Broken processing agreements between merchants and ISOs are a reality of the acquiring industry, but ISOs can minimize the downside by avoiding high-risk relationships, according to industry executives.
Merchants that decide to switch processors while still under contract or that stop transacting because of business failure are in breach of their processing contracts, says Holli Targan, a partner at the Southfield, Mich.-based law firm Jaffe, Raitt, Heuer & Weiss PC. When a merchant is in breach, ISOs can collect a cancellation or termination fee, but most pass because the results are not worth the time and effort, industry observers say.
Processing contracts often include a liquidated-damages provision, which acts as the cancellation or termination fee, according to Targan. The provision can come in either a set amount or a payout of the contract, she says.
The payout "may be the average [transaction] fee for the last 12 months multiplied by the number of months remaining in the term of the agreement," Targan says.
Merchant failure is often the cause of a broken contract, and it is mostly unavoidable, industry executives say.
"You just have to deal with it," suggests John Priore, president and CEO of Alpharetta, Ga.-based processor Priority Payment Systems LLC. "There [is] a certain percentage of businesses that are going to go out of business each year, and that's something you have to financially plan for."
Americans started 671,800 businesses in 2005, but 544,800 businesses closed that year, according to the most-recent figures available from the Washington, D.C.-based Office of Advocacy for the United States Small Business Administration. Two-thirds of new firms survive at least two years, and 44% survive at least four. Most processing contracts last three years, according to acquiring executives.
Seeking clients that have operated for a number of years is one way to avoid a potentially doomed businesses, Priore says. "For those of us who focus on long-term residual income, it's imperative that we sign up merchants that have a product or service that has some stick to it," he says.
But as the economy continues to weaken, even low-risk merchants sometimes cannot avoid closing. Restaurants and convenience stores are low-risk clients because of minimal charge-backs. "Rarely is anyone going to ask for their money back for a meal they had two weeks ago," says Jon Perry, managing partner of Ft. Worth, Texas-based ISO 888QuikRate.com. High-risk clients usually sell high-ticket services, such as marketing consultation or graphic design, Perry says.
About two months ago, Perry lost a restaurant client that was processing approximately $45,000 per month but had to close. He did not collect a fee because the restaurant was a low-risk client because of minimal charge-backs.
"We're really not going to add insult to injury," Perry says. "In a lot of cases, these are entrepreneurs who are going to start another business. And if you treat them right, they are usually going to come back."
Do Your Homework
Besides seeking low-risk clients, performing extensive background checks on potential clients helps ISOs avoid risky merchants.
QuikRate works with community banks to evaluate potential clients. Perry asks how long a merchant has been in business and seeks information on its interactions with its bank. "I've talked to people who say they're going to do up to $100,000 in credit cards, and you start talking to them and [their plan] is a little loosey-goosey," he says. "They don't have a full grasp of charge-backs."
Still, none of the executives ISO&Agent Weekly spoke with would turn away a new business as a client.
Columbia, Tenn.-based ISO Continental Credit Systems performs an extensive background check on new and potential clients. "We want to make sure if they go out of business, they can cover any potential losses," says Dinah Suppes, Continental vice president of operations.
"I'll take a lot of things into account" with new businesses, she says. "Did they work at a restaurant for 12 years before deciding to open their own? If they did, then they probably do know what they are doing."
Considering Other Factors
Some merchants choose to end their processing contracts early. "Today's merchant is very service-oriented," Priore says. "If their current provider drops the ball," merchants may seek a new processor.
If another provider offers a merchant a better deal and the merchant insists on being released from a QuikRate contract, Perry allows it. "I don't need a merchant going into their next chamber of commerce meeting and poisoning my business with what they might say about how we handled the situation," he says.
Merchants that switch contracts and fail to alert their processor can face legal action. For an ISO, it often is not worth the time and effort to pursue the case in court. "Depending on the dollar amount, we actually may take them to small-claims court," Suppes says. "It doesn't happen often, but it's not uncommon."
Perry had a customer who took part in a free-terminal program go out of business and give the point-of-sale device to another merchant. Perry could have pursued the money for the $200 terminal, but he passed. "I have to honestly ask myself, 'Is it worth my time?'" he says.