What is a Chargeback?

A “chargeback” provides an issuer with a way to return a disputed transaction. When a cardholder disputes a transaction, the issuer may request a written explanation of the problem from the cardholder and can also request a copy of the related sales transaction receipt from the acquirer, if needed. Once the issuer receives this documentation, the first step is to determine whether a chargeback situation exists. There are many reasons for chargebacks—those reasons that may be of assistance in an investigation include the following:

  • Merchant failed to get an authorization
  • Merchant failed to obtain card imprint (electronic or manual)
  • Merchant accepted an expired card

When a chargeback right applies, the issuer sends the transaction back to the acquirer and charges back the dollar amount of the disputed sale. The acquirer then researches the transaction. If the chargeback is valid, the acquirer deducts the amount of the chargeback from the merchant account and informs the merchant.

Under certain circumstances, a merchant may re-present the chargeback to its acquirer. If the merchant cannot remedy the chargeback, it is the merchant’s loss. If there are no funds in the merchant’s account to cover the chargeback amount, the acquirer must cover the loss.

Four Common Reasons for a Chargeback

The most common reasons for chargebacks include:

  • Customer disputes
  • Fraud
  • Processing errors
  • Authorization issues

Although you probably cannot avoid chargebacks completely, you can take steps to reduce or prevent them. Many chargebacks result from avoidable mistakes, so the more you know about proper transaction-processing procedures, the less likely you will be to inadvertently do, or fail to do, something that might result in a chargeback. (See Minimizing Chargebacks in this section.)

Of course, chargebacks are not always the result of something merchants did or did not do. Errors are also made by acquirers, card issuers, and cardholders.

Minimizing Chargebacks

Most chargebacks can be attributed to improper transaction-processing procedures and can be prevented with appropriate training and attention to detail. The following best practices will help you minimize chargebacks.

  • Declined Authorization. Do not complete a transaction if the authorization request was declined. Do not repeat the authorization request after receiving a decline. Instead, ask for another form of payment.
  • Transaction Amount. Do not estimate transaction amounts. For example, restaurant merchants should authorize transactions only for the known amount on the check; they should not add on a tip.
  • Referrals. If you receive a “Call” message in response to an authorization request, do not accept the transaction until you have called your authorization center. In such instances, be prepared to answer questions. The operator may ask to speak with the cardholder. If the transaction is approved, write the authorization code on the transaction receipt. If declined, ask the cardholder for another Visa card.

Failure to respond to a referral request may result in a lost sale if a cardholder does not have an alternate means to pay.

  • Expired Card. Do not accept a card after its “Good Thru” or “Valid Thru” date.
  • Missing or Questionable Cardholder Signature. In the card-present environment, the cardholder’s signature is required for all magnetic-stripe and some chip transactions. For example, a card and signature is required if Card Verification Method (CVM) is signature preferring, except for qualified Visa Easy Payment Service (VEPS) transactions. Failure to obtain the cardholder’s signature could result in a chargeback if the cardholder denies authorizing or participating in the transaction. When checking the signature, always compare the first letter and spelling of the surname on the transaction receipt with the signature on the card. If they are not the same, ask for additional identification.

A chip card and the chip-reading device work together to determine the appropriate cardholder or verification method for transaction (either signature, PIN or CDCVM). If the transaction has been PIN verified, there is no need for signature.

  • Legibility. Ensure that the transaction information on the transaction receipt is complete, accurate, and legible before completing the sale. An illegible receipt, or a receipt which produces an illegible copy, may be returned because it cannot be processed properly. The growing use of electronic scanning devices for the electronic transmission of copies of transaction receipts makes it imperative that the item being scanned be very legible.
  • Digitized Cardholder Signature. Some Visa cards have a digitized cardholder signature on the front of the card in addition to the hand-written signature on the signature panel on the back. Checking the digitized signature is not sufficient for completing a transaction. Sales staff must always compare the customer’s signature on the transaction receipt with the hand-written signature in the signature panel.
  • Fraudulent Card-Present Transaction. If the cardholder is present and has the account number but not the card, do not accept the transaction. Even with an authorization approval, the transaction can be charged back to you if it turns out to be fraudulent.

The Chargeback Lifecycle

Step 1:  The Merchant Contacts the Payment Processing Service

During this step, the merchant requests that payment be made in exchange for goods and/or services.  This is different from a pre-authorization (“pre-auth”), because the end result will be the actual transfer of money – not just information about how much money can be transferred (as in, how much money the customer has available in his or her account).

Step 2:  The Acquirer Sends Info to the Payment Processor

The processing company is the entity responsible for actually making the request to transfer funds.  Essentially, what they do is to package every bit of information they have about the transaction (including the cardholder’s name, AVS and CVV data, expiration date and so on) along in one neat bundle to be expedited by the actual credit card company or bank.  This is where processing fees come into play, but there’s still one more step before the banks get involved…

Step 3:  The Processor Verifies Customer Information

During this process, the information about the transaction is verified against the data on file for the credit card number.  If there are any major discrepancies, the transaction is denied.

Step 4:  The Customer’s Bank/Credit Card Company Authorizes the Transaction

If everything looks okay on their end, banks or credit card companies will authorize the transfer of funds and send confirmation back to the processor.  At this point, the funds are removed from the credit cardholder’s account, though they have yet to arrive in the merchant’s accounts.

Step 5:  The Processor Transfers Money to the Merchant

This step is automatic, but due to the vagaries of digital banking, it may take some time.  At this time, the funds are generally considered to be “owned” by the merchant rather than the cardholder.

Step 6:  The Cardholder Disputes the Charges

During this process, the cardholders notify their banks or credit card companies that something has gone wrong, filing a chargeback request using one of the attendant reason codes (the most popular being wrong/defective merchandise and card theft/unintentional fraud).

Most chargeback requests are required to be filed within 120 days of the transaction (180 days on international orders), but there are several exceptions to this rule, including instances of defective merchandise.  But no matter when they’re filed, there are three general reasons for chargebacks:

  1. Customers are confused about the purchase.  Either they don’t remember authorizing the transaction (which is often the case with recurring charges) or the description of the transaction they receive is lacking details (which is why you should always send an accurate receipt with every transaction).
  2. They are the legitimate victims of some sort of fraud.  Either their cards have been compromised by a thief or their numbers have been used by a family member/friend without their consent.  Generally, children are the culprits here, but they can also be readily available scapegoats if the cardholder is involved in reason three…
  3. The cardholders are actively trying to defraud you.  Either they’re trying to get the product for free, they regret buying the product and can’t figure out (or don’t like) your returns policy, or they use your product for a while and try to get their money back (often called “wardrobing”).

Step 7:  Credit Card Company Reviews the Data

During this process, the company examines the data they’ve collected concerning the transaction in question.  If they find little evidence of fraud or wrongdoing, they may well deny the customer’s chargeback request.  However, because card policies are so generous (it’s good marketing for credit card companies), the chargeback generally goes on to the next step.

Step 8:  Chargeback Notifications are Sent Out

The Credit Card Company or bank sends notification to the merchant that the customer is challenging the purchase.  These notices will often come with a list of credible proof required to cancel the chargeback process and the deadlines for submitting this information (which are typically limited to just a few days).

As an example, Visa considers evidence “compelling if it includes:

  1. “Correspondence between the cardholder and merchant that proves the merchant spoke to the cardholder or received a letter stating that they acknowledge the validity of the transaction.”
  2. “Evidence that the merchant swiped or imprinted the card, received an authorization approval, and the cardholder’s signature.”

Most other majority credit card companies are similarly inclined, though – to protect yourself – you should also try to collect:

  • The customer’s IP address (and if possible, use software that digitally identifies the individual computer)
  • Shipping information, including package tracking data
  • A signature obtained during delivery
  • Proof that the customer visited your website before, during and after the purchase process
  • If possible, proof that the customer is using your product

Step 9:  Proof Sent by the Merchant is Reviewed

The credit card company or bank reviews the proof sent in by the merchant and, if it is sufficient, the card company will cancel the chargeback request and the merchant gets to keep the money.  However, only about 40% of chargebacks are ever successfully canceled.  In most cases…

Step 10:  Customers are Refunded and Merchants Absorb Chargeback Fees

The money that was sitting in the merchant’s account is debited back to the customer’s account and a fee (sometimes as high as $30) is assessed for the “work” that the credit card company or bank did during the chargeback process.

Two Critical Windows of Opportunity

Now that you understand the basic chargeback life cycle, you can see that you really only have two windows of opportunity to combat chargebacks: before purchases are made and during the chargeback investigation.

Remember, credit card companies aren’t out to get you (even if it might seem that way during your investigation).  Really, they’re out to protect and serve their clients – your customers.  So be smart.  Do everything you can to prevent chargebacks, but still collect all of the evidence you might need to convince a bank or creditor of your company’s good intentions should chargebacks occur in the end.