A Dispute Over Continuing Residuals Could Affect Other ISO And Agent Contracts

In a decision that could have far-reaching implications for the merchant-acquiring industry, a U.S. District Court judge has ordered independent sales organization Electronic Merchant Systems to pay more than $5.4 million in breach-of-contract damages to a sales agent. The decision arises from a dispute over residuals and the interpretation of contract stipulations.

For five years, Infinity Capital LLC, doing business as Choice, exclusively sold payment-processing services on behalf of EMS. In 2015, Choice began to sell for other independent sales organizations with EMS’s approval. But in 2018, EMS terminated the relationship because it claimed Choice violated a non-solicitation provision, according to the ruling filed June 3 in the U.S. District Court for the Northern District of Ohio. In August 2018, Choice had sought to sell 65% of its residuals to a bank, which wanted to alter an amended agreement to better protect its continued right to the residual stream.

According to Judge James S. Gwin’s order, EMS rejected these changes and the residual sale collapsed. On Sept. 14, EMS terminated the amended agreement and ceased paying residuals, which totaled $133,000 per month, to Choice. Choice claimed EMS wrongly stopped paying, Gwin said. EMS claimed that once Choice brought the customer to EMS, Choice could not offer those customers any service, even services that EMS refused to provide, and that Choice wrongfully solicited its merchant customers.

If unanswered by EMS, the judge’s order mandates that EMS pay Choice more than $5.4 million, which is the value of the residuals for 120 months. That amount reflects a $170,120 residual overpayment EMS made to Choice, which is related to the judge’s granting of EMS’s unjust-enrichment claim. Gwin, however, granted Choice’s claim that EMS had no right to terminate the residual and breached the amended agreement by doing so, the order says.

EMS intends to appeal the decision, says John M. Alten, an attorney at Ulmer & Berne LLP, which is representing the Cleveland-based ISO. “EMS intends to ask the appellate court to reverse the ruling in this regard,” he said in a statement to Digital Transactions News. A court date has not been set yet because the actual judgment has not been entered, he says.

“We are pleased that the court found that Choice breached its obligations to EMS. But EMS disagrees with the court’s decision to rewrite the clause of the … contract by which the parties agreed that Choice would lose its right to continued residuals if it failed to comply with its obligations,” the EMS statement continued. “Enforcement of this provision would be especially appropriate here where Choice’s violations were numerous and substantial. By unilaterally rewriting the bargained-for consequences of the agent’s breach, the court decision encourages agents to flout their non-solicitation promises.”

“In this case, I believe that the court already has provided needed certainty on what is and what is not enforceable, not only for the benefit of the parties to a contract, but for the benefit of the larger industry engaged in a robust market of residual purchases and sales,” Sheila G. Corvino, an attorney at CorvinoLaw who is representing Choice on the contract negotiation with EMS, says in an email.

The case is important for the industry because “it forms a helpful guide on drafting ISO contracts, on how the parties should work together to address contractual questions after execution, and how best to respond to alleged breaches,” Corvino says.

Both the processor and ISO can learn from this case, she says. The processor should have a concise definition of what constitutes solicitation that doesn’t constitute an unreasonable restraint of trade, Corvino says. The ISO should ensure contracts have cure rights, or the ability to fix a problem under the contract. She said the ISO also should look for breach protection.