Your Contract Doesn’t Protect You: Recent Decision Should Make You Worry About Your Merchant Reserves

You are a merchant who does everything by the book. Should you have reservations about merchant contracts, especially how they treat reserves?

Almost certainly, yes.

Reserve provisions enable processors to keep a portion of funds from a transaction in a separate account, held at an acquiring bank until the risk of trailing liability ends.

Acquiring banks and processors rely on reserves to protect themselves against potential liability from credit card chargebacks and other disputed transactions. Reserve provisions enable processors to keep a portion of funds from a transaction in a separate account, held at an acquiring bank until the risk of trailing liability ends. A merchant agreement not only defines who owns the reserves, but how long they may be held by the acquirer post-termination before distribution to the merchant.

Until recently, banks and processors could feel relatively secure about the protection offered by standard reserve provisions. Yet the recent decision in Federal Trade Commission v. MOBE Ltd., Case No. 6:18-cv-862-Orl-37DCI (M.D. Fl. Aug. 8, 2018) suggests that things may not be as straightforward as they seem when it comes to the question of who owns and control merchant reserves. Qualpay and Synovus Bank learned this the hard way when the Court construed the apparent ambiguity in their merchant agreement regarding this question against them, and held that the merchant owned the reserves.

The recent decision in Federal Trade Commission v. MOBE Ltd., Case No. 6:18-cv-862-Orl-37DCI (M.D. Fl. Aug. 8, 2018) suggests that things may not be as straightforward as they seem when it comes to the question of who owns and control merchant reserves.

This ruling came about after the Federal Trade Commission obtained a temporary restraining order (“TRO”) against MOBE Ltd., an allegedly fraudulent business education program, and other related parties. The Court entered an order enjoining defendants’ unlawful conduct, freezing their assets, and appointing a receiver. The TRO included an asset freeze that covered “reserve funds held by payment processors, credit card processors, merchant banks, acquiring banks, … third party processors, … or other entities[.]”

Even though the processors and banks were not parties to the litigation, the FTC and the court-appointed receiver took the position that the reserve funds being held by them were equally subject to the TRO.

Qualpay and Synovus Bank sought emergency relief from the TRO on the grounds that the reserve funds were their property, under their control, and should therefore be excluded from the asset freeze and turnover order. The Court rejected this position, and held that the reserve funds constituted MOBE’s property and were therefore subject to the TRO.

The FTC and the court-appointed receiver took the position that the reserve funds being held by them were equally subject to the TRO. 

In reaching this conclusion, the Court focused on the parties’ roles relative to the underlying transactions, and found that the payment processor and acquiring bank are “middlemen” service providers without any entitlement to the net transaction proceeds. The Court also concluded that the merchant agreement was ambiguous with respect to ownership of merchant reserves, and construed this language against Qualpay and Synovus as the drafting parties.

It bears emphasis that the merchant agreement employed fairly standard language that is widely used in the industry regarding the character and ownership of reserves. The Court cited this language, including a clause allocating ownership of the reserves to the merchant, and made additional observations about the parties’ relationship, which favored the reserve fund being turned over to the receiver. For example, the Court observed that Qualpay and Synovus performed due diligence both before, and during, the contractual relationship, which suggested that the money at issue was “akin to collateral.” The Court – which obviously lacked a good understanding of how chargebacks operate – also found that over 180 days had passed since termination, so the risk of chargebacks had likely ended, and MOBE’s contingent interest in the reserve funds had therefore materialized; and thus, the receiver should now have control over those funds, even under alternative theories of ownership.

The Court cited a clause allocating ownership of the reserves to the merchant, and made additional observations about the parties’ relationship, which favored the reserve fund being turned over to the receiver.

The Court seized upon the fact that MOBE was the party granting Synovus a security interest in the reserve account, and held that a merchant can only grant a security interest in something that it owns. The Court also referenced provisions that allowed Synovus to deduct funds from the reserve account if there were insufficient funds in the settlement account, which the Court viewed would not be necessary if the bank owned the reserve account; and noted language that described the reserve account as part of the “property held by Bank.”

Based on the foregoing, the Court observed that Qualpay and Synovus were the “contributing authors to their own misfortune,” and held that any ambiguity in the merchant agreement regarding ownership of the reserve funds must be construed against them as the drafters – not MOBE.

After MOBE, reserves are now fair game for seizure by receivers in FTC cases.

This decision should be a wakeup call to acquirers and processors across the board. Based on over 20 years of experience in the payments industry, I can tell you that the vast majority of merchant agreements employ the same or similar language.

After MOBE, reserves are now fair game for seizure by receivers in FTC cases, and the standard reserves and security clauses present in most merchant agreements are vulnerable to attack, and may be ineffective to protect acquiring banks and processors’ valuable interest in these funds.

This decision should be a wakeup call to acquirers and processors across the board. The vast majority of merchant agreements employ the same or similar language.