n ISO in New Hampshire recently asked me to review one of its new ISO agreements in which the processor claimed that the deal was a 0% liability deal for the ISO. However, the wording of the first draft of the processor's proposed agreement said that the ISO was liable for "any loss incurred by processor or member for any reason attributable to a merchant, including without limitation, losses due to Association fines, chargebacks, fraudulent practices of a merchant, merchant ACH rejects, returns, credits or fees and other uncollected amounts due from merchants."

The processor was in effect asking the ISO to sign an agreement that made the ISO liable for 100% of losses. The ISO admitted that it genuinely believed the agreement to be a 0% liability deal, but it did not understand the terms of its own agreement.

This event has inspired me to write on the subject of liability. Keep these five points in mind when considering your liability under an ISO agreement:

1. Talk First, Sign Later

   Before a processor drafts (or an ISO reads) an ISO agreement, both parties would greatly benefit by having a frank and open discussion about which party carries exactly what liabilities for which losses.

   I advise any reader of this column to take written notes during these types of conversations. In your notes, indicate the date on which the conversation took place and the name of the representative from each company involved in the discussion. In the unlikely scenario that you have to interpret ambiguous contract terms signed after negotiations take place, you may find these notes extremely useful (perhaps even as evidence in a trial) for proving the intention of the parties to the agreement.

   For example, in the situation described above, if my client signed the 100% liability agreement, the client may have been in a position to argue that, notwithstanding the written agreement, the parties never agreed to that distribution of liability because all of the negotiations contemplated a 0% deal.

   Needless to say, you should never sign a deal unless it's the deal you actually want.

2. Ask Your Mother to Read the Liability Clause

   As one of my professors in law school used to say, if your mother can't understand your drafting, then your drafting is no good.

   ISOs often do not realize that the terms of an ISO agreement are negotiable. If the liability clause in your ISO agreement doesn't make perfect sense to you, it will make less sense to a judge who knows very little about the industry. That judge may have to interpret those vague clauses that could potentially cost you your business-or more. Processors usually have enough resources to retain qualified legal counsel in order to draft clear agreements. You should be aware of this, and you should not hesitate to improve upon the many poorly drafted ISO agreements out there.

3. Allocation of Liability

   I believe there is currently no industry standard concerning liability. Whether an ISO takes all, none, half or some other portion of the liability for losses, it is a business issue for the processor and ISO to reflect on and negotiate.

   Pricing will vary according to the liability assumed. It is recommended that a party carry out an amount of due diligence on merchants that is commensurate with the portion of liability that it takes.

   For example, if an ISO carries no liability, then there is less interest on the part of the ISO to do due diligence on merchants. In contrast, a processor assuming full liability owes itself a commonsense business obligation to carry out a thorough due diligence on each new potential merchant. Make sure that the agreement you sign reflects your understanding of the deal you made.

4. Payment

   Very few ISOs pause to consider how they will pay for any liability they incur under an ISO agreement. I propose the following as a useful model: If the loss for which the ISO is liable is less than $5,000, then the amount should be automatically deducted from residuals owed to the ISO, or from the reserve account maintained in the ISO's name, with documentation of the deduction sent from the processor to the ISO.

   If the loss for which the ISO is liable is equal to or greater than $5,000, then the processor should send an invoice for the amount to the ISO, giving the ISO: (a) a reasonable delay, such as 30 days, within which to pay the amount and (b) a choice as to whether the ISO wishes to have this amount deducted from its residuals or to pay the amount by check.

5. Claims Against Merchants

   Never forget that, technically, merchants are liable for most of these losses. Of course, it's easier for a processor to cover its losses by deducting them from ISO residuals than by suing errant merchants. However, I highly recommend that ISOs obtain the right from processors to sue merchants directly for any and all losses for which the ISO has indemnified the processor.

   I have yet to find a processor that has not agreed to this concept in principle. When closing deals with merchants, I would also recommend giving them clear information as to their liability under their merchant agreement. Make it hard for merchants to say they were not aware of this risk they are carrying.

On a final note, I recommend that you discuss with your accountant the extent of your liability under your ISO agreements.

Liability under an ISO agreement is like liability and risk under any other kind of agreement-it should be planned for and accounted for with due care and attention.

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 by e-mail: atlas@adamatlas.com or by phone: 514-842-0886.