American Express Merchants Win The Latest Round

by Steve Berk

Power can take several forms.  It can be as overt and raw as Libyan leader Muammar Gaddafi bombing his own people, or it can be as subtle as controlling the agenda of a Board meeting so that the interests of shareholders are not just ignored but substantially defeated by the power of the agenda.

The mighty American Express (2010 Q4 revenues exceeding $7 billion) has dominated its merchants -- millions of businesses large and small -- by a very nuanced form of power: a simple contract provision.  Not the entire contract, simply one provision; a line or two, buried deep in the fine print, prohibiting merchants from bringing a class action claim against American Express in Court or before an arbitrator.  Any claim, large or small.

So what?  Doesn't sound like that big a deal. Well it is. It is one of those subtle forms of power that are "game changers".  Without the right to file a class action (in any forum) merchants are rendered defenseless to the whims of American Express.  For example AmEx can: (1) raise rates; (2) issue bogus chargebacks to customers, leaving the merchant without compensation for good or services sold; (3) refuse to honor valid charges; and (4) tack on unearned or even unlawful fees.

A lone merchant could theoretically go it alone and challenge American Express, but from a practical standpoint could they really proceed?  Even if American Express is 100% wrong the merchant faces two likely insurmountable challenges.  First, retribution and dismissal from the American Express family - the death knell for a restaurant or hotel, which rely heavily on customers using their AmEx card.  Second, challenging American Express is expensive.  How can an individual merchant afford to hire an attorney to pursue a claim worth only, $10, $100, even $10,000?  It would certainly give them pause.  Legal fees would easily exceed any recovery and no lawyer can afford to take the case on a contingency.  So in the end, the rational merchant bites the bullet and walks away empty handed; meanwhile the class action prohibition allows AmEx to get away with this exploitation on a large-scale basis.

A hypothetical may be useful.  Let's say Nancy owns a nice bed and breakfast on the Maine Coast. Eight rooms, short season, beautiful ocean vistas.  High roller Zach rents all eight rooms for a week in the height of season to impress his working class family and lives it up, meals, drinks, and enjoys of all the amenities.  His bill for the festivities: $25,000.  He pulls out that platinum American Express and charges it all.  Nancy runs the charge through, it clears, and minus the 2.56% ($640) she must pay American Express, it's a good start to what she hopes will be a comeback season from a long recession.

Three months later though, she gets a statement from American Express, with a chargeback on high roller Zach's bill for $15,000.  Needless to say, that's a lot of money for Nancy.  She calls American Express and they explain that high roller Zach's hedge fund went kaput and he is unable to pay over $250,000 in AmEx charges.  So AmEx is sharing its pain with its merchants and reversing valid charges to recoup its credit losses, "Sorry."

"What?  You can't do that!  The charges went through.  There was no valid basis for a chargeback.  The transaction was legitimate."

Poor Nancy (and potentially millions of other merchants); she can't afford a lawyer in addition to the $15,000 she is already out, and any kind of class or mass action has been eliminated by American Express' clever contract lawyers in New York.  She is left without recourse to fight what is flagrant unlawful conduct by American Express.

But here comes the Second Circuit Court of Appeals to the rescue.  By striking down the class action ban in the American Express merchant contracts, the Second Circuit Court of Appeals breathed hope into claims like Nancy's.  Last week, on remand from the Supreme Court, the court of appeals upheld its previous opinion:

We found the class action waiver unenforceable, "because enforcement of the clause would effectively preclude any action seeking to vindicate the statutory rights asserted by the plaintiffs."

This decision alone can serve as a deterrent to overreaching conduct and other more subtle efforts by American Express (and indeed other companies) to take advantage of their previously unchecked power.