The chargeback process is lengthy and confusing for merchants. It involves numerous institutions, requires exhaustive evidence documentation, and takes up vast business resources. Plus, it is an expensive.
Figuring out the entire customer dispute process is time consuming with no guarantee of reversing a repudiated charge dispute.
To help demystify the chargeback process, you need to understand how it works. Below is a complete overview of each stage in the process so you will be better prepared to not only reduce the risk of chargebacks, but also to win disputes when they do occur.
What Is the Chargeback Process?
The chargeback process refers to every step each industry player (issuers, banks, cardholders, merchants) must take to resolve a disputed payment charge. Through representment and arbitration, card banks and card networks decide the at-fault party who takes on the financial fallout for incidents related to an unsafe payment environment.
Chargebacks are considered a necessary consumer protection. Cardholders can repudiate charges found on credit card statements, helping to protect users from fraud, incorrect payments, or errors associated with credit industry practices. Such protections increase the trust between businesses and customers.
Unfortunately, chargebacks create multiple interactions across varied instances of fraud. Plus, all involved parties want to mitigate any potential losses. The end result is a fight over who should take on the risk and financial liabilities.
The chargeback process gives each industry player a fair chance to present their case. Each party can explain why they are not responsible for costs related to a faulty transaction.
Who is Involved in the Chargeback Process?
There are five different entities that take part in a safe credit card transaction and chargeback process:
- The Cardholder: The verified owner of the card who disputes a credit charge
- The Merchant: The vendor who sold a product or service
- The Issuer: The bank that provided the credit card to the cardholder
- The Acquirer: The bank that facilitates payment transactions for the merchant
- The Card Network: The card brand that creates the payment infrastructure for the entire industry
Each entity (with its conflicting interests) adds more complexity to the chargeback process, making it a time-consuming and bureaucratic judgment system.
Stage 1: The Chargeback Process Begins With a Cardholder Dispute
In a perfect world, online transactions would occur flawlessly. But with rampant fraud and the many variables associated with technology and human error, we do not live in a perfect world. A cardholder can dispute transactions for many different reasons, initiating the chargeback process.
The Customer Files a Chargeback
On average, a customer has 45 – 180 days to repudiate a charge (card network and issuing bank dependent). All individual transactions used on a credit account have the potential to become a chargeback. For example, if an identity thief makes unauthorized purchases with a stolen credit card, the victim can file a chargeback and minimize any financial damage.
Other common reasons a consumer might file a chargeback include forgetfulness, shipment problems, or friendly fraud. With one call to the issuing bank, a customer can refute a charge.
Of note: there are some rare instances of bank chargebacks, where the issuer corrects charges without the consumer’s knowledge.
The Initial Fund Reversal
Once the issuing bank receives notice of the start of the chargeback process, the consumer is granted a conditional refund. Issuers have customer-first policies that almost always side with the consumer and provide upfront liquidity.
The issuer will then contact the vendor who facilitated the payment and their acquirer bank to debit the original transaction amount. Merchants will experience revenue losses, plus any associated fees. Such immediate fund reversals are contentious, as pending chargebacks can cause cash flow issues for organizations.
In addition, if the chargeback process is initiated too many times, that merchant can be put in the high-risk category, and lose their ability to process credit card transactions all together.
Chargeback Identification
Next, the issuing bank starts an investigation into the disputed charge. The institution will review all customer claims and determine the authenticity of the customer inquiry, a process that can take up to six weeks.
In particular, the issuing bank will label the chargeback with a reason code. Reason codes are identifiers that help describe why the customer repudiated a charge. Each card network may have its own labels for each chargeback code, denominated in 2-4 alphanumeric digits. Common dispute reasons include:
- Declined Authorization
- Services Not Received
- Canceled Recurring
- Incorrect Transaction Codes
- Credit Not Processed
- Fraud
- Quality of Goods and Services
Upon review, issuers deliver any codes and supporting documentation to the merchant acquirer bank. The acquirer sends an official chargeback process notice
Stage 2: The Chargeback Process and Merchant Representment
The chargeback process can be abused by consumers. This phenomenon is known as ‘friendly fraud’, and occurs when a legitimate card holder uses the chargeback process as a way to avoid paying for goods or merchandise they ordered and received.
The chargeback represent process is a mechanism available to merchants to fight chargeback abuse.
Merchant Challenge
Once the chargeback process begins, merchants receive an official dispute notification and have an average of 7 to 10 days to act and fight back against the chargeback. Return letters are provided by the acquirer, and they may give guidance on whether the reason code is worth fighting with an official Chargeback Debit Advice Letter. Signed rebuttal paperwork with proper documentation signifies to the acquiring bank that the merchant wants to fight the disputed transaction.
Evidence Compilation
Merchants must provide ample evidence to overturn the current dispute ruling. Specific documents are also required to achieve compliance with the issuing bank. Different card networks use varied forms, submission formats, and evidence, each with different reason codes. Common data a merchant should supply include:
- Store return policies
- Signed terms and conditions
- Proof of delivery
- Sales receipts
- Shipment tracking numbers
- Card verification numbers
- Address Verification Service (AVS) matches
- Confirmed bill-to and ship-to address matches
The more evidence that proves a verified and authenticated transaction occurred, the better. Since merchants are required to submit so much proof in such a short period of time, fighting a chargeback requires an extensive amount of business resources.
Representment Package Delivery
Once the merchant delivers all evidence to the acquiring bank, the representment package is sent to the issuer, who will engage in a review process. At the same time, the acquiring bank will initiate a second temporary refund to the merchant. Two credits exist while the review period for the disputed charges continues, one for the customer provided by the issuing bank and one for the merchant from the acquiring bank.
Stage 3: Issuer Review
The issuing bank engages in a complete review of the evidence submitted by the cardholder and the merchant. The entire process can take an additional six weeks, institution-dependent.
After deliberation, one of three possible options will occur:
- Issuer rules in merchant favor: If the merchant provides compelling evidence that asserts a transaction occurred in good faith, the issuer sides with the vendor. The provisional refund on the merchant side becomes permanent, with all lost revenue restored.
- Issuer rules in favor of the cardholder. If the merchant cannot provide any evidence that vindicates the disputed transaction, the issuer rules in favor of the cardholder. The consumer’s refund remains permanent, and the merchant takes on all financial damages.
- Issuer rules in favor of a second chargeback: In particular cases, the issuer can file a second chargeback. Such actions are often related to new data or information found during the review process.
The second chargeback is often known as pre-arbitration, as the particular dispute might need additional mediation from the card network.
In many instances, the second chargeback means the merchant provided adequate evidence, but one of the other industry players has renewed interest to fight the current ruling. Acquiring banks also have the right to request a second chargeback if the issuing bank sides with the cardholder.
Stage 4: The Chargeback Process Gets Reopened
This step does not always occur. However, there are three primary reasons why a second chargeback might be necessary:
- There is new information from the cardholder
- There is a change to the chargeback reason code
- The documentation provided by the merchant is incomplete, invalid, or uncompelling
In many ways, the second chargeback operates as a failsafe, ensuring that the entire review and judgment process proceeds fairly. If new evidence surfaces that could change the outlook of the dispute, it deserves a second hearing.
For example, if the issuer deems that the merchant’s first representment package is incomplete, the merchant has the choice to continue contesting the dispute. Likewise, if the cardholder deems a ruling that favors the merchant as unfair, they may also submit new evidence that further corroborates their initial claim.
Sometimes, the issuer simply wants additional evidence that confirms any claims. Often, more subjective data not included in the first chargeback cycle may be requested, such as customer service logs or a history of communication with the client.
In essence, an entire cycle of evidence compilation, representment submission, and issuer review repeats. Any interested parties can re-contest to their benefit. The issuer will once again review all evidence and make a new decision.
Stage 5: Chargeback Process Arbitration and Finalization
If either party is dissatisfied with the outcome of the second chargeback cycle, they can request mediation by the final industry player, the card association itself.
Issuing and Acquiring Bank Evidence Submissions
In the final arbitration stage, the issuing bank and acquiring bank operate on behalf of the cardholder and the merchant. Both banks provide evidence and representment packages to the card network, so the work of the two disputing parties is complete.
Still, the decision to go to arbitration should not be taken lightly. Arbitration involves a hefty set of penalties and fees in addition to the already assumed chargeback fees and related costs used to fight the dispute. Estimates of initial arbitration costs can reach hundreds, if not thousands of dollars. Plus, it adds an additional 10 – 45 days to the entire chargeback process.
Part of the difficulty comes from the varied requirements related to evidence submissions. Both the issuer and acquiring bank must follow the unique format of each card network’s arbitration proceedings. It is no wonder that on average, only 2% of chargebacks reach the arbitration stage. Arbitration is mostly reserved for high-ticket, expensive items whose value is worth fighting for.
Final Decision and Fees
Once the chargeback process uncovers all of the evidence, the card association completes a review of all material and makes a final decision. When completed, the chargeback process closes and the losing bank pays all arbitration fees.
In the merchant’s case, most of the related fees are taken from their merchant account by the acquiring bank. The money from the sale, the value of the product, the chargeback fees, and the cost of fighting the losing dispute are all shouldered by the vendor.
More importantly, banks and card networks keep a record of all disputed transactions. Since the chargeback process is costly and time-consuming, it is in everyone’s best interest to limit the total amount of repudiated charges. As a result, card associations maintain a chargeback ratio that compares the volume of chargebacks against a merchant’s total transactions.
For merchants with too many chargebacks and lost disputes, additional penalties are enforced. A high chargeback ratio speaks to bad business practices that threaten the legitimacy of the payment environment and the chargeback process. It is a way to encourage vendors to remain selective when they fight a chargeback and how they use arbitration.
Final Thoughts
While reform is needed, the chargeback process continues to protect the safety of the payment industry. Understanding the benefits and pitfalls of chargeback can help lower dispute volume, and new mitigation solutions can help solve the current chargeback maze.
Ideally, all parties involved can work together to limit disputes, as the best way to fix chargebacks is to use chargeback protection software to stop them before they start.