Credit Card Merchant Fee Settlement – Damages Provisions

Credit Card CroppedThis post will evaluate the settlement’s damages provisions.  You can find my first post providing background on the litigation here.  The settlement provided that upon the court’s preliminary approval, the card networks would pay $6.05 billion, 2/3 from Visa and 1/3 from MasterCard into a settlement fund.  Depending on how many merchants chose to opt out, however, the defendants retained the right to reduce the fund through take down payments of up to 25% of the total and to kill the deal if opt outs exceeded that amount.  Opt outs exceeded that amount, but the defendants have not abandoned the settlement.  In addition to the flat fee award, Visa and MasterCard agreed to cut their applicable interchange fees by 10 basis points for eight months.  Rather than actually reducing the fees paid by merchants, however, Visa and MasterCard would withhold 10 basis points from collected fees that would otherwise have been paid to card issuers.  This amount would then be contributed into the settlement fund within 60 days from the expiration of the eight-month period.  This contribution would be non-refundable, regardless of opt outs.

Let’s start by putting the damages provisions in perspective.  There is no doubt that on an absolute basis the damage figure is enormous.  These contributions, however, would be all-inclusive, meaning that class counsel would deduct their attorneys’ and experts’ fees as well as the substantial costs of administering a fund that will distribute monies to millions of merchants. The objectors argued that the seemingly high $7.25 billion estimated figure amounts to only three months of inter-change fee revenue to the issuing banks, and nothing in the settlement prohibited the defendants from increasing the merchants’ fees to enable the issuing banks to recoup the entire amount paid in relatively short order.  Indeed, nothing in the settlement prevented Visa and MasterCard from increasing interchange fees by 10 basis points immediately, effectively rendering the eight-month discount provision a complete nullity.  One could say that the settlement’s efficacy from a damages perspective depends on the kindness of strangers.  Except the card systems aren’t really strangers, are they?  They are business partners, so to speak, who have allegedly screwed the merchants for years by charging them supra-competitive fees.

Of course, the question whether the settlement provides a fair, reasonable, and adequate damages turns on factors plagued with a great deal of uncertainty.  To recover any damages at all, of course, the plaintiffs must prevail in litigation.  If they are unlikely to prevail, or if doing so would take considerable time, a settlement will look more reasonable than if a litigation victory were more likely.

Here, the timing issue can be resolved quickly.  The proposed settlement is unlikely to provide relief to the class significantly more quickly than would a successful trial.  The current case was filed over seven years ago, and it came on the heels of prior multi-year class litigation by essentially the same parties.  Although the prior case involved the tying of debit and credit cards, it too involved a concern about excessive interchange fees. More than a decade of litigation has surely enabled the parties to sort through the issues.  More than a year ago they filed over 500 pages of dispositive motions.  Presumably, the court could decide the case based on this paper or set it for trial in relatively short order. The settlement, by contrast, is subject to substantial opposition by a majority of the named plaintiffs and countless other class members, including the largest merchants.  If it is approved, years of appellate review are likely to follow. So, from the perspective of timing, the choice between settlement and litigation would appear to be a wash.

Whether the plaintiffs would prevail, however, and how damages might be measured, are more difficult questions.  Court appointed expert Alan Skyes of New York University School of Law concluded that “plaintiffs’ face a substantial probability of securing little or no relief at the conclusion of trial.”  He identified the following issues on which the plaintiffs would need to prevail:

(1)  the existence of market power;

(2) whether the practices at issue are on balance anticompetitive under the rule of reason;

(3) whether plaintiffs can prove their damages with reference to an acceptable benchmark or counterfactual;

(4) whether plaintiffs are barred from recovering damages by the indirect purchaser principle, questions of class certification, and the effects of the release associated with the settlement of previous litigation.

Prof. Sykes’s confident tone, however, is belied by the caveats he places on his analysis.  Although he examines legal precedent, he maintains that he is not opining on who is right, but only on the relative uncertainty given that precedent.  He then offers a hypothetical example to demonstrate that even if the plaintiffs likelihood of prevailing on each issue were relatively high, their likelihood of prevailing on all of them could be relatively low.  That sort of reasoning, however, must presume a substantial degree of independence among the decisions on the various issues.  And that isn’t the case.  They are all highly inter-related to the extent that talking about them separately looks more like a defendant’s litigation strategy than a meaningful objective assessment of the plaintiffs’ likelihood of success.

To be sure, any rule of reason case is speculative.  But given circuit and court precedent in earlier litigation involving the very same parties, the plaintiffs’ case is quite strong as rule-of-reason cases go.  These courts have already held that (1) the merchants constitute a class for the purposes of challenging the fees that they pay; (2) Visa and MasterCard rules constitute a horizontal agreement among the banks joining the card associations; (3) the defendants have market power based in part on their power over merchants; and (4) the merchants are direct purchasers of the card networks’ services, not indirect purchasers.  To be sure, the court might reach a different result on any of these issues this time around.  But the prior decisions are sound, and it is hard to believe that the defendants would pay out $7 billion dollars if they believed that they had a chance to win on any of these issues.

Prof Sykes raises more serious concerns about the core issue of liability — whether default interchange fee and prohibiting merchants from refusing the cards of individual banks is anticompetitive.  He recognizes correctly that these rules were important to the early development of the card systems at a time when they surely had no market power.  Rather than show that those justifications continue, however, he concludes that “a court may be reluctant to declare that these practices have become antitrust violations by virtue of industry maturation especially given the uncertainties that would attend to their abolition.”

Perhaps he’s right, but he shouldn’t be.  Many practices are, on the one hand, perfectly lawful in an environment where the proponents have no market power and good reasons to pursue them (as the card systems did in the 1960s and 1970s).  On the other hand, however, these same practices become suspect when practice by entities with substantial market power and without good reasons to continue them (as is the case for the card companies today). As Prof. Sykes explains, default interchange and the honor-all-cards rules were necessary to overcome the chicken and egg problem in getting card systems off the ground.  This problem was particularly acute because banks had to be convinced to commit assets to a business model that conflicted in a fundamental way with their standard model.  As I’ve addressed in prior work, credit cards required banks for the first time to extend interest free credit.  It was not an easy sell.

Now, of course, the world has changed.  Credit cards are an established business that no player in the system — cardholder, merchant, or bank — is likely to abandon.  The banking sector has morphed from one that was largely local and atomistic to one in which the largest banks are now famously too big to fail.   No one could reasonably believe that these banks still not need the protection of the Visa or MasterCard default interchange and honor-all-cards rules to operate an efficient card system.  A legitimate legacy should not shape the contours of a very different modern world.  Judge Gleason has demonstrated that he understands this reality as has the Second Circuit.  I have argued that there are continuing justifications for retaining some aspects of default interchange and honor all cards to safeguard the role of smaller banks in the credit card systems.  But the court can deal with that in fashioning a remedy, and I’ll explain how in my next installment.  The plaintiffs chances of winning the case are thus stronger than Prof. Sykes claims.

Prof. Sykes is more convincing when he expresses concern about the difficulty of identifying a counter-factual world absent the anticompetitive aspects of modern credit card fee setting.  He correctly rejects the notion that no revenue should shift from merchant to issuer because a wealth of economic analysis and historical practice supports the efficiency of the merchant-to-card-issuer revenue flow.  That the enforcement agencies have examined the card systems closely without seeking to undo default interchange or the honor-all-cards rules is indeed troubling for the plaintiffs.  But my gut tells me that the DOJ didn’t conclude that default interchange and honor all cards are pro-competitive.  They simply lacked the guts to push the card associations on these issues when they could grab lower hanging fruit.

Nevertheless, calculating damages would remain an enormous challenge. There is no precise way to measure how much of the current interchange fee constitutes an anticompetitive overcharge.  US card acceptance fees are generally higher than in other countries, but market differences could account for some or all of that difference.  Conversely, American Express’s merchant fees are generally higher than Visa and MasterCard, even though AmEx sets its fees unilaterally.  AmEx, however, offers many charge cards that do not provide interest revenue, and it has always marketed its brand as one that attracts customers who are likely to spend more.  These distinctions may explain AmEx’s higher fees without undermining the possibility that Visa and MasterCard cards are priced at supra-competitive levels.

When the Australian government decided to regulate interchange fees, it reduced them by about 50 percent.  Georgetown Law Center Professor Adam Levitin has thus speculated that competitive interchange fees might be half of their current levels.  If that figure is correct, damages when trebled would be $300 billion.  Unfortunately, there is little evidence to suggest that the US and Australian markets are comparable.

Another approach would be to compare the merchant fees paid to Visa and MasterCard to the fees charged by the Discover Card system.  Unlike American Express, which offers many charge cards, but like Visa and MasterCard, Discover issues primarily credit cards.  It also does not have a wealthy or corporate customer base sufficient to compel merchants to pay above competitive-level acceptance fees.  Historically, Discover’s merchant fees have been about 25 percent below Visa and MasterCard.  That comparison would yield damages of $25 billion dollars, which would be trebled to $75 billion.  Perhaps Visa and MasterCard could show that their brands are more attractive to merchants than the Discover brand, thus reducing the damages figure.  Conversely, even Discover’s fees may be inflated because of the price umbrella created by Visa’s and MasterCard’s fees.  As a result, there is a huge range of potential damage awards if the merchants prevailed at trial, potentially ranging well more than an order of magnitude above what the settlement provides.

In the end, Prof. Sykes may be right.  Figuring out damages may be an insurmountable challenge.  But perhaps damages are not the primary concern of the merchants opposing the settlement.  Could they actually care more about changing the market dynamic going forward?  My next post will try to answer that question by examining the settlement’s injunctive relief provisions.

You may also like...