The Green Sheet Online Edition
February 22, 2010 • Issue 10:02:02
Claws in merchant contracts
From the point of view of a processor, among the most important language in ISO or agent agreements is that which restricts ISOs or merchant level salespeople (MLSs) from engaging in certain kinds of solicitation or competing behavior. These clauses are found in virtually every contract in our industry.
An article such as this can never capture everything about such clauses, so I will focus on aspects of them that might not be obvious to all readers.
Nonsolicitation and noncompetition clauses serve to protect merchant portfolios from disappearing. But to understand the clauses that protect portfolios, it is useful to understand attrition: the key indicator of how quickly a given merchant portfolio is shrinking.
Attrition is the process by which merchants in a given portfolio drop out of the portfolio and migrate to other banks. Some merchants leave because they dislike their current providers, others because they are solicited by new providers and others because their providers simply go out of business. In our industry, attrition is usually quantified as a percentage of annual processing volume.
For example, if an ISO processes $100 million through its merchants annually and enough merchants leave the portfolio to reduce transaction volume to $90 million, the attrition rate is 10 percent.
At the recent Northeast Acquirers Association conference in Mt. Snow, Vt., more than 100 payment professionals were asked to define the industry standard rate of attrition. There were no answers. Attrition varies enormously from one ISO to another, from one industry to another and from one processor to another. Consequently, it was hard for anyone to give a specific answer.
However, there is another reason why industry attrition figures were not forthcoming: the attrition rate for any given processor is a closely guarded business secret. The secret of one's attrition can affect financing, reputation and other sensitive factors. While everyone else's attrition may be a secret to you, your own attrition should not be; you can easily calculate it using basic reporting on your portfolio.
Keep an eye on your attrition, as it will help you calibrate your business growth regardless of your nonsolicitation and noncompetition obligations.
The nonsolicitation clause, defined
A nonsolicitation provision in our industry is a clause in an agreement whereby one party agrees to not solicit a defined group of merchants for a specific period of time. For example, an ISO of a processor may undertake to not solicit merchants that it has referred to the processor (the defined group of merchants) for the term of the ISO agreement and for five years thereafter (the specific period of time).
The purpose of a nonsolicitation clause is to protect the merchant portfolio of the party that benefits from it.
Degrees of nonsolicitation obligations
Many nonsolicitation obligations I have seen in our industry have been the following, listed from most to least severe:
- No solicitation of any merchant of the processor or its sponsoring bank
- No solicitation of any merchant of the processor
- No solicitation of any merchant you brought to the processor
- No solicitation of any merchant you brought to the processor within the last three years
Notice that the highest degree of nonsolicitation obligation bars you from soliciting any merchant from the processor's acquiring bank; these may be merchants that are quite far removed from your work as an ISO or MLS. The industry norm for an ISO is item 3, under which you are required to not re-solicit merchants you brought to the ISO.
This makes sense because you are in the best position to use your knowledge of those merchants to re-solicit them.
Noncompetition clause, defined
A noncompetition clause is one whereby a party agrees not to enter into similar solicitation agreements with third parties for some fixed period of time. In a sense, this has the effect of imposing a certain kind of exclusivity for the party that commits to it.
If you are the party seeking to benefit from this kind of clause, be aware that the law in some states will limit the right of an entity to impose exclusivity on MLSs. That state law may limit the effectiveness of the clauses you have drafted. On the other hand, if you are being asked to agree to a measure of exclusivity, consider what you are receiving in exchange and whether the bargain is worthwhile.
Degrees of noncompetition clauses
Many noncompetition obligations I have seen in our industry have been the following, listed from most to lease severe:
- No right to provide any service for any third party
- No right to solicit merchant services for any third party
- No right to solicit any merchants of the processor for a third party
- No right to solicit any merchant you have referred for a third party processor
Notice how noncompetition clauses can achieve the same results as nonsolicitation clauses but by different means. A noncompetition clause can prevent you from referring merchants to a third party, while a nonsolicitation clause can prevent you from re-soliciting a certain set of merchants.
Regardless of the type of nonsolicitation or noncompetition clause to which you may be bound, always take a moment to reflect on the consideration you are giving in exchange for being bound by it. When well-paid executives leave their place of employment on good terms, they are often asked to sign a noncompetition agreement that may keep them out of a certain market for a specific period of time.
Those undertakings are done in consideration of payment. Similarly, the extent to which you are bound by nonsolicitation and noncompetition clauses should be coupled with some consideration for having agreed to them. Now, let's be clear that in our industry, it is almost never acceptable for an MLS to move a merchant that it has just brought to an ISO.
However, in the case of an exclusive agreement, for example, an agent will want something in return, such as training and support from the ISO.
The legal interpretation of nonsolicitation and noncompetition clauses is ultimately done under the state law that applies to your agreement and the law of the states where you work and reside. Some states will severely limit the rights of a party to enforce noncompetition clauses, while others will be more lenient. The lesson to be drawn from this is that a contract, although worded strongly, may not actually have the force of law.
Parties should always try to be moderate in their drafting of these clauses so as to provide a suitable level of protection in exchange for a suitable price. The ideas set out herein may not apply to your individual agreement; instead they should serve as food for thought as you go about negotiating your ISO and agent agreements.
In publishing The Green Sheet, neither the author nor the publisher is engaged in rendering legal, accounting or other professional services. If you require legal advice or other expert assistance, seek the services of a competent professional. For further information on this article, e-mail Adam Atlas, Attorney at Law, at email@example.com or call him at 514-842-0886.
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