By Adam Atlas
Attorney at Law
Yes, your processor or super ISO can go belly-up. ISOs spend a lot of time eking out a living on thin margins, chasing merchants and agents, and shooting for a successful exit. Busy with their own challenges, ISOs sometimes overlook the possibility that the entity paying them their residuals – a processor or super ISO – can go under.
With the specter of increased interest rates looming, I thought it would be a good time to look at bankruptcy. The purpose of this article is to highlight some causes, consequences and lessons learned from processor and super ISO bankruptcies.
Like so many businesses, processors are leveraged. They borrow millions of dollars in the hopes of turning it into tens of millions. Right now, with record-low interest rates, money is fairly cheap by historical standards. Lenders, however, still want to be repaid with interest and on time.
Heavily indebted processors often operate on thin margins. This means that, in any given month, the amount of gross residuals that come in, less all amounts owed to lenders, ISOs, employees and other suppliers, is not very much. It might even be zero.
Like a heavily indebted individual, a processor may be "living month-to-month." If a large, unexpected expense comes along, like a major loss from a big merchant leaving the processor to go elsewhere, the results can throw a processor in a precarious financial situation into the red.
When a heavily indebted processor doesn't have the money to make ends meet in a given month, it either doesn't pay its ISOs or it doesn't pay its creditors, or both. If ISOs are unpaid (for no reason) they are likely to take their business elsewhere – making the processor's financial situation even more dire. If creditors are not paid, they call in their loans.
When a processor's loan is called, rather than simply having to make the monthly payment, the whole amount that it owes is due and payable – which could be in the millions of dollars. The processor then has to decide if it is capable of refinancing or whether it will simply throw in the towel.
Processors and super ISOs have a lot on the line. They have executives on salary, employees providing merchant and ISO support, information technology systems, and a stable of ISOs that expect to receive residuals every month in exchange for the hard work they do selling merchant accounts.
Bankruptcy occurs when the processor's debts exceed its ability to pay them, and creditors are no longer willing to negotiate.
A bankruptcy involves taking what is left in the bankrupt processor and dividing it among creditors, who almost always expect to receive less than they invested. Secured creditors, meaning those with a Uniform Commercial Code or similar security interest filed before the bankruptcy, will rank ahead of unsecured creditors that have no such security interest.
The key assets of a typical processor or super ISO are its banking relationships, through which it is able to supply processing for merchants; its merchant agreements, which generate revenue; and its ISO and agent agreements, through which it is able to secure new merchant relationships.
Unlike the bankruptcy of a manufacturer, where the factory machines can be purchased and repurposed in another factory, ISO and merchant relationships are harder to auction off or transfer without loss of value. A truck that goes up for auction in the bankruptcy of a delivery company can be put to use with, perhaps, only a rebranding.
An ISO agreement is hard to transfer to a buyer of the assets of a bankrupt processor because the ISO has a living, organic relationship with the merchants; the processor, such as it was; and the acquiring bank, through its sponsorship.
Sale of assets upon bankruptcy takes place under the direction of a trustee. The trustee in bankruptcy is a neutral third party whose role is to "babysit" the assets to protect the best interests of creditors until such time as a suitable buyer comes along to buy them.
Numerous ISO agreements contain language that allows the parties to terminate in the event that one of them becomes bankrupt. It's key here to put yourself in the shoes of the trustee in the bankruptcy of a processor. Would you terminate all your ISO agreements and keep all the residuals for the business that is to be auctioned off, or would you rather keep paying residuals thereby earning the loyalty of ISOs to the new owner?
Common sense tells us that the latter (pay the ISOs) is the better choice. Whoever buys the assets of a defunct processor, assuming the buyer knows anything about the merchant processing industry, will likely demand the right to acquire the ISO agreements as well. ISO agreements are the lifeblood of a processor; my understanding is that about 80 percent of new merchants come to processors through ISOs. With attrition constantly gnawing at a portfolio, new merchants from ISOs are necessary.
Although legally the ISO may lose its claim for a continued relationship, the business logic of a successor to the processor mitigates strongly in favor of keeping ISOs and paying what they are due. This does not mean guaranteed clear sailing for the ISO, but it does mean there are compelling business reasons for the new owner of the processor business to honor promises made to ISOs by the old one.
If your processor is headed for bankruptcy, it's important to stay in close communication with the processor or its trustee in bankruptcy and also review your legal rights under your ISO agreement so that you make it through with the least damage possible. If your processor is financially unstable, consider sending some of your business elsewhere (subject to your own minimums or exclusivity) just in case things do not go well.
The scenarios discussed herein track a common way that bankruptcies unfold, but each one is unique and obviously could differ from what I've described.
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, email Adam Atlas, Attorney at Law, at firstname.lastname@example.org or call him at 514-842-0886.
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