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September 10, 2012

What the Credit Card Settlement Means to You

On July 13, 2012, Visa and MasterCard, along with 13 banks, agreed to settle an anti-trust class action lawsuit that accused them of fixing the prices paid by merchants for MasterCard and Visa transactions. The settlement attracted attention because the value of the settlement is approximately $7.25 billion, and the plaintiffs' attorneys who obtained the settlement proclaimed a great victory for American consumers. Several of the plaintiffs immediately protested the settlement, however, and claimed that it accomplishes nothing. What really happened?

Swipe fees. The background of the lawsuit rests in the process that occurs between the time the consumer makes a purchase with a Visa or MasterCard and the time the consumer pays his or her credit card bill that comes from the financial institution that supplied the card. First, the consumer's purchase creates an obligation by the consumer to pay the purchase price. The selling merchant is the first person to hold this obligation. The merchant does not collect this obligation directly from the consumer; instead, the merchant sells the right to collect this obligation to an "acquirer" or "acquiring bank," for an amount that is usually about 1.5% to 3% less than the face amount of the obligation. Thus, the merchant might actually receive 97 cents out of every $1.00 sold to the consumer, and the discount is referred to as a "swipe fee." For many small retailers, the swipe fees are their third-highest cost, after rent and payroll.

After the acquiring bank buys from the merchant the right to collect on the consumer's payment obligation, the acquiring bank sells the right to Visa or MasterCard for a little more than the acquiring bank paid, but still less than the face amount of consumer's payment obligation. Next, Visa or MasterCard sells the right to collect on the consumer's payment obligation, for a slightly higher price but still less than the face amount, to the financial institution (the "card issuer") that issued the MasterCard or Visa card to the consumer. Finally, the card issuer sends a bill to the consumer for the face amount of the payment obligation, at which point, the card issuer hopes, the consumer is in a position to pay the amount described on his or her credit card bill as the "minimum amount due" and does so. In this payment process, each of the intermediary financial institutions, including MasterCard and Visa, have taken a small cut of the original purchase price. Economists studying credit payment systems speculated that swipe fees were being kept at artificially high levels and that one result is that banks and other financial institutions compete with each other to obtain MasterCard and Visa business, such as by offering customers credit card reward programs.

In 2005, several retailers, including Kroger Co., Safeway Inc. and Walgreen Co., filed antitrust lawsuits alleging that swipe fees were too high because Visa, MasterCard, and 13 major banks had allegedly formed a combination to eliminate competition in the payment process. The lawsuits were consolidated into one proceeding under the caption In re Payment Card Interchange Fee and Merchant Discount Litigation, 05-MD-1720, in the U.S. District Court in the Eastern District of New York in Brooklyn. Before the settlement agreement was announced, the proceeding had been scheduled for trial, starting in September, 2012.

The settlement agreement provides for an eight-month reduction in the swipe fees, having an estimated value of $1.2 billion, plus cash payments to members of the plaintiff class of retailers of $6.05 billion.

Checkout fees. A major consequence of the settlement agreement is the possibility of "checkout fees." Up to now, MasterCard and Visa have prohibited merchants from adding a fee when a customer pays by means of a MasterCard or VISA, although their standard agreements do not prohibit merchants from offering a discount for payment in cash. In the antitrust lawsuit, the plaintiffs called this prohibition the "No-Surcharge Rule," and alleged that the defendants imposed the No-Surcharge Rule on merchants so that consumers, who are not surcharged if they pay by credit card, have no reason to seek less expensive payment methods.

In the settlement agreement, Visa and MasterCard agreed that they would to end their No-Surcharge Rule, and merchants who wish to do so will no longer be prohibited by Visa or MasterCard from charging a fee upon customers for using the card.1 The allowed fee, sometimes called a "checkout fee," will remain limited to an amount equivalent to the swipe fee paid by the merchant.

Checkout fees will not necessarily be appearing soon. Ten states, including New York, prohibit them by state statute.2 In the other states, the No-Surcharge Rule imposed by Visa and MasterCard will not end until the settlement agreement is approved by the court where the antitrust lawsuit is pending, which is estimated to occur in early 2013. Because in most cases the checkout fee will be 3% or less, it is too early to tell whether consumer resistance and increased bookkeeping expense will prevent merchants from charging checkout fees.

Debit cards. The case and the settlement do not involve debit cards. The payment process for debit cards is subject to a different legal regime. Under the "Durbin Amendment," an addition to the Dodd-Frank Act of 2010, merchants are prohibited from imposing a charge upon customers for use of their debit cards. Further, the fees that any "large" bank – defined to be a bank with total assets of $10 billion or more may charge merchants to reimburse a debit purchase are capped by regulation by the Board of Governors of the Federal Reserve System (the Federal Reserve Board).

What About Other Credit Cards? American Express, Discover, and other card companies are not parties to the settlement agreement and should be affected only indirectly, if at all. Interestingly, the standard American Express and Discover agreements with merchants contain nondiscrimination provisions stating that, if the merchant adds a checkout fee for using their respective card, then the merchant must charge the same checkout fee for all credit cards.

What happens next? The settlement agreement is far from final. The settlement agreement allows Visa and MasterCard to cancel the agreement if merchants having 25% of credit-card sales volume choose not to participate. The National Association of Convenience Stores (NACS) and Wal-Mart Stores, Inc. have expressed their opposition to the settlement. One of their objections is that approval will permit Visa and MasterCard to raise their swipe fees in the future without merchants having recourse. If enough other merchants join with NACS and Wal-Mart, then MasterCard and Visa might cancel the settlement. Whether or not opposition to the settlement agreement reaches 25%, the settlement agreement will not be effective until it is approved by the U.S. District Court where the case is pending, estimated to occur by early 2013. Approval by the District Court can be appealed, in a process that could take years.

Conclusion. The Visa and MasterCard settlement could have a significant effect on how the costs of processing credit card payments are paid. The antitrust lawsuit was based on the premise, which was only alleged and not proven, that swipe fees were kept artificially high and, incidentally, hidden from consumers. The settling plaintiffs claim that swipe fees will go down and be more visible to consumers. Depending upon how consumers react to the possibility of paying more for a purchase when they use a credit card, or less when they pay cash, the settlement could initiate a reversal in the consumer trend of recent past decades to substitute plastic and electronic payments for cash.

For further information, please contact Christopher J. Bonner at Hiscock & Barclay, LLP.


1It should be remembered that the allegations of the plaintiffs have not been proven or disproven at trial.

2 New York General Business Law, § 518. Paradoxically, merchants are permitted under New York law to offer a cash discount, as long as the pricing difference is clear and conspicuous and as long as the difference is called a cash discount rather than a surcharge for using a credit card. 



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