Factoring is when a merchant processes credit cards for another merchant, or other business, not approved under the merchant's own processing application & agreement (aka that the account wasn’t specifically set up for).
Factoring is a major violation of the Credit Card Association rules.
If a merchant is found to be factoring the merchant will not only lose their merchant services account and be liable for major penalties, but will also be added to the Match List (aka TMF List) making it impossible to process credit cards through any other processor or bank, for life.
Merchants are commonly, and easily, caught factoring due to cardholder disputes or chargebacks.
Side note: Included within the scope of factoring is the situation where a business owner will process their own personal or business credit cards to get cash from their merchant account, or for another business.
Because of risks including money laundering and chargebacks, credit card processors forbid factoring.
When a business applies for a merchant account, its processor completes an underwriting process. During underwriting, the processor seeks to understand the merchant’s business model and what they plan to sell. They also perform due diligence to ensure the business isn’t going to do anything that would cause undue risks to the processor.
Processors approve an account based on the information the business provides. They sometimes complete additional research, such as performing a site visit. In most cases, they pull a business credit report and a personal credit report for the business owner or guarantor.
Factoring occurs when the business then sells goods or services that differ from what the underwriting process approved.
The core reason factoring is an issue for credit card processors is because of money laundering. Their goal is to ensure that businesses aren’t funneling funds from illegal activities through their merchant accounts.
Another concern with factoring is the risk of chargebacks. If a customer charges back a transaction that doesn’t match the account’s description, the merchant will lose the dispute. The business will be responsible for the transaction amount and any chargeback fees. If the merchant can’t cover the disputed amount, the processor becomes responsible.
The good news with factoring is that in some cases, processors can catch transactions before they go through.. Risk analysts review payments for red flags such as unusually high amounts, and they hold the funds if appropriate. After researching the payment, they may reverse it, returning the money to the cardholder.
This process can prevent a situation that would otherwise result in a chargeback or legal repercussions.
Factoring can occur without the merchant realizing they’re doing anything wrong. Let’s use Bob’s Liquor Store as an example. Bob’s average transaction amount is $50. Occasionally he provides alcohol for special events, so his account is approved to run transactions up to $1,000.
Bob is trying to sell his car for $8,000. He has an interested buyer who asks if she can pay by credit card. Bob offers to run the card through his liquor store’s credit card terminal.
While Bob isn’t intentionally laundering money, he is violating the terms of his merchant agreement. He’s also putting himself at risk for a chargeback. If the car buyer disputes the transaction with her bank, she’ll likely win. After all, why would someone purchase a car from a liquor store? Bob won’t be able to prove that the transaction was a legitimate use of his account.
Another example of factoring is businesses selling marijuana when they were approved to sell supplements or similar products. Most credit card processors don’t allow merchants to sell medical or recreational marijuana. While some states have legalized these sales, the federal government still considers them illegal.
Merchants who sell substances such as kratom or illegal drugs through their merchant account are also engaging in factoring.
Whether intentional or not, factoring can lead to chargebacks, fees, lawsuits, and even criminal charges. It can also result in the closure of a merchant’s account.
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