Chapter 7 Credit Cards

• Jurisdiction: United States

Chapter 7 Credit Cards

Credit card services may be separated into two categories: credit card processing services (for the merchant who accepts the card) and credit cards issuance (to a credit card user).

A. Credit Card-Processing Services

Credit card-processing services enable businesses to accept credit and debit card payments from their customers and turn their sales into cash. Credit card processing involves a network of institutions with numerous intermediaries. An analysis of all of the relative rights of all of the parties is well beyond the scope of this book. In this chapter, we will limit our focus to the relationship between the bank offering credit card-processing services and its customer (whom we will call the "merchant").

B. General Terms of a Merchant Services Agreement

Credit card-processing services are governed by a merchant-services agreement between the bank and the merchant. As part of the agreement, the merchant is required to maintain a merchant account, usually at the bank that is providing the credit card-processing services. The merchant pledges and grants a security interest in the merchant account to the bank in order to secure the merchant's obligations under the merchant-services agreement. The bank may also require the merchant to maintain a reserve account and pledge it as additional security. The merchant-services agreement may permit the bank to hold the funds in the merchant account and any reserve account for a period of time (it can be several months) after the bank stops providing credit card-processing services in order to cover chargebacks and returns (discussed below).

Under the merchant-services agreement, the bank makes funds available to the merchant on account of credit card transactions before the bank itself receives payment from the issuers of the credit cards. This credit is referred to as "provisional credit" or "float."

The bank is compensated for providing credit card-processing services by applying a discount rate assigned to the merchant, which in a simple case is a percentage of sales. For example, if a merchant is assigned a 2% discount rate, the merchant will receive $98.00 for every $100.00 in sales processed through the bank. The bank may charge additional fees for credit card-processing services and for providing credit card machinery.

1. Chargebacks

As provided above, the bank agrees in the merchant-services agreement to make funds available to the merchant in the form of provisional credits. The merchant in turn is obligated to indemnify the bank for "charge-backs." A chargeback occurs when a credit card-holder disputes a charge. The dispute may be on account of theft of the card, failure to receive a product, or some other legitimate reason. The merchant has a limited amount of time to dispute a chargeback. If the merchant does not dispute the chargeback or fails to dispute it in time, then the credit card-holder's account will be credited in the amount of the chargeback. The merchant must then indemnify the bank for the potential loss stemming from the provisional credit that the bank previously extended to the merchant on account of the item that was later charged back. The bank may cover the indemnity obligation by debiting the merchant account. Exposure to chargeback liability generally lasts between 90-120 days after a credit card transaction, but it can extend up to 180 days.⁷³

2. Returns

Returns can also result in delayed liability. When an item sold by the merchant is returned, the purchaser may receive either cash or a credit to the purchaser's credit card. The merchant, as a result, is then obligated to indemnify and repay the bank for the return. As is the case for chargebacks, the merchant's indemnity obligation for returns is often paid by a debit from the merchant account.

C. Bankruptcy Issues Related to Credit Card-Processing Services

The filing of a bankruptcy case will invariably occur in the middle of a credit card cycle. The moment that the petition is filed, the bank providing credit card-processing services will have (1) an unliquidated contingent pre-petition claim for chargebacks and returns with respect to prepetition transactions, and (2) an unliquidated contingent post-petition claim for chargebacks and returns with respect to post-petition transactions. The bank may have a right of setoff against the merchant account and any reserve account. In addition, the debtor may want to continue to use the bank's credit card-processing services post-petition.

1. Post-Bankruptcy Limits on Payment of Chargebacks and Returns by Debiting the Merchant Account

Outside of bankruptcy, a credit card processor typically sets off any chargebacks and returns against the merchant account. Once a...