engaging in questionable transactions?
  • Does your contract allow you to take a reserve against potential chargebacks?
  • Do you have the authority to automatically set off against incoming sales drafts any fees owed to you?
  • And if the merchant goes into bankruptcy, will you have to stand in line with all of the merchantsí other creditors before being paid?

   Typically, the parties to the merchant contract are the Visa/ MasterCard member bank and the merchant. Thatís because the card associationsí rules require that the member bank be primarily responsible to Visa and MasterCard for the merchant relationship. Often, independent sales organizations (ISOs) are also parties to these agreements, particularly when the ISO ďownsĒ the merchants or takes on liability for losses attributable to merchant transactions. Whether an ISO is a party to the agreement or not, it should insist that certain provisions be included in the contract. Protective provisions are particularly important if an ISOís deal with the member bank provides that the ISO takes on some or all of the chargeback or other loss risk for merchants.
   Generally courts looking at merchant contracts will read those contracts quite literally. Therefore, itís important that the contract be clearly written and that the agreement contain provisions that authorize you to take protective actions if such action is necessary. Set forth below are a few of those clauses.

   1. Change of Business. First, the agreement should contain a clause allowing you to terminate the contract if the merchant changes its type of business, or the way it conducts business. You have evaluated the credit-worthiness and riskiness of the merchant based on the information given to you on the merchant application. Your assessment of the merchant and your willingness to do business with him may change if the merchant suddenly starts to sell travel packages to Mexico along with the Mexican trinkets he originally told you about. Your assessment of the merchant may also change if he starts to sell those trinkets over the phone or through the Internet, instead of only out of his storefront. Alternatively, the contract could require the merchant to give you advance notice of his intent to change his business and then allow you to terminate the agreement if you decide you donít want to process those types of transactions.



   2. Set-Off rights. Second, the contract should authorize you to deduct from funds otherwise owed to the merchant those amounts the merchant owes you. These include fees, fines and chargebacks. And include a provision that specifically authorizes you to automatically debit the merchantís settlement account without notice and without the merchantís consent. That way, you wonít have to ask for money owed to you and you will have a greater likelihood of actually being paid back.

   3. Termination. The termination rights that will protect you the most will allow you to terminate the agreement with or without cause at any time and without prior notice. The problem with that type of provision is that usually merchants, especially larger ones, will want to have the same right to terminate. If you want to tie the merchant in for a period of time, then an alternative is to include a clause that will give you broad discretion to terminate the contract under certain circumstances. These include allowing you to terminate for the merchantís material violation of the Visa/MasterCard rules, for a violation of any internal rules you have informed the merchant about (including the contract) or for excessive chargebacks.

   4. Reserve Account. The contract should enable you to require the merchant to establish a separate account to secure the merchantís obligations to you. The best provision would allow you to require a reserve under any circumstance, within your discretion, if you have reason to believe the merchantís actions, or incoming items, so warrant it. Alternatively, you could lay out in the agreement the conditions under which the reserve requirement will kick in. Again, the broader the language, the better it is for you. Not only should you be able to impose a reserve, you should also take a security interest in that reserve and in all sales drafts, so that you stand first in line among the merchantís creditors.

   5. Limited Liability. The agreement should limit, to a very specific amount, your potential liability under the contract. For example, liability could be limited to 12 months worth of fees paid to you. Itís also important to disclaim liability for special, incidental and consequential damages. This will ensure that you do not have to pay, for example, for the merchantís lost income if the system goes down and the merchant is unable to process transactions for a period of time.

   6. Merchant Bankruptcy. Under the bankruptcy laws, once a business declares bankruptcy, merchant acquirers that have paid chargebacks on behalf of the merchant are not allowed to recoup such amounts from merchant funds. Moreover, the acquirer may be forced to continue processing for the merchant. There are a number of contract clauses to protect you from this situation, chief among them a provision stating that the arrangement between the merchant and the acquirer is a contract of ďfinancial accommodation,Ē and taking a security interest in all merchant reserves.

   These are just a few of the ways you can protect the foundation of your acquiring business and minimize losses due to unforeseen merchant actions and circumstances.


Holli Hart Targan is a partner at Jaffe, Raitt, Heuer and Weiss, P.C. in Detroit. Ms. Targanís law practice concentrates on merchant acquiring, e-commerce, and payment system issues. You may reach her at 313-961-8380 or at .