Legal
Merchant Ownership Debunked

by Holli Hart Targan

   If you've been in the merchant acquiring business for more than 2 minutes, you know that you should want to "own" the merchants. It sure sounds like an important thing. But what does "ownership" get you, how do you know if you have it, and why should you care? This article will debunk some common misperceptions surrounding merchant ownership.

Urban Legend #1: The Bank Always Owns the Merchant

   Somehow, somewhere along the line someone started a rumor that the Visa and MasterCard rules ("Rules") mandate that the member bank "own" the merchants. It would seem to make sense: after all, the bank is the gateway into the Visa/MasterCard interchange system. Also, the Rules tightly control a number of aspects of the merchant acquiring process, such as who has the authority to sell card processing services, the settlement process, how the Visa and MasterCard logos may be used, and cardholder information security procedures that must be observed.
   Since the Rules themselves are often a mystery, it's a common assumption that the member banks must "own" the merchant relationships. However, having read those erudite tomes more often than I like to admit, as far as I can tell, it's simply not true. Nothing in the Rules requires that the bank own the merchant contracts.
   Now that's not to say that the Rules don't have quite a bit to say about the merchant relationship. For example:

  • The bank must be a party to the merchant contract,
  • The bank must handle all merchant funds,
  • The bank must have the authority to terminate the merchant contract, and
  • The bank is ultimately liable to the card associations if the merchant defaults on chargeback liability.

   But none of this means that the bank must "own" the merchant contract. Which begs the question‹what exactly is merchant ownership?

The Benefits of Ownership

   Typically when you own something you have the right to possess it or to enjoy the benefits of it. But how can anyone really "own" a merchant relationship? It is not like a piece of personal property, such as a car, which can be owned by possession and evidence of title. So generically we say that the ISO or the bank or the processor owns the merchant contract. When most people talk of merchant ownership, they are referring to the right to move the obligation to process a merchant's transactions from one processor or bank to another. In other words, the party that controls who will process the merchant's transactions is the party that "owns" the merchant relationship.
   For example, if a bank owns the merchants, an ISO or sales representative is prohibited from soliciting a merchant that it placed with the bank at the end of its contract with that bank. The bank may agree to continue to pay the ISO or sales rep residuals on the merchant, but the ISO/sales rep is not authorized to move the merchant's processing relationship to another bank.
   In the best of all worlds, the ISO/bank contract will specify which party "owns" the merchant relationship. The contract will spell out in great detail exactly what rights the bank and the ISO have regarding the direction of the merchant's processing, both during the term of the ISO/bank contract and after termination.
   But the best of all worlds is usually make-believe, and typically it's only a pipe dream for the ISO/bank contract to detail all the permutations of merchant ownership. If the contract is silent on the issue, then we have to look at what I call the "indicia of ownership" to see what the parties intended regarding who owns the merchants.
   The totality of each situation must be carefully examined. But in the absence of clear contract language, an affirmative response to the following questions indicate that the ISO may have some ownership interest in the merchant relationship:

  • Does the ISO perform credit underwriting?
  • Is the ISO a party to the merchant contract?
  • Does the ISO take on liability for merchant fraud?
  • Does the ISO take any liability for merchant chargeback risk?

   Thus, the Rules do not mandate that the bank "own" the merchant relationships. In the absence of clear contract language stating which party has the right to control who processes the merchant's transactions, the bank's and ISO's responsibilities must be examined to determine who owns the merchant contract.
   Given the above, there are a few situations in which an ISO or sales representative should not care whether it owns the merchants. One is where the ISO is able to negotiate a clause in its bank/processor contract stating that the ISO will continue to receive residuals for as long as the bank is deriving revenue attributable to the merchant that the ISO solicited. Another is where the sales rep sells its residual stream up front to the bank/processor.

Owning the Residual Stream

   If you are an ISO and your bank or processor won't permit you to move the processing of your merchants or to solicit merchants after termination of the relationship, all is not lost. An ISO can still "own" its residual stream. In fact, an ISO always owns its residual stream, unless the contract states otherwise. This enables the ISO to sell its right to receive residuals to a third party, which is an asset that has economic value.
   In essence, the ISO gets a lump sum payment at a negotiated amount (say, 18 multiplied by the average monthly amount it receives from the bank). The purchaser gets the right to receive the residual amount from the bank for as long as the "sold" merchant continues processing with that bank. The ISO is legally assigning its rights to receive compensation under its bank contract to the third party purchaser.
   Sometimes the bank/ISO contract will prohibit this assignment of payment from the original ISO to a third party. The bank's position may be that the right to receive compensation goes hand-in-hand with the ISO's responsibility to service the merchant. And if the ISO is no longer receiving residuals on a merchant, it has no incentive to make sure the merchant is kept happy. Further, the bank may not want to leave merchant servicing responsibilities up to someone designated by the ISO ‹ someone they don't know and may not want to do business with.
   One of sales reps' biggest worries is how to protect the merchant portfolio asset they believe they are building. The surest way to know what your rights to the merchants are is to spell out those rights with specificity in your bank/ processor relationship. An ISO can own its residual stream. An ISO can own the merchant relationship. But it's best for everyone if the bank/ISO contract spells it all out.