by Mark A. Cunningham

   The bankcard acquiring industry should brace itself for an increase in merchant lawsuits over the next several years. On the one hand, cardholders are becoming more sophisticated in their knowledge of the credit card system and more willing to use chargebacks as a device for challenging transactions they justifiably or unjustifiably dispute. At the same time, merchants are becoming more and more dependent on credit card processing in conducting their business and, therefore, more likely to challenge contract terminations through lawsuits in which they seek increasingly higher damage awards. Caught in the crossfire are acquirers which must decide whether to terminate high-risk merchants and, if so, whether to list them on a terminated merchant file. How acquiring institutions go about making and implementing these decisions will make a significant difference in their profitability and, in some cases, ultimate survival.
   A decision issued last year by the Supreme Court of South Dakota illustrates the costs and risk posed by terminated merchant litigation. In that decision, the court affirmed a $259,000 damage award obtained by a restaurant with a single storefront against First Premier Bank and MasterCard International.. The restaurant commenced the lawsuit charging that First Premier and MasterCard breached their contract and tortiously interfered with the restaurant's business relationships when they terminated its credit card processing agreement for excessive chargebacks and placed the restaurant on the terminated merchant file. The trial turned against First Premier and MasterCard when the restaurant introduced evidence demonstrating that it had experienced few, if any, chargebacks in two years of processing with the exception of the single two-month period which led to the termination. To make matters worse, neither First Premier nor MasterCard bothered to notify the restaurant that they had terminated the credit card processing agreement. Instead, the restaurant discovered that it had been terminated at the start of a busy weekend when the credit card system stopped approving transactions.
   Although a relatively insignificant case for First Premier Bank and MasterCard in light of their size, the damage award could have been catastrophic for a small to mid-size ISO. The damage award also does not take into account what certainly amounted to hundreds of thousands of dollars in attorneys' fees and costs incurred by First Premier and MasterCard defending the lawsuit which had been pending for five years. Nor does it take into account the attorneys' fees and costs incurred defending a parallel proceeding involving the same parties in another state or the costs, interest, or attorneys fees which First Premier and MasterCard may have had to pay to the prevailing party. But these losses represent only the hard costs of litigation. Companies often fail to recognize that in addition to the prospect of a damage award, litigation takes employees away from conducting the business of the company to meet with lawyers, attend depositions, and testify at trial. These "soft costs" can be as devastating to litigants as an unfavorable damage award and even more difficult to swallow.

Effective Litigation Risk Management

   Understanding that the costs of litigation can be astronomical is of little value unless businesses also take steps to mitigate their risk of finding themselves named as a defendant in a lawsuit. Acquires also must understand that beginning to think about litigation risk management when faced with the decision of whether to terminate a particular merchant is often too late.
   Instead, effective litigation risk management begins at the start of the merchant relationship. The rules of a merchant relationship are established by the credit card processing agreement and how those rules are constructed will likely determine the outcome of the dispute. They can determine where and how a dispute will be litigated, the timing of any litigation, opportunities for business solutions, damage exposure to the company, and a host of other critical issues. Many acquiring institutions and departments, however, routinely use form agreements drafted years earlier by some unknown lawyer. These agreements may not address recent developments in the law or changes in the way a company manages its portfolio and can put acquirers at a significant disadvantage in the event litigation erupts. Other acquirers "borrow" agreements from their competitors making slight modifications in wording or form. These acquirers put themselves at even greater risk. One credit card processing agreement is not the same as the other. They are based on different state laws and may be enforceable in one state and unenforceable in others. Credit card processing agreements also have different terms and are drafted by lawyers of varying skills taking into account the specific circumstances of their client.
   Having a well drafted credit card processing agreement represents only the first step in effective litigation risk management. If your employees have only a vague understanding about the subject matters addressed in your credit card processing agreement or the meaning of the fine print, they will inevitably make mistakes and these mistakes can be costly. Just remember what happened to First Premier when someone failed to notify the restaurant of the decision to terminate the credit card processing agreement. Effective litigation risk management, therefore, also requires an educational component to inform employees about the credit card processing agreement, how it is structured, and what it means. Arming employees with this information provides them with the resources for making reasonable and effective decisions.
   Periodic contract reviews and education help set the stage, but effective litigation risk management also involves establishing a formal process for how legally significant decisions are made, reviewed, and documented within a company. In most cases, the framework for the process already exists in the form of your historical business practices. However, unless these policies and procedures conform to the rules of the merchant relationship as defined by the credit card processing agreement and are designed to place your business in the best possible position in the event of litigation, you are unnecessarily exposing the company to litigation risk.

Merchant Portfolio Compliance Programs and Audits

   Managers who are explicitly or implicitly charged with the responsibility of effective litigation risk management have three choices available to them. They can ignore the issue. They can attempt to monitor and address litigation risk on an ad hoc basis or, alternatively, they can establish a business culture which recognize the importance of effective litigation risk management to the bottom line. For those choosing to confront the issue directly, a merchant portfolio compliance program and audit can offer managers a way of significantly reducing the risk of litigation for substantially less money than the cost of defending even a small lawsuit.
   A merchant portfolio compliance program is a set of written procedures establishing how and when contracts will be reviewed, how employees will be educated, and how legally significant merchant relationship decisions will be made, reviewed, and documented. Most compliance programs begin with an audit of current contracts, procedures, and policies to identify areas of concern. However, even entities with existing compliance programs are well-served by periodic audits to make certain that the compliance program is being implemented and to allow for adjustments for changing business practices and legal requirements.
   When properly structured and implemented, compliance programs establish a process for making certain that your credit card processing agreements are up-to-date, that your employees understand the agreements, and that legally significant decisions relating to the portfolio are made strategically with the lowest possible risk of litigation. Further, when litigation proves unavoidable, a compliance program will place the company in the best possible position to defend the lawsuit and mitigate the risk of a significant damage award. The cost of a compliance program and audit will vary depending on the size and nature of your business, but whatever you spend now will be more than offset if you avoid even a single lawsuit later.


   A merchant portfolio compliance program and audit represents preventive medicine for your business and, like other preventive medicine, entails an upfront investment of time and money to offset a more significant future risk. It also involves a telephone call with your legal counsel. Your attorney can you design and implement a merchant portfolio compliance program which suits your business style and needs. In a culture where lawsuits have become the norm rather than the exception, too many businesses continue to ignore or self-diagnose their legal problems and wonder what when wrong later. What will you do?