Entering into a Merchant Processing Agreement?

Setting up an online business is relatively straightforward and inexpensive. Your web developer has designed a site and you have worked out your marketing and pricing strategies so as to establish your presence on the World Wide Web with access to consumers on a global basis.

One of the last steps is finding a payments solution which will allow you to take their money. Unfortunately the online credit card processing industry may soon make you feel like a sardine in shark land, and the history of start-up web merchants is littered with “bad luck” stories, many of which occur as a result of two factors.

1. A failure to undertake any due diligence investigation, however basic, into the Internet Payment Service Provider (IPSP) or Merchant Service Provider (MSP), its financial affairs and its demonstrated ability to back up its promises; and
2. A failure to negotiate and properly understand the terms of the Merchant Processing Agreement.

Time is of the essence…

We understand that processing arrangements are often made under considerable time pressure and that the industry as a whole can be characterised as extremely dynamic. Lawyers, who generally take too long (and cost too much for many marginal businesses), are not suited to the industry and legal aspects often take a back seat to technical issues such as integration.

However the risk of entrusting your money to a third party, and the difficulties which come with trying to retrieve it through the legal system from an MSP which is most likely outside South Africa, suggest that at least some attention should be paid to proactive risk management.

Due Diligence

Obviously the more in-depth the investigation the better. If you do not wish to pay for an investigative service or report then a good start is to use a major search engine (we recommend Google and particularly the Google Groups service) and enter the name of the MSP together with any of the following: “theft”, “scam”, “fraud”, “legal proceedings”, “lawsuit”, “frozen” or any other relevant term you can think of.

Have a look at other sites using the MSP’s services and, if you are not involved in a high-risk business such as gambling, porn or pharmaceuticals, then it is a good idea to avoid MSPs involved in these areas as the risk of fraud or funds being frozen is higher and potential losses may not be adequately separated from other clients, such as you.

Merchant Processing Agreements

We have set out below a non-exhaustive list of some of the more important clauses to be aware of when entering into a Merchant Processing Agreement.

1. Make sure that the type of merchant and the type of business are clearly and accurately specified up front so that there can be no misunderstanding as to your processing requirements.
2. What is the term of the Agreement? How long will the contract be in existence if neither party terminates it?
3. Is the Agreement exclusive? If you wish to hold other accounts with other MSPs make sure that you are not prevented from doing so by the terms of the Agreement.
4. How can the Agreement be terminated? Take special care to observe formalities regarding notice periods and the manner in which notice may be given. It may, for example, suit your purposes to insist that notice can be given by confirmed e-mail.
5. Make sure that you understand the terms included in the definitions section, especially those relating to chargebacks, credits and any other feature which may entitle the MSP to cancel the Agreement.
6. Does the MSP have a workable plan for dealing with chargebacks?
7. What level of support is offered? An MSP should, depending on the nature of your business, offer at least a 24/7 helpdesk service.
8. Normally provision will be made for the MSP to retain a percentage of funds processed as a rolling reserve – essentially the MSP’s security against chargebacks, credits and fines. The rolling reserve is normally set at 10% and the final reserve is usually repayable to the merchant, less deductions, after the expiry of 6 months from the date of the last transaction processed. This position may change according to the nature of your business and you should also check whether the MSP retains the right to increase the percentage withheld and the applicable time period.
9. What is the monthly transaction volume limit? Check the circumstances under which the MSP retains the right to reduce the volumes it is prepared to process on your account. A reduction in volumes can be disastrous for your business.
10. What practices are prohibited on the part of the merchant? Make sure that you are aware of what you are not allowed to do to avoid premature termination of your account.
11. What practices must be undertaken by the merchant? These are usually set out by the relevant Card Association Rules.
12. What law governs the Agreement (e.g. is it subject to SA or US law?) and where will any court proceedings or dispute resolution take place. When things go wrong you may find yourself having to sue the MSP in a foreign country and under the legal rules of that country. This will generally be prohibitively expensive.
13. Does the Agreement make provision for alternative dispute resolution such as arbitration or online dispute resolution? Online dispute resolution is often worth insisting on as it may allow you to more easily proceed against an MSP. Arbitration awards are less expensive and far more readily enforceable than judgements.

Remember to negotiate

There are a large number of MSPs offering a wide variety of services at different pricing levels. It pays to shop around and you should not feel pressured to enter into an unfavourable arrangement with any one MSP.

Pay particular attention to the various fees and commissions which the MSP wishes to levy against processed funds – many of these are unjustified.

Conclusion

Remember that the cost in time and money of a rudimentary due diligence, some comparative shopping and gaining some understanding of the Merchant Processing Agreement is virtually nothing when compared to the potential risks accompanying an online processing arrangement which you do not properly understand and where there is no real agreement between the merchant and the MSP.


10 Mar 2004

This article is intended to provide general guidance and does not constitute professional advice relating to specific instances. Should you wish to place any reliance on the information presented in this article we strongly advise that you consult your legal advisor or the Electronic Law Consultancy - info@e-lawconsultancy.co.za