By Adam Atlas
Attorney at Law
When should you begin preparing for the day you'll sell your rights under an ISO agreement? The day you sign the agreement. I have written previously about key things to consider in a portfolio sale, such as pricing, service, nonsolicitation provisions and purchase price payment schedule. I thought it would be helpful to share a few of the portfolio-sale snafus I've seen over the years so that you can avoid them in your portfolio sale transactions.
If the deal closes on May 15, who gets paid April residuals payable in May, and who gets May residuals payable in June? Sellers must clarify this issue when negotiating, drafting and closing buyout transactions.
Note that negotiations can go on for weeks, making the anticipated closing date and final residual payment to seller incorrect. Take a moment in preliminary negotiations to arrive at an understanding of the rules on which the parties agree for the last residual payment.
Most sellers have a purchase price holdback that applies to their transactions. The holdback is paid to the seller over time and may be reduced in correlation with the amount of attrition in the portfolio sold.
If the portfolio meets the performance goals the parties agree upon and generally expect, the entire holdback is to be paid. However, if the portfolio does not meet those goals, the seller loses rights to the holdback, either in part or in total.
Thus, the seller needs the portfolio to be well taken care of after the sale and will sometimes agree to service the portfolio for the duration of the holdback period. What happens if the portfolio is neglected during that time? Attrition - and perhaps the seller will be forced to forfeit the balance due on the sale.
Sadly, I have witnessed some purchasers neglect purchased portfolios, causing dire consequences for the sellers. Sellers must ensure that their buyout agreements require undertakings by buyers to protect purchased portfolios during the holdback period.
How is attrition calculated? Both the basis of attrition (for example, merchant count versus revenue) and the method of calculating the attrition (for example, a benchmark against a set of declining monthly goals or annual goals) are variable.
There is no single way to correctly calculate attrition. There are, however, clear and less clear ways of explaining in a buyout document how attrition should be calculated.
All parties should agree that the language in all sales documents must be clear and understood by both parties before closing. I have seen buyout clauses that leave sellers very surprised at how little rights they have in a balance of sale because they misunderstood the attrition calculation clause.
One good way to solve this issue, in addition to clear language in the agreement, is to attach a kind of amortization schedule that states the actual merchant count or dollar amount of residuals that are expected to be generated by the portfolio.
Some sellers sell their credit and debit card residuals but believe they can hold on to gift card, lease, annual fees or other ancillary service fees. This could result in a serious misunderstanding with purchasers. People purchasing portfolios generally do not like sellers to hold on to trailing payments from portfolios that they sell.
That said, good reasons often exist for a seller to hold on to some fees, and if that is the case, that arrangement must be part of the clear understanding with the purchaser.
For example, I advised in a case involving a seller who had a lower pci Payment Card Industry (PCI) Data Security Standard (DSS) price than the purchaser, so it made sense for the seller to keep supplying PCI services to the merchants for the term of the purchase price holdback period.
Again, the imperative here is clear drafting of the applicable purchase agreement sections so that neither party is surprised following closing. Purchasers, in particular, can be very edgy when they see merchants in a portfolio they bought making payments to the seller of the portfolio after closing.
I have seen a number of transactions close well after their intended closing date because the processor was not prepared far enough in advance of the deal. It's unrealistic, for example, to expect a processor to consent to a portfolio assignment within hours of learning of it. As a seller, you must know the details of your ISO agreement and carefully plan and coordinate your portfolio sale with all parties involved to be sure a workable schedule is established. Processor consent for the release of portfolio information is likely necessary at the time the purchaser begins due diligence, which is long before closing.
Also, many ISO agreements contain a right of first refusal on the part of the processor to acquire the portfolio. While these rights are rarely exercised, ISOs still must follow the terms of their agreements by making an offer to the processor before attempting to close a sale. ISO agreements also contain confidentiality clauses; sellers should be careful not to violate those clauses when shopping their portfolios.
Sellers who commit to bring a certain number or volume of merchants to a purchaser will enjoy a higher purchase price. However, placing merchants at one ISO can be very different from placing them at another.
It is not unusual for sellers to make substantial commitments to purchasers regarding the number or processing volume of merchants they will place with the purchaser as a condition to the payment of a certain balance of sale or holdback.
However, if you commit to place 100 merchants per month, but half of your merchants are declined, you will have signed up for a commitment that is exceedingly difficult to sustain. I have seen sellers with huge disappointments in this regard. One possible solution is to do a trial run with the new ISO for a few months before agreeing to a sale.
In publishing The Green Sheet, neither the author nor the publisher is engaged in rendering legal, accounting or other professional services. If you require legal advice or other expert assistance, seek the services of a competent professional. For further information on this article, email Adam Atlas, Attorney at Law, at atlas@adamatlas.com or call him at 514-842-0886.
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