by Ben Dwyer All merchant accounts have a contract and a term; some merchant account contracts have an early termination fee.
A contract is a good thing because it provides protections for businesses and processors by clearly outlining the responsibilities of each party under a merchant processing agreement.
A contract term is also a good thing. Without a term, a processor would not be obligated to provide processing services for any length of time. Most businesses would find it very disruptive to lose the ability to accept cards without warning, or to have regular changes to their service.
A fee to cancel a contract before the term expires is a bad thing. Contracts are terms are unavoidable, but avoid early termination fees whenever possible.
CardFellow does not allow processors to charge businesses a fee to cancel a contract regardless of the term, but all processors within CardFellow’s marketplace require businesses to sign a contract that dictates the details of the merchant service agreement. Having the contract to detail the services is good; avoiding fees if you need to cancel is even better.
Addressing Confusion
The ideal merchant account is one that you can cancel at any time without penalty. Business people and processing professionals alike often refer to this type of merchant account as not having a contract, or as having a month-to-month agreement. Both of these declarations are incorrect and create confusion regarding the true nature of merchant account agreements.
To learn why, we need to look at the actual meaning of the key phrases “contract,” “term,” and “termination fee.”
Contract
A contract is an agreement entered into by two or more parties with the intention of creating a legal obligation.
All merchant accounts have contracts (usually referred to as “Merchant Processing Agreement” or “Merchant Services Agreement”) because the contract outlines the responsibilities that the processor and the business have to one another. Contracts are used in a variety of situations, and you’ve likely signed quite a few in your life, whether for your business or personal life (such as for buying a car, or house, or taking loans for college.)
Term
A term is the period of time during which all or part of a contract is in effect.
A merchant account contract remains in effect for as long as a business is processing. If a contract term expires, the processor would no longer be obligated to provide credit card processing services for the business.
Termination Fee
A termination fee is a charge levied when a party cancels or dissolves a contract prior to the end of the contract term. There are different types of termination fees, and different amounts that you can be charged. Regardless, a termination fee is always a fee for ending (terminating) the contract.
The termination fee is the source of the issue, and it is what you want to avoid when entering into a merchant services agreement.
Putting it All Together
A merchant account contract always exists, and it dictates the term of the agreement and the termination fee. For example, which of the following options would you rather have?
A.) A merchant account contract that has a month-to-month term and a $500 termination fee
B.) A merchant account contract that has a 5-year term that automatically renews and a $0 termination fee
It would cost $500 to cancel Merchant Account A regardless of when. However, you could cancel Merchant Account B at any time without penalty.
No Contract Credit Card Processing
All credit card processors have a contract. What people are *really* looking for when searching for small business credit card processing without a contract is a credit card processor that does not charge a termination fee. That is, a contract that doesn’t bind them to a processor for longer than they would like.
Month-to-Month Contracts
The phrase”month-to-month contract” simply means a contract that can be cancelled with a month’s notice. It’s a contract without a long term. It does not automatically mean that there is no termination fee for ending the contract. The term (length) of a contract is inconsequential if there is no penalty to cancel the agreement.
Contract Term
All merchant account contracts will declare the length of the contract term in one of the following three ways.
Open-Ended
In very rare cases a merchant account contract term will commence once the agreement becomes effective, and will continue until cancelled by the processor or business. In the case of an open-ended term, the business would have to pay a termination fee (if one exists) regardless of when it cancels the agreement.
An example of how an open-ended term may be worded in a contract is as follows:
“The initial term of this agreement shall commence after it becomes effective, and it shall continue until we or you terminate this Agreement upon written notice to the other.”
However, these types of contracts are not very common in merchant services.
Fixed
A fixed contract term applies an initial term to the processing agreement. The processor can charge a termination fee (if one exists) if a business cancels the agreement prior to the end of the term. Once you fulfill the initial term, you would be able to cancel the contract without paying a termination fee, provided you do so before any auto-renewing terms kick in.
An example of the language used for a fixed contract term taken from First Data’s Program Guide is as follows:
“… In the event that Client terminates this Agreement within three (3) years from the date of approval by First Data Merchant Services … Client will be charged a fee for such early termination, if so indicated on the Application…”
In this sentence, the processing company is stating that a termination fee may apply if the business cancels the contract within 3 years of the approval of the contract. What is important to realize here is that the contract term remains in effect even after the first three years. Only the processor’s ability to levy a termination fee expires.
Automatically Renewing
Contract terms that automatically renew begin with an initial term, and then automatically renew for successive terms unless they are cancelled within a certain window of time. Automatically renewing contract terms are very common, and they make it difficult for a business to avoid being charged a termination fee, if one exists.
An example of the language used in a merchant account contract for an automatically renewing term is as follows:
“The initial term of this Merchant Agreement shall be for the term of three (3) years (the “Initial Term”) … this Merchant Agreement will automatically renew for successive one (1) year periods … unless a party provides the other parties with notice of its intent not to renew this Merchant Agreement at least ninety (90) days prior to the expiration of the then current term.”
The initial term of this contract is three years, and it automatically renews thereafter for another year unless the business cancels the contract ninety days prior to the expiration of the current term. This means that businesses have a narrow window during which to cancel their contract.
Cancellation Fee / Early Termination Penalty
Termination fees are not created equal, and processors have different motives (some more reputable than others) for charging them.
Why Cancellation Fees Are Charged
Processors charge termination fees for a number of reasons, but the primary function of a termination fee is to guard against losses or to generate profit.
For example, there is a real cost that processors incur to underwrite, onboard, and maintain a merchant account. If a business cancels its merchant account before the processor generates enough profit to cover underwriting expense, the processor will lose money. A cancellation fees guards against this type of loss.
Termination fees also serve as a barrier to attrition (when a business closes it merchant account). A termination fee is one of many tactics that a processor can employ to make it difficult for its clients to switch to a competitor.
Power to Waive Fees
The credit card processing industry is a virtual web of processors, acquirers, independent sales organizations, and independent agents collectively referred to as merchant service providers.
Merchant service providers contract with one another to provide services, and not all merchant service providers have the power to waive termination fees.
Location Within Paperwork
The majority of merchant account contracts declare the amount of a termination fee within the fine print of the agreement. However, some processors declare the amount of the termination fee on the application portion of paperwork, and then refer to the fee from within the merchant account contract.
Don’t assume that a processor does not charge a termination fee simply because one is not visible on the merchant account application. Processors often bury termination fees deep within the fine print. If you don’t see a termination mentioned in either the application or the agreement, ask the processor where to look to verify the amount of the termination fee, if any.
Flat
A flat termination fee remains the same regardless of when you terminate your contract. It does not lessen the closer you are to the end of your contract, unlike some other types of cancellation fees. This can actually be less expensive, depending on when you cancel. If you’re cancelling early in your contract, a flat fee is generally cheaper than a pro-rated fee or a “liquidated damages” fee (explained below) because the early cancellation means a higher variable fee.
Prorated
A prorated termination fee will decrease over time. Here’s an example of a prorated termination fee set forth in a merchant account contract:
“Merchant shall pay … the sum of (i) $350.00 if terminated before completion of the first year of the Initial Term; or (ii) $250.00 if terminated after completion of the first year of the Initial Term …”
Liquidated Damages — Based on Lost Profit
Although any type of termination fee is *technically* a charge for liquidated damages, we reserve the name for a particular type of termination fee that is especially damaging and controversial.
Some processors, such as Pivotal Payments base the termination fee on lost profits rather than a flat dollar amount. For example, if a processor is making $150 a month from a business’s merchant account, and the business cancels the account ten months prior to the end of the term, the business would have to pay a termination fee of $1,500.
You should avoid termination fees when possible. This is especially true of termination fees based on lost profits.
For example: Here’s language used in a merchant account contract for a termination fee that is based on lost profit taken from Pivotal Payments’ agreement:
“Merchant shall pay … damages (“Damages”) representing the greater of: (a) five hundred (500) dollars; or (b) the amount determined by computing the number of months remaining in the Agreement, and multiplying that number by the average monthly fees paid by Merchant.”
In this sentence, the company explains that they will determine the fee based on your actual processing, which can add up fast.
Getting Out of a Merchant Account Contract
The goal in getting out of a merchant account contract is to cancel the agreement without being subject to a termination fee. Since the termination fee is just one clause within the contract, many variables of your individual situation will determine whether the termination fee clause may be nullified.
Your lawyer is the best place to get advice about getting out of a merchant account contract without termination fees.
Enforceable
Merchant account contracts are like any other in that the degree to which they can be enforced depends on a number of variables pertaining to your individual situation. Your lawyer will be able to examine your processor’s contract to determine whether the termination fee is enforceable.
State Laws
State and local laws impact merchant account contracts. Check the laws in your state regarding early termination and cancellation fees.
For more details about cancelling your merchant services contract without an early termination fee, see our article Early Termination Fees: Cancelling Your Merchant Processing Agreement, written by attorney Nate Baber.
by Nate Baber