In today’s retail market, there are several strategies that merchants are increasingly using to defray the cost of accepting credit cards. All these are meant to effectively pass on the cost of accepting credit cards to the consumer at the point of sale. There are credit surcharges (adding a small fee to a transaction if paid by credit card), cash discounts (offering a lower price if paid with cash) and dual pricing (posting two prices for an item – cash vs credit). The card issuers and card networks do not like merchants using these strategies, as it makes the use of credit cards more expensive to consumers – incentivizing consumers to switch to lower cost (and less profitable) payment methods such as debit cards and cash. The card industry is continually pushing back against these market trends by putting in place rules and regulations for merchants that make it more difficult for merchants to assess these fees.
Merchants did not always have these options. For the 30+ years, these types of surcharges and discounts were not allowed, providing credit card companies with the ability to generate huge profits from swipe fees and other transaction-based charges while merchants had few options other than pay the merchant fees. While the tide has changed in the last 10 years, it is interesting to look at the history of card processing and these fees to see how we got here.
The Early Days Before Credit Card Surcharges and Duel Pricing
In the 1950’s and 1960’s, Visa and MasterCard were created from regional associations of banks that formed joint ventures to operate regional credit card networks. In these early years, credit cards adoption was hindered by the lack of available technology. Credit card processing started out as a very manual process, with salesclerks conducting authorizations either by telephone, or manually checking against list of invalid card numbers. As a result, credit cards represented a miniscule percentage of the total number or dollar volume of retail transactions through the 1970’s.
In fact, the transaction volume was so small that the government did not feel the need to regulate the industry and set standards in the early days. Instead, use of credit cards were governed by various private agreements entered into between card networks, issuer banks, merchants and cardholders.
The Early Wars for Credit Card Surcharges
As transaction volume increased, some merchants started assessing fees or offering differential pricing (cash price vs credit price) to incentivize consumers to pay with cash and check instead of the higher cost credit cards. The card industry did not like this and moved to restrict this practice, which in turn caused the government to get involved. In 1968, Congress passed the Truth in Lending Act (“TILA”), which said that the “card issuer may not, by contract, or otherwise, prohibit any such seller from offering a discount to a cardholder to induce the cardholder to pay by cash, check or similar means rather than use a credit card.”
The TILA also required lenders, including credit card issuers, to disclose the cost of credit as an annual percentage rate (APR). Based on the definition of APR, card issuers were required to include any surcharges and price differences in the APR calculation. Given that a 5% surcharge in monthly transaction could increase the APR by 60% (5% x 12 mos.), credit card issuers were even more motivated to stop merchants from tacking on a 5% surcharged on credit card transactions.
The card networks’ solution was to incorporate no-surcharge rules into the credit card networks’ operating rules. But this did not go over well with merchants. In 1974, litigation was instituted by Consumers Union against American Express (“Amex”), claiming that Amex’s contractual ban on differential pricing was an illegal restraint on trade constituting an antitrust violation. Amex settled the lawsuit by agreeing to allow merchants to provide consumers with differential price information.
The Card Industry Fights Back Against Credit Card Surcharges
But the card industry kept battling to protect its margins – both though operating restrictions and lobbying efforts. In 1976, these efforts paid off – with the federal government issuing its first ban on surcharging, providing that “no seller in any sales transaction may impose a surcharge on a cardholder who elects to use a credit card in lieu of payment by cash, check or similar means.”
This was a temporary ban that needed to be renewed periodically. It was renewed once by Congress in 1981, however, in 1984 Congress opted to allow the ban to expire.
While the Federal ban may have expired, the credit card companies did not give up. The card industry fought the lapse on the Federal ban on two fronts. First, the card companies retained the no-surcharge rules in contracts required to be signed by any merchant agreeing to accept the issuers credit cards. Second, credit card companies lobbied state legislators to introduce surcharge bans at state level. Through this lobbying pressure and using the excuse of consumer protection, ten states banned credit card surcharges – including some of the most populous states – California , New York, Texas and Florida.
The combination of contractual prohibitions on surcharging and the multi-state bans led to an absence of protection for the merchant against the excessive processing fees of the credit card networks for almost thirty years.
The Return of Cash Discounting and Credit Card Surcharges
In 2005, a pet company located in Atlanta, Georgia named Animal Land sued Visa claiming that its no-surcharge rule violated antitrust laws by preventing Animal Land and other merchants from assessing a small charge to customers for using credit cards as opposed to cash, checks or debit cards. This led to other merchants and trade associations in the US bringing claims against the major credit card networks that the card networks were engaging in illegal price-fixing in violation of the federal antitrust laws, and effectively banning merchants from incentivizing consumers to use less expensive payment methods.
After eight years of litigation, Visa and MasterCard entered into a national class action settlement, agreeing to drop their contractual prohibitions against merchants imposing surcharges on credit-card transactions. In January 2013, Visa agreed to change its operating rules so that a merchants “may assess a fixed or variable US Credit Card Surcharge on a Visa Credit Transaction, subject to applicable laws or regulation.” Similarly, MasterCard changed its rules permitting any merchant to “require a MasterCard Credit Cardholder to pay a Surcharge.” For the first time in almost thirty years, merchants became entitled to add a surcharge for credit card transactions.
The class action litigation settlement applied primarily to the forty states that had no prohibition on surcharging at the state-level. However, the ten states that still had anti-surcharge statutes quickly came under pressure from pro-surcharge lobbying efforts. In October 2013, a federal judge in New York declared the State’s ban on assessing a surcharge to be unconstitutional and in violation of the right to commercial free speech. A federal court in California followed suit in March 2015, striking down a similar Californian prohibition on surcharges.
While a few States still have restrictions and the payment industry continues to fight against surcharges and discounts, the tide has turned for the merchants.
Author Note: Some content and facts stated in this post were based on information in a paper named ‘A History of Credit Card Transaction Costs and the Suppliers Newly Minted Right to Surcharge to Make Credit Cards a More Competitive Payment Channel’ pubished by Scott Blakeley, Esq. & Ruth Fagan, Esq
