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Five Things an ISO With Liability Should Know

By Adam Atlas

In my experience, there are two kinds of ISOs with liability: (1) the kind who know exactly what they are getting into and (2) the kind who don't know anything about the meaning of liability. I wrote this column for both. Unfortunately, many ISO liability clauses receive even less attention than you're giving to the first paragraph of this column.

Some would say that the ISO business is essentially a sales business; however, the difference between vacuum cleaner salesmen, for instance, and ISOs is that the vacuum cleaner salesmen are never liable for fraud committed by their customers.

In contrast, ISOs are often liable for not only fraud committed by their customers but also breaches of applicable laws, association rules and applicable merchant agreements. Therefore, a serious ISO is a lot more than just a sales business mainly because many assume liability for a myriad of wrongdoings by the merchants to whom they promote bankcard services.

Whenever entering into an ISO agreement, one of the principal business decisions to make is whether the ISO should take liability for "merchant losses" under the agreement. The following is a typical industry-standard definition of merchant losses:

Chargebacks or any other charge to a merchant including, but not limited to, any and all negative deposits (unfunded customer credits), loss relating to merchant fraud, processing fees, authorization fees, and other charges, that have not been paid by merchant to processor as required under the merchant agreement.

I have never seen the same definition of merchant losses twice. Each agreement has its own unique approach to this subject. Acquiring banks generally believe that merchant losses are any liability that they have to associations or issuing banks on account of merchant activity, which could include: unpaid processing fees, fraud, chargebacks, underfunded customer credits, fines for violations of association rules, and other expenses related to such losses.

There is a general consensus among banks and ISOs as to what merchant losses actually are; however, ISOs sometimes believe that merchant losses are something less than the acquiring bank's interpretation.

In order to avoid misunderstandings and draft a mutually beneficial liability clause between a bank and an ISO, consider the following:

1. Understand and Agree on Definitions

Take time to discuss with the bank the meaning of the term "merchant losses." Discuss examples of what would or would not be included in the definition.

Take notes during the conversation, and amend the definition to match your understanding during the discussion. The worst possible time to learn the meaning of the definition is when the bank sends you a $100,000 invoice for merchant losses.

2. Discuss Limitation of Liability

It is very unusual for a bank to cap ISO liability on merchant losses, but it's worth discussing. For example, perhaps the ISO wants to assume full liability, but only up to $1 or $2 million, at which point the bank and ISO could share liability.

3. Pricing

The better pricing that an ISO gets for taking liability is not money to put in the bank. Part of that additional revenue must be invested in underwriting by the ISO; otherwise the ISO is setting itself up for disaster.

On a similar point, shop around. There are many deals out there to choose from, especially if your deal count is more than 100 merchants per month.

4. Payment Schedule

Most ISO agreements require that merchant losses are due immediately on demand by the bank. Think outside the box on this. An ISO with liability is like an insurance policy for the bank on its merchant processing business.

It makes sense that the bank should pay some kind of a premium for that insurance; for example, by allowing the ISO to pay the merchant losses on a payment schedule, rather than in one lump sum. Remember, in this scenario, the ISO is paying money to the bank that the bank would likely not otherwise recover.

5. Pinpoint Liability

The ISO agreement should be explicit so that the ISO should not be liable for merchant losses caused by the bank. Assuming the agreement reflects this principle, then as soon as a loss occurs, the ISO and the bank should work together to rapidly determine the facts behind how the loss occurred and who should assume liability for the loss. It's too easy to assume that the ISO should carry liability and pay close attention to the facts.

Occasionally, mismanaged ISO liability leads to more than financial loss. Sometimes, without any intentional wrongdoing, default by an ISO on a liability clause results in an ISO being listed on the Terminated Merchant File (TMF), or Member Alert to Control High-risk Merchants (MATCH) List.

These are lists, maintained by the bank associations, of merchants and other intermediaries that have been terminated for breaches of association rules, among other reasons. The associations deny that the lists are intended to deny merchant services to merchants or ISO agreements to ISOs.

In my practice, the de facto result of such a listing is often termination of the business of the listed entity. For this reason, remember that a mismanaged ISO liability clause can be more costly than the actual amount of the liability assumed-it can put the ISO out of business.

There are a host of other issues to consider when negotiating a liability clause. Some newly registered ISOs have never dealt with underwriting or liability issues.

Liability, like any business risk, can be mitigated with some basic protection such as due diligence on merchants and underwriting. These protections are not mysterious and should be embraced enthusiastically by an ISO carrying liability.

When you assume liability for merchant losses, think of your merchants as your children. You will likely benefit from their successes and suffer from their failures.

In publishing The Green Sheet, neither the author nor the publisher is engaged in rendering legal, accounting or other professional services. If legal advice or other expert assistance is required, the services of a competent professional should be sought. For further information on this article, please contact Adam Atlas, Attorney at Law by e-mail: or by phone: 514-842-0886.

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