Chargebacks negatively impact the merchant's operation and profitability by reverting payments and return transaction funds back to the cardholder or bank account holder. Chargebacks are always initiated after completion of the online payment and – in most cases – initiated when the products or services have already been provided to the buyer. In those situations the merchant looses both the transaction amount and the shipped product(s) which can do great damage in terms of turnover and profit. Before going into detail about chargebacks, it is good to have an understanding of the term "chargebacks".
What are chargebacks?
A chargeback is the return of funds to a consumer forcibly initiated by the bank of the cardholder or bank account holder as a result of a fraudulent transaction, an unresolved dispute between seller and buyer or a processing error. Specifically, it is the reversal of a prior transfer of funds from a consumer's bank account or credit card.
Chargebacks are instated to provide consumers protection for financial loss as a consequence of card fraud, unauthorized bank transfers and (unintended) processing errors.
Besides the most common and widely known credit card-related chargebacks, it is also possible for consumers to dispute (SEPA) direct debits or payment methods that rely on (SEPA) direct debits (e.g. ELV) which have not been (properly) authorized.
Chargeback process (cards)
- A consumer contacts his bank or financial institution to initiate a chargeback (due to fraud or unresolved dispute). The card issuer or bank will verify the consumer's claim and initiate a retrieval request or a chargeback. A retrieval request is basically a request for more information from the issuing bank to the acquiring bank which helps the issuer to determine the eligibility of a customer's complaint and the chance of chargeback success (this has to do with the rules and regulations by the applicable scheme (e.g. MasterCard, Visa, SEPA) which determine under what circumstances chargebacks may be initiated. A retrieval request is often followed by a chargeback. Sometimes the issuer may decide to directly initiate a chargeback.
- Retrieval requests and chargeback notifications are processed through the systems leveraged by the scheme and are forwarded to the acquiring bank – the one that processed and settled the original transaction on behalf of the merchant. The chargeback systems provide the ability to exchange chargeback-related information and documentation between issuers and acquirers anywhere around the globe For example, a Japanese credit card can be used fraudulently at a French-based online seller. The French acquiring bank will then be notified by the Japanese bank representing the legitimate Japanese cardholder.
- The acquirer verifies whether the retrieval request or chargeback information is in accordance with scheme regulations. If not, they will revert back to the issuer.
- If the retrieval request or chargeback is in accordance with the dispute regulations, the acquirer will try to prevent the chargeback from being withdrawn from merchant funds. The chargeback rules prescribe circumstances and require specific evidence to be able to "represent" a chargeback, or prevent the reverse payment. For example, if a fraud-related chargeback relates to a payment that was processed with 3D-secure, and the SecureCode was provided – the merchant bears no liability in case of fraud. In those situations, the acquirer can directly represent the chargeback.
- If their acquirer cannot (directly) represent the chargeback, he will turn to the merchant and request for compelling evidence in accordance with the rules to be able to represent the chargeback. In some cases the merchant is able to provide the required evidence which can prevent the funds from being reverted back to the cardholder. For example, in case the chargeback relates to a dispute "products not received" and the merchant can provide a signature of the cardholder (when he or she signed for the receipt of the goods) which matches the signature on file with the card issuer, the chargeback can be prevented.
- In case there is no representment possibility or the chargeback case is lost (the evidence is not compelling and rules prescribe that the liability lies with the merchant), the acquirer will notify the merchant of the chargeback, reverse the payment and withdraw the chargeback amount from merchant funds.In case the dispute cannot be resolved through the normal chargeback process, the acquirer or merchant has the option to start a so-called compliance case whereby Visa or MasterCard will examine the chargeback case and provide a definitive ruling, either in favor of the merchant or consumer. Please note that to start these types of compliance cases, the schemes will charge between 100-300 US dollars. If charged to the acquirer, they will most often be forwarded to the merchant, which sometimes removes the appetite to get a final ruling (also keep in mind that most rulings will be in favor of consumers as the chargeback rules tend to protect consumers).
Chargeback reason codes (cards)
Every chargeback that is initiated by an issuer will be processed with a specific reason code. This reason code relates to one of the following three general categories causing chargebacks:
- processing-related: authorization expired, late settlement, duplicate processing (billed twice the same amount), incorrect amount billed, refund not processed
- delivery-related: products not received or not as described, customer returned goods but never received a credit/refund back to the account.
- fraud-related: transaction not authorized by legitimate cardholder
Both MasterCard and Visa have set their own reason codes, but there is some clear resemblance between the schemes' chargeback rules and dispute resolutions. Their chargeback guides describe in detail what these reason codes comprise and what remediation and representment options there are per specific reason code.
Fraud and chargebacks (cards)
One of the most common reasons for a chargeback is a fraudulent transaction (often referred to as card-not-present fraud or card-absent fraud). Fraudulent transactions can occur as a result of (physical) cards being stolen, card data being compromised (hack) or identity theft.
In cases of card-not-present transactions, the merchant is usually responsible for the fraud-related chargeback and associated fees (acquirers most often do charge chargeback handling fees roughly between 15-40 euros per chargeback).
Friendly fraud occurs when the card or payment details have not been stolen or compromised but still the consumer denies the transaction. This can occur for a number of reasons, some of which are: the consumer forgot about the recurring subscription, the consumer does not recognise the descriptor on their credit card statement, the consumer is not happy with the product or service and did not attempt to or did not get a refund.
There are many easy ways of avoiding or reducing friendly fraud. Always remind the consumer of an upcoming recurring transaction through an email or other notification. Make sure that your descriptor on the consumer's statement is clear and if possible include your customer support contact details in the descriptor. Make your refund policy clear and generous and make sure that your customer support is easily reachable.
Where EMV in the Point-of-Sale environment pushes fraud and chargeback liability to the non-EMV compliant party, does 3D- secure provide a similar liability framework in the online space. Online merchants processing their MasterCard and Visa card payments using 3D-Secure technology (MasterCard SecureCode, Verified by Visa) benefit from chargeback protection for fraud-related reason codes.
Even in case of fraud, when the merchant challenged the cardholder to enter his SecureCode – but the issuer has not issued a secure code, or the secure code has been compromised somehow – the merchant is not financially liable. Exemption to this general rule is that commercial cards are excluded from the "global liability shift programs" as laid down by MasterCard and Visa. Merchants could still face a chargeback for fraud committed with business or corporate credit cards.
Unfortunately, in some markets, the roll-out of 3D-secure is limited or has caused purchasing and conversion issues for both cardholders and online merchants. That is why in some markets and some segments, merchants are not committed to using 3D-secure, leaving a scattered market in terms of 3D-secure adoption and usage.