o matter where you find yourself in the chain of participants in the processing business -association, bank, processor, ISO, sub-ISO, MLS or merchant - at one point or another, you are very likely to have reserves on your mind.

A reserve, often referred to in agreements as a "reserve account" or a "holdback," is typically a varying amount of cash withheld by one party in a processing or sales relationship in order to protect itself against losses for fraud, chargebacks, association fines or other losses. The purpose of this column is to highlight certain issues that every participant in the electronic transactions business should keep in mind when negotiating or dealing with a reserve account.

1. Which Reserve Account? Never forget that between the acquiring bank and the merchant, and all ISOs in between, there could be as many as four or more separate reserve accounts. When there is fraud involved in a merchant account, one of those reserve accounts is drawn upon. No matter which entity you are, make it your business to inquire which of the reserve accounts is being drawn upon. For example, suppose you are an ISO with 100% liability, and the bank that you are indirectly selling for maintains: (a) a reserve account for each merchant you sign-up and (b) a separate reserve account on amounts owed to you.

   If a merchant sends through $10,000 worth of fraudulent transactions, which reserve account do you think should be debited first, yours or the merchant's? I assume that you would prefer the merchant's reserve account be the first line of defense in protecting your interests. If you are a processor, you also have an interest in your bank debiting the merchant reserve account before yours. It is critical for all parties to know which reserve account is at issue at all times.

2. Which Agreement? Once you have identified the reserve account in question, consider which agreement governs that reserve account. For example, if it is a merchant reserve account, terms governing that account will most likely be defined in the agreement between the applicable bank and merchant.
3. Due Diligence. Every participant in the business profits from the reserve account being set at the right level. The reserve account must not be so low as to leave the bank, processor and ISO (who is liable) unprotected. However, the amount on reserve should not be so high that it will be cost-prohibitive for the merchant. Each participant in the business benefits when appropriate due diligence is undertaken at the outset; the nature of the merchant' business and the appropriate amount of reserve account should be set out from the beginning.

4. Adjustments. Banks and processors are sometimes quick to increase a reserve account balance, but slow to reduce the same account. It makes good business sense for banks and processors to monitor larger reserve accounts and take steps toward reducing them when it is reasonable to do so. This kind of proactive customer service will build loyalty. Live reporting of all relevant reserve accounts should be the industry standard.

5. Talk First. Before taking any drastic action with respect to a reserve account, all parties concerned should have a conversation. I have seen many good merchant-bank and ISO-processor relationships fall apart because of poor communications over one or two merchant reserve accounts.

   All parties concerned could save tens of thousands of dollars or more, for example, simply by discussing whether to double or empty a reserve account. Remember, the personal relationships in this business are far more valuable than the sum of all reserve accounts.

6. Interest. It would be fruitful to consider who should keep the interest earned on reserve accounts. A number of processors hold tens of millions of dollars, if not more, of reserve accounts for ISOs. By law, those monies have often already been earned by the ISOs, but are kept simply as security for the processor. ISOs should speak with their processors, and processors should speak with their banks about shared entitlement to interest on those reserve accounts.

7. Merchant Termination. Educate merchants to claim what is rightfully theirs in a reserve account following termination.

8. ISO Termination. Educate ISOs to claim what is rightfully theirs in a reserve account following termination.

9. Rights on Transfer. When an ISO portfolio is transferred from one processor to another, consider what happens to the reserve account left at the old processor, especially following the 180 days standard hold period for such reserve accounts.

10. Avoid Using It. By undertaking the right due diligence and following up with subsequent adjustments and adequate communication between all parties, a reserve account ideally should go untouched for the entire term of the applicable agreement.

Like all safety equipment, reserve accounts are helpful to all concerned, when properly used. When misused, they can be catastrophic to an otherwise healthy business relationship. As usual, I advise to proceed with caution and to keep the lines of communication open.

In publishing The Green Sheet, neither the author nor the publisher is engaged in rendering legal, accounting, or other professional services. If legal advice or other expert assistance is required, the services of a competent professional should be sought. For further information on this article, please contact Adam Atlas, Attorney at Law e-mail: atlas@adamatlas.com; phone: 514-842-0886.