Information on Merchant Accounts,
Ecommerce and Credit Card Processing

December 16th, 2015 by MSI Newsletters


Filed in: Monthly Newsletters |

Chargebacks are something that almost all merchants who accept credit cards will have to deal with at one time or another. In our experience, there is often a lot of bad information about how the chargeback system works and what parties are involved in the chargeback process. We want to briefly overview how the chargeback system works and how this can affect merchants who receive a chargeback from a customer.

Chargebacks can be a costly surprise for the unsuspecting business owner and even more so for merchants in certain higher risk industries, where chargebacks are often a constant burden. Some consumers even know how to use the chargeback system so well, they commit a type of fraud called friendly fraud using the chargeback system.

What is a chargeback?

To begin, a chargeback is essentially a dispute made by a customer or the bank that issued the credit card to the customer. This dispute could be for a number of reasons but essentially they are disputing the validity of a transaction with their card card and a merchant who accepted it. The terms may vary by the type of card and how a transactions is processed, but the ability to request a chargeback is a fundamental protection that comes with all credit and debit cards. Once a chargeback is initiated, it is important for merchants to quickly respond to the chargeback claim, as they will lose the money they had previously received for the transaction if they do not respond.

The chargeback process

A chargeback is initiated when a card holder or their bank feel that a transaction was not valid, for the amount, service, quality of goods that a merchant sold, or a number of other reasons. One of the most common types of chargebacks is simply if a card holder’s credit card number is stolen and used by a thief. Some other common reasons for chargebacks are : defective goods or goods are not as described, non-authorized sale, key data points missing from point of sale system, delay in batching transaction, duplicate transaction or credit not issued and non-delivery of sale item. Unfortunately many of these chargebacks reason codes such as defective or goods not as described can be very subjective and the issuing bank tends to rule heavily in favor of their customer. Also, issuing banks will sometimes initiate a chargeback if the transaction is outside of the normal behavior pattern of the customer, and we’ve seen these types of chargebacks actually happen 3 to 4 months later. If you receive one of these issuing bank chargebacks, it’s a good idea to check with your processor because we have found that in rare cases you’re better off not responding. But, this is only in rare situations so make sure your processor has given you this advice otherwise, you’re guaranteed to lose the chargeback.

When a chargeback is requested, the card issuer files a chargeback request with the merchant’s processor. That processor immediately withdraws the funds for the transaction from the merchant. These are held in a reserve account pending the outcome of the chargeback investigation.

The merchant is then notified by their processor that they have received a chargeback and asked to provide proof that the transaction accepted by the merchant was legitimate. The merchant has 14 days to respond to this request or the issuer will automatically rule against them. Proof for a retail merchant is often a signed receipt and evidence that the card was swiped through a terminal or POS system. Now with the advent of EMV terminals we are seeing more and more chargebacks initiated by card issuers for non-EMV terminals. For Online and other non-retail merchants, proof is often showing tracking numbers and a delivery signature, but in any case it is much more difficult to prove the legitimacy of a transaction where the customer’s card was not electronically captured. Even if a merchant has a signed receipt or invoice, this is not proof of delivery for a non-swipe environment such as a phone or Internet order.

The processor then sends whatever information received from the merchant to the card issuer.

The card issuer then makes a decision on the validity of the transaction, and either returns the collected money back to the merchant, or releases it to the cardholder, depending on which side they rule in favor of.

If the issuer rules in the favor of the cardholder, the merchant may still has an opportunity for arbitration over the validity of the transaction, but there is significant, and irrecoverable, cost to the merchant if they wish to go to arbitration. The cost is $500 to take the case to arbitration and most processors won’t take the case to arbitration unless the merchant has paid the $500 and they feel the merchant has a very good chance of success. The arbitration process then takes another 45 days to complete.

Important points

  • Chargebacks can generally be made for 120 – 180 days after a transaction is considered settled. This is important because in the event of custom, recurring, or prepaid products or services, the liability for a chargeback is often considered beginning on the date the transaction and service is considered complete, which may not be the initial date of the sale itself, but the date of the final payment. If the transaction is for a future deliverables the time frame for a chargeback can go up to 540 days.
  • Here is a brief description of chargeback time limits:
    • In cases that involve delayed delivery or performance of goods and services, the period is 120 days from the date the goods and services were supposed to be provided.
    • In cases that involve interrupted services that were immediately available, then the 120 days begins when the services cease and the chargeback cannot exceed 540 days from when the services started.
  • If you do receive a chargeback, make sure not to refund the transaction! The money from the original transaction is already going to be reversed from your account. Refunding after a chargeback has been initiated can result in losing the recaptured chargeback funds money and not being able to recover the refund you just made. If a chargeback is in process, let the process play out even if the customer is requesting a refund directly.
  • It’s important to understand that the card issuer is the one making the decision on whether a transaction was valid or not. The processor acts as an intermediately between the card issuer and the merchant, but they do not have any say in how the issuer rules. They will however help the merchant if there is specific technical information requested by the issuer, such as proof that a transaction was swiped, as well as offering customer support through the chargeback process.
  • It may not be obvious as to the processor’s entire role in the payment process, but because of the risk of chargebacks, processors are actually acting as a guarantee and lender to a merchant accepting credit card transactions. The processor is completely labile for the cost of a chargeback if the merchant is unable to repay it. So in essence, a processor is issuing a loan to a merchant, every time they accept a card from a customer. It is only after a period of months when the risk of a chargeback goes to zero, that the money actually guaranteed to the merchant.
  • Merchants who receive excessive chargebacks can be terminated by card associations, and in some cases are prohibited from accepting cards again in the future, both personally and the business that received the chargebacks. Card associations will levy hefty fines for merchant who continually exceed allowable chargeback levels. Most processors have their own limits but MasterCard will start fining a merchant if they have chargebacks and refunds over 2% or a total of 150 chargebacks in one month period.

Friendly Chargebacks

A type of fraud that has become increasingly common over the past 10 or so years is called friendly fruad. Friendly fraud is where a legitimate customer requests a chargeback to avoid paying for a good or service while at the same time having no plan on returning the product back to the merchant. Because of certain chargeback protections that favor the consumer, this is still something that many businesses experience. In the case of frindly fraud, if a merchant loses the chargeback, they can use the legal system. either by filing a police report, or can use the small claims or regular court system in effort to try and recover either the payment or the goods that were provided. This can be costly in itself, so it’s a good idea to be 100% sure that friendly fraud has occurred and the cost of goods is worth the time and effort to try and recover.

Retrieval Requests

Before initiating certain chargebacks, the issuer may require a copy of the electronic data or copy of the draft associated with a transaction to substantiate a chargeback. If proper documentation is not given to the issuer, the retrieval request will then move into a chargeback status, and depending on the reasoning behind the retrieval request, the merchant may not be able to win if they didn’t reply to the initial request. Treat retrieval requests like chargebacks if you ever receive one.


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