eterans of this industry will tell you that when you are promised "lifetime" residuals, make sure the processor or bank offers something more than the lifetime of a fruit fly. With all due respect to banks and processors, very few of them will take the time to walk you through the termination provisions of your ISO agreement or show you just how many loopholes and trap doors exist that allow them to stop paying residuals.

I advise readers to read these provisions closely and really reflect on how they will affect a steady flow of residuals.

In negotiating approximately 100 ISO deals over the past 18 months, I have learned that the termination rights of a bank or processor will vary widely from one deal to the next. ISOs are also often uninformed as to what they can really ask for when negotiating these provisions.

The purpose of this column is to tell you what a bank or processor is capable of giving. I'm not saying that every deal should be written in this manner, but rather that I have assisted clients in closing deals such as these, and this kind of deal is well within the grasp of many ISOs working with reasonable processors.

Before I get into the substantive points, I want to emphasize that I will not propose anything that is not also reasonable from the perspective of a bank or processor acting in good faith. After all, banks and processors are entitled to important protections that are necessary and expected in any ISO deal.

I have decided to divide ISO residual termination rights into the three categories: 1) bare minimum; 2) negotiable and 3) no-deal rights, as follows:

Bare Minimum

I have never seen an ISO agreement that leaves out the conditions for termination listed under this heading. ISOs with a strong bargaining position, such as those that represent a large portion of the business of a processor, or those that sign at least 200 merchants per month, are often in a position to negotiate a deal where the following three conditions are the only conditions under which residuals may be terminated:

Fraud

An ISO can never expect to continue receiving residuals after it has committed fraud. However, the real bargaining power of an ISO is revealed when negotiations begin over who decides when fraud has occurred.

Most ISOs have deals where the bank or processor determines fraud, which gives them an automatic right of termination without prior notice.

Imagine, however, a more influential ISO that is capable of demanding that an occurrence of fraud can only be determined if a court of competent jurisdiction first determines it. In that case, the burden of going to court and proving a wrongdoing is on the part of the bank that wants to stop paying.

Less influential ISOs have to face the decision of the bank, which acts alone and decides that fraud has occurred. Then they must go to court to prove that there was no fraud and to get the residual payments moving again.

Few ISOs are able to mount this kind of legal challenge when they have lost their residual payment stream. Consider, therefore, which party should prove fraud or absence of fraud.

Material Violation of a Material Rule

Most ISO agreements are made subject to the "Rules" (i.e. the Visa and MasterCard standard operating rules). Few ISO agreements make it an obligation for the bank or processor to actually inform the ISO of the content of the Rules.

This gives most ISO agreements a kind of surreal element to them; as if ISOs had to swear allegiance to the "King of the Associations" without knowing what edicts that king might bring down from time to time in the Rules.

I have written to senior counsel at both Visa and MasterCard asking them to motivate their members to change this part of the business, but I have not yet noticed any material change in the vast majority of ISO agreements.

Now that I have finished my rant about the Rules, I can get back to the focus of this section, which is to say that no ISO will get away with keeping its residuals if it violates, in a material manner, a material Rule.

There is, of course, room for debate over what is material and what is not. When you agree to this kind of a clause, remember that the Rules sometimes refer back to the ISO agreement. As such, a minor violation of an ISO agreement might be construed as a violation of the Rules and will give a bank a right to terminate residuals.

Competition

No ISO should expect to continue receiving residuals if it is intentionally and actively taking merchants from the bank serving as its principal source of residuals. This is like biting the hand that feeds you.

Be careful to look closely at non-competition and non-solicitation clauses to see that they are not broader than they need to be.

For example, I recently negotiated opposite a major East Coast processor that wanted to make any contract between the ISO and a merchant a violation of the non-compete clause.

This was simply going too far. For example, if the ISO wanted to sell carpeting to the merchant without interfering with the merchant's relationship with the processor, the ISO would be in violation of the ISO agreement.

Don't forget, banks and processors are allowed to make good deals that make sense, so don't hesitate to ask for one.

If you sign an ISO deal and the three conditions listed above are the only conditions under which your residuals can be terminated, then consider yourself lucky and among the top 10% of ISOs in the nation.

Negotiable

The following conditions for termination of residuals are acceptable under the right business circumstances. These are the kinds of conditions that, after negotiation, can be removed or added to an ISO agreement. None of them are absolutely necessary unlike the three listed above.

Any Rule Violation

ISOs sometimes forget that banks are required to comply with the Rules just like ISOs. When an ISO is in material violation of a material Rule, the sponsoring bank of the ISO places the bank's membership in Visa or MasterCard in peril.

This is why the banks are so serious about Rule compliance. As a consequence, it's understandable that some banks will make any Rule violation grounds for terminating residuals.

However, there are a few pieces of middle ground to think about before accepting such a harsh clause. For example, consider an obligation on the part of the ISO to indemnify the bank for fines imposed on the bank on account of ISO breaches of the Rules.

Similarly, a cure period, a period of time defined in a contract for the defaulting party to fix the problem, is reasonable for minor Rule violations.

Breach of ISO Agreement

There are some breaches, such as material violations of non-compete clauses, which are unquestionably a reason to terminate residuals. However, if an ISO fails to adequately train one merchant in violation of its obligation to train merchants under the ISO agreement, then that, in my view, should not be grounds to terminate residuals.

Take time to reflect on which kinds of breaches should entitle the bank to stop paying residuals. Similarly, don't forget the other side of the coin, which is to consider which kind of breaches by the bank will allow the ISO to move the portfolio elsewhere. I'll discuss that topic at length in another column.

Cure

The length of the cure period for the various kinds of breaches is a negotiated point and should correspond to a reasonable treatment of both parties. In other words, if the ISO answers the phone with the wrong name once, I do not think that is a circumstance in which the bank can terminate without advance notice and a cure period of at least 30 days.

No Deal

The following conditions for termination of residual rights often appear in ISO agreements, and I would reconsider signing any ISO deal that contains the following:

Termination for Any Reason

Believe it or not, some ISO agreements allow banks to terminate residuals for any reason whatsoever. This kind of wording usually appears in agent or sub-agent agreements of less reputable businesses. I recommend thinking twice about doing business with anyone who proposes a contract with this kind of wording.

Any Violation of ISO Agreement

If there is absolutely no limit on the kind of ISO agreement breach that gives rise to a right to terminate residuals, then the bank is left, in my view, with more power than it should reasonably expect to have. A reasonable ISO agreement should enumerate at least two classes of ISO breaches; those that entitle the bank to stop paying residuals and those that do not.

Unintentional Competition

Suppose an agent under an ISO, who is not exclusive to the ISO, takes a merchant from the ISO's bank to another bank without knowing that the merchant was with the ISO's bank. This kind of potential breach of the ISO agreement by an agent of the ISO is not the kind of activity that a reasonable bank should be able to rely on to terminate residual payments.

By no means is this discussion meant to be exhaustive. Instead, it's meant to stimulate thought and provoke banks and ISOs into thinking about drafting and agreeing to deals that are fair for both parties and make good business and legal sense.

At the end of the day, the more severe the termination clause, the less attractive the bank becomes. In my view, it makes good business sense for banks to propose reasonable termination clauses.

Unreasonable clauses will win banks and processors a few portfolios for little consideration, but, in the long run, those entities, and the individuals directing them, loose credibility in the industry. As veterans of the industry will tell you, credibility is worth a lot more than all the residuals put together.

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.