Chargebacks 101

Chargebacks play a crucial role in the payments ecosystem, offering consumers protection against fraud and errors, maintaining confidence in card payments. This is particularly vital in e-commerce, where the risk of fraud is perceived to be higher. However, for merchants, chargebacks pose a significant and costly challenge.

Merchants often face headaches as consumers initiate chargebacks for issues not intended to be addressed by this process, sometimes without attempting to contact the merchant first. As chargebacks become more prevalent, businesses are increasingly taking measures to defend themselves. It's essential for merchants to understand what chargebacks are and how to effectively prevent and combat them.

What are chargebacks, and what do merchants need to know in order to prevent and fight them as effectively as possible?

What is a Chargeback?

A chargeback is the result of a disputed credit or debit card transaction. If the cardholder's bank approves the dispute, they reverse the transaction, taking funds from the merchant and returning them to the cardholder. The cardholder's bank reviews the dispute, provides a provisional credit if deemed valid, and collaborates with the card network and acquiring bank to complete the chargeback process.

Chargebacks for credit cards were first implemented in the 1974 Fair Credit Billing Act (§ 161. Correction of billing errors), an amendment to the Truth in Lending Act.

Debit card chargebacks were implemented later by the Electronic Fund Transfer Act in 1978. These acts were intended to outline protective measures for consumers.

Chargebacks originated as a response to widespread fraud, addressing the issue of fraudsters using stolen credit card details for purchases. Before the Fair Credit Billing Act, cardholders had limited recourse to reclaim funds from merchants receiving fraudulent payments. The chargeback process empowers consumers to seek refunds from their banks, allowing banks to make decisions on handling the situation, laying the groundwork for the dispute system we have today.

How Do Chargebacks Work?

Chargebacks are initiated by cardholders, evaluated by banks, and paid for by merchants. A single chargeback, from initiation to resolution, can last months or even years.

While banks will sometimes file chargebacks for things like authorization or processing errors, most chargebacks occur when a cardholder contacts their bank to dispute a charge on their account. Usually, they do this because they don’t recognize the charge and believe it to be fraudulent.

In some cases, a cardholder might dispute a charge because they feel they didn’t get what they paid for and the merchant has refused to resolve the issue.

Once a chargeback has been initiated, it will go back and forth between the issuing bank and the merchant until either one of them agrees to accept liability or until the card network must be called in to resolve the dispute.

What is the Chargeback Process?

The chargeback process begins with the merchant choosing to either accept the chargeback or fight it through representment. In representment, the issuing bank reviews the merchant’s evidence and either reverses or upholds the chargeback. In most cases, the chargeback ends here, but there are exceptions.

1. When a cardholder disputes a transaction with their issuing bank, the bank decides whether or not the customer has grounds to file a chargeback.
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2. If a chargeback is granted, the bank will notify the acquiring bank—AKA the merchant’s bank—and debit the funds from the merchant’s account.
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3. The merchant can either accept the chargeback or fight it by resubmitting the charge along with a rebuttal letter and the necessary evidence to disprove the claim. This process is called representment.
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4. The issuing bank will review the new evidence and make a decision. If they find in favor of the merchant, the funds will be returned.
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5. At this point, any party unhappy with the decision can contest the issue further by initiating pre-arbitration. This most often occurs when the issuing bank decides in the merchant’s favor, but then receives new evidence that puts that decision in question.
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6. If neither party accepts liability during pre-arbitration, the chargeback moves to arbitration. Here, the card network will examine the evidence and make a final decision. This decision can’t be appealed further, and the losing party will be required to pay hundreds of dollars in fees.

Time limits for merchants to respond to a dispute vary based on the credit card network and the reason code. Note that the timer begins when the chargeback is initiated, not when the merchant is notified, so the merchant’s deadline may not be the exact time frame outlined by the card network’s policies.

What Do Chargebacks Mean for Merchants?

For merchants, chargebacks mean a loss of revenue that can be as much as twice the original transaction amount, once fees and other costs are factored in. They also cause the merchant’s chargeback ratio to increase, which can lead to serious consequences.

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If a merchant’s chargeback ratio exceeds certain thresholds established by the card networks and other financial institutions they do business with, they may face fines, additional chargeback fees, and even termination of their merchant account. The most common threshold is 1%, but Visa recently lowered theirs to 0.9%.

How Many Chargebacks Occur Annually?

Information about chargebacks is generally only shared with the parties involved, and the card networks don’t seem interested in sharing whatever data they have. That makes specific information about how many chargebacks occur difficult to come by.

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We do have some data from a 2018 survey by Javelin Research showing that nearly half of all customers have disputed a charge, and a majority of those have disputed more than one.

We also know that chargebacks continue to grow year after year. A 2018 study by Aite Group predicted that the total value of chargebacks would climb to $35 billion by 2021, and given the increase in disputes that accompanied the COVID-19 pandemic, it wouldn’t be surprising to find we’ve already far exceeded that number.

How Do Cardholders File a Chargeback?

Filing a chargeback without first consulting the merchant is not advised and, in some cases, unlawful. If the cardholder has already attempted to reconcile the issue with the merchant with no success, they can simply call their bank and ask to dispute the transaction.

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The bank will typically give the cardholder a provisional credit for the amount of the charge while they investigate the validity of the claim. The cardholder should be prepared to describe the problems they had with the merchant and the steps they took to resolve the matter.

Why Do Customers File Chargebacks?

Customers often file chargebacks when they don’t recognize a transaction or are somehow dissatisfied with their purchase. As friendly fraud becomes more prevalent, it's important to note that in some cases the customer may simply be trying to get something for free.

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In order to identify the reason a customer disputed a charge, it can be helpful to examine the reason code on the chargeback.

Every chargeback has a reason code associated with it. The major card networks (Visa, Mastercard, Discover, and American Express) established these codes to clearly identify the reason a chargeback was requested.

What are Chargeback Reason Codes?

Chargeback reason codes tell merchants the reason the customer is disputing a charge, according to the information they provided to their bank. Each reason code has certain standards of proof and evidence associated with it that determine whether the chargeback is valid or not.

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While the reason code will tell you how the cardholder justified the dispute to their bank, it’s important to keep in mind that this isn’t always the real reason for the chargeback.

Some customers may incorrectly think that a charge on their account was unauthorized because they don’t recognize the name of the business listed in the transaction description. Others may have forgotten about a recurring charge they signed up for.

There are also some customers who want to file a chargeback because of a negative experience they had with the merchant, but know that the reason they have isn’t a legitimate basis for a dispute. In order to get the chargeback, they lie to the bank about their reason for requesting one. In some cases, a customer may have made a purchase with the intention of fraudulently disputing the charge later in an effort to get their money back.

When Can a Cardholder Legitimately Dispute a Charge?

Chargebacks are not something that cardholders can just use whenever they don't like an item they purchased. There is usually only one situation where a cardholder's first move should be to ask their bank for a chargeback: true fraud.

If a cardholder is a victim of true fraud (unauthorized use of stolen credit card credentials), then a chargeback is most legitimate and ethical way for the issuing bank and the merchant to resolve the issue.

Customers can also file chargebacks when they didn’t receive the product or service they paid for, whether because of a lost or damaged shipment or an incorrect item being sent. Being double-charged or overcharged the agreed purchase amount is another legitimate reason for a dispute.

However, problems like these are usually resolved more quickly and easily when the customer contacts the merchant, and a chargeback should only be used when the merchant is uncooperative.

Then there are the customers commit first-party misuse, better known as "friendly fraud," by filing a chargeback without a legitimate reason.

Customers can’t dispute a charge simply because they are dissatisfied with the product or service they received. These issues must always be resolved with the merchant directly.

Contact us to discuss ways to navigate chargebacks and disputes

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