Card Association rules and regulations deem a wide range of business models inherently high risk. In addition to the obvious suspects such as adult-oriented Web sites, escort services, gambling Web sites and Internet pharmacies, this designation also applies to travel-related businesses, jewelry stores, car rental agencies, computer and consumer electronics vendors, and even attorneys.

MasterCard International considers all e-commerce high risk. Given the low chargeback threshold for domestic processing, as well as the difficulty of domestic placement for many merchants with past processing problems, an increasing number of high-risk merchants are turning to offshore processors.

The offshore allure

Processing offshore presents advantages. Despite its attractive qualities, however, offshore processing remains rife with obstacles and risks. Let’s discuss the potential benefits first. The biggest advantage is clear: Offshore processors will take merchants who simply cannot use domestic processors, whether due to business model, excessive chargeback rates, termination by a prior processor and/or placement on MATCH (an acronym for Member Alert to Control High Risk, a database used by acquiring banks to identify terminated merchants).

High-risk merchants processing offshore may also benefit from more lenient rules governing chargeback levels. For instance, Visa U.S.A. rules set a monthly chargeback limit of 1%, forcing many online and MO/TO merchants to expend extensive resources to minimize chargebacks.

Offshore processors are not bound by the same rules as their U.S. counterparts: The chargeback level permitted for comparable Visa transactions internationally is 2%, double the U.S. threshold. This enables merchants to shift resources from chargeback management to other areas.

In addition, many offshore jurisdictions offer tax and other financial incentives to entice merchants’ business away from U.S. banks. Many also have less stringent obscenity laws; this offers certain businesses a comfort level they cannot achieve domestically.

Buyer beware

Offshore processing has downsides. Plainly, the biggest disadvantage is the cost: Offshore processors and aggregators frequently charge astronomical discount rates of 12% to 15%, along with hefty transaction and chargeback fees. The buy rates for merchant level salespeople (MLSs) are similarly high.

In addition, Visa and MasterCard generally look upon offshore processing with disfavor; card Association rules strictly limit the conditions under which offshore processing can take place. Visa rules prohibit cross-border processing entirely, unless the enterprise actually conducts a portion of its business abroad.

Moreover, merchants who violate these rules face stiff fines, penalties and the possibility of being prohibited from processing at all. (Resourceful merchants can circumvent these limitations without running afoul of card Association rules by incorporating, and employing at least some personnel, offshore.)

Who’s behind the magic curtain?

Merchants who process offshore must also be wary of unscrupulous processors in countries that have strict privacy laws. Offshore processors don’t generally publicize (and often refuse to disclose) the identity of their acquiring banks. Thus, unsuspecting merchants may not learn of a processor’s precarious position until it is already too late.

Some offshore merchant agreements fail to identify not only the acquirer but also the individuals running the processor. This is because many offshore processors are unregistered and aggregating transactions in the name of another processing entity. Since risk is calculated based on an evaluation of a merchant’s business model, aggregated accounts are extremely risky due to the potential for contamination by a single “bad” merchant. Visa sets strict rules for aggregating, and MasterCard does not allow it.

Nevertheless, an otherwise vigilant business may discover too late that it is part of an aggregated portfolio and lose its ability to process when another merchant’s transactions exceed the portfolio’s chargeback limit and cause the entire account to collapse.

Snooze and you lose

Businesses processing offshore sometimes encounter administrative delays. Delayed processing leads to delayed payment; this causes cash-flow problems. Merchants often receive chargeback reports in an untimely or inconsistent manner as well, which can prevent them from contesting chargebacks.

Such shoddy reporting practices can cripple a merchant’s implementation of chargeback reduction measures, possibly resulting in a merchant’s termination and placement on MATCH. In addition, while domestic processors generally offer merchants real-time online viewing and reporting, offshore processors often cannot do so. This makes it more difficult to monitor transactions and thereby sets the stage for belated discovery of problems.

Merchant agreements for offshore processing also frequently contain choice of law and venue provisions. These provisions dictate which country’s laws will govern disputes pertaining to the contract and specify the country and court where disputes must be resolved.

A U.S. merchant entering an agreement containing such provisions may be proscribed from turning to U.S. courts for relief. Thus, it may be extremely difficult to enforce rights because of provisions that force the merchant to locate and retain counsel in the appropriate jurisdiction familiar with the applicable law. Obviously, the difficulties of trying to sue and collect from entities based in such places as Cyprus, Lebanon and Gibraltar are legion. Even the preliminary steps of locating counsel and initiating suit can prove to be so costly and time-consuming that many merchants merely walk away.

Don’t throw caution to the wind

Merchants need to approach offshore processing with wary eyes: In truth it is best suited only for merchants who cannot get a domestic account, or for strong-stomached, calculating merchants who want to exploit card Association rules and live at the chargeback precipice.

In any case, merchants and MLSs should do business only with reputable processors and make sure they know the names of the individuals running the processor, as well as the identity of the acquirer handling the account. Finally, as always, a merchant must carefully review and make sure to understand the complete terms and conditions before entering any merchant agreement.

The information contained in this article is for informational purposes only. Please consult an attorney before relying upon it for your specific legal needs. Theodore F. Monroe is an Attorney whose practice focuses on the electronic payment and direct marketing industries. For more information about this article or any other matter, please e-mail Monroe at [email protected]