Choice wins residual benefits after costly battle with EMS

As a June 3, 2019, ruling by U.S. District Court makes clear, contract disputes between ISOs and sales channel partners can be lengthy and expensive, especially those involving termination for cause. At issue is a contractual disagreement between Cleveland, Ohio-based Francis David Corp., d/b/a Electronic Merchant Services (EMS), and EMS channel partner Infinity Capital LLC and John Paul Golino, d/b/a Choice. The parties disagreed about residual payments and operating terms, according to court documents.

In rendering his opinion, U.S. District Court Judge James S. Gwin, Northern District of Ohio, noted that Choice joined EMS in 2010 and became a top producer for the ISO. Disputes can be traced to 2016, when the parties renegotiated their agreement.

At that time Choice, the plaintiff, sought, and EMS, the defendant, agreed to change their contract to allow Choice to sell for other processors. Choice continued selling for EMS, but also sold other companies' processing services, as well as some processing services of its own. In 2018, the defendant terminated its relationship with the plaintiff.

At issue in this case is whether the parties' agreement required EMS to continue paying Choice residuals for merchants that Choice brought to EMS. Choice believes it does; EMS disagrees. Also at issue is whether the 2016 amended agreement permitted Choice to sell its own credit processing services to the customers it brought to EMS when the additional services did not reduce EMS customers' processing levels. Put another way, the question is whether Choice could sell EMS Merchants additional processing capacity that EMS declined to provide.

The parties were at an impasse over these issues. Choice claimed EMS breached the amended agreement when it stopped paying residuals to Choice. EMS claimed that Choice “wrongfully solicited its merchant customers,” according to the court.

Central to case: a non-solicitation clause

Judge Gwin cited a non-solicitation clause in the contract as central to the case. The clause stipulated that Choice agreed not to solicit EMS merchants, directly or indirectly, for anything other than training or support, without the express permission of EMS. Choice also agreed to refrain from getting any existing EMS merchant to terminate or reduce a relationship with EMS.

“Under the Amended Agreement EMS was generally required to continue making residual payments so long as the merchant customers that Choice brought to EMS continued using EMS services,” Judge Gwin wrote. “However, the Amended Agreement included a penalty provision, the loss of the residual, if Choice violated the non-solicitation provision.”

In 2018, Chesapeake Bank attempted to purchase residual streams from Choice. As part of its negotiations with Choice, Chesapeake Bank sought to change the amended agreement to better protect Chesapeake's continued right to the residual stream. EMS rejected those changes and the Choice-Chesapeake Bank sale of Choice's residual rights collapsed.

The next day, EMS accused Choice of breaching the amended agreement's non-solicitation provision by providing services to an EMS merchant. Choice responded that it had only provided secondary sourcing to EMS merchants, arguing that the amended agreement allowed secondary sourcing for EMS customers as long as it did not reduce EMS's processing volume. EMS then terminated the amended agreement and ceased paying residuals to Choice. Both parties sued separately, and the court consolidated the cases.

A split decision

The court partially granted and partially denied Choice’s breach of contract claim. Contract damages seek to compensate actual harm, not punish breaches or deter them through the looming guillotine of draconian damages. Thus, contractual penalty clauses are unenforceable, the court determined.

However, the judge also found the residual termination clause to be an unenforceable penalty. Thus, the court concluded EMS had no right to terminate Choice’s residual payments and by doing so breached the amended agreement. Noting that residual payments are subject to fluctuation, the court concluded that “fluidity makes valuation tricky, but not impossible.” Basing its valuation on Choice’s monthly residual stream of $133,000 and factoring in a 2 percent merchant attrition rate, the court, ruling in favor of the plaintiff, ordered EMS to pay a total of $5,527,791.29, plus attorney fees, to Choice.

Adam Atlas, Attorney at Law, pointed out that the case illuminates several key matters in the payments industry: non-solicitation clauses, lifetime residuals and agent agreement terminations.

"Perhaps the most striking part of the case is the ruling that a termination of all residuals for a technical violation of the non-solicitation clause is actually a penalty and unenforceable,” Atlas stated. “In other words, the punishment of losing all residuals does not fit the crime of moving a handful of merchants. This Ohio law decision may be informative for courts in other states considering the question of whether a non-solicitation violation is grounds to terminate all residuals."

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