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Low Transparency of Chargeback Mechanism for Credit Card Payment Introduce Connected Lender Liability to Enhance Consumer Protection

  • 2017.05.09

Very often Consumers prepay significant sums for goods or services for convenience or discounts, or due to particular business models.  If, however, the retailer closes down, consumers, as unsecured creditors, have a slim chance of recovering the prepayments from the winding-up process.  Because of this, they may suffer the double loss of "not enjoying the goods or services purchased and failing to recover the payment".  Although consumers making prepayments for services or goods by credit cards are protected by the chargeback mechanism, the in-depth study conducted by the Consumer Council reveals a lack of clear and consistent application procedures and requirements set out by card issuers for raising a chargeback request; and there is also a lack of transparency or service pledge when it comes to handling chargeback requests among card issuers.  In the absence of a set of publicly accessible guidelines, it would be difficult for consumers to ascertain whether they have any chargeback protection in transactions.  Besides, the mechanism cannot protect consumers who make purchase by credit card instalment payment plans (IPPs), indicating room for improvement.

The Consumer Council has examined the operation of chargeback and relevant laws and regulations in Europe, the USA and various countries in Asia in its in-depth report, Consumer Protection on Prepayment and Retailer Insolvency – Review of Chargeback and Beyond.  The Council strongly recommends card issuers (most are banks) and liquidators to increase transparency of chargeback and to work out a specific guide and service pledge on the mechanism.  The respective authority should also apply greater supervision.  To fully enhance protection of consumer prepayments, the report recommends the Government to consider introducing connected lender liability by legislation, allowing consumers using IPPs to also recover loss from the card issuer directly in the event of retailer insolvency, without resorting to winding-up process that offers only a slim chance of recovery.

Credit cards are a very common form of payment.  The total expenditure on retail sales on Hong Kong-issued credit cards in 2016 was HK$470 billion, and a significant part of which could comprise prepayments.  The 3 major insolvencies in recent years reviewed by the Council share some commonalities: all involved prepayments, all affecting a large group of consumers, the amount involved in transactions was substantial, and the amounts were on the rise.  Although there was a handful of successful recovery of prepayments making use of chargebacks, some card issuers failed to provide consistent and clear guidance for chargeback applications, while some even refused to handle consumers' requests for chargebacks.

Chargeback mechanism

Chargeback is a consumer protection mechanism provided by credit card associations to cardholders.  Where retailers, for whatever reasons, fail to provide services or goods that are paid by credit cards, the card issuer may raise a chargeback claim against the acquirer (i.e. the business operator collecting payment on the retailer's behalf) to reverse the relevant transaction.  If the acquirer accepts the claim, it would pay back the card issuer the transaction amount and then the card issuer would reimburse it to the cardholder.  This mechanism is provided by the contractual arrangements among the credit card association, card issuers and card acquirers.

The Council conducted a questionnaire survey in 2016 to major card issuers (mostly banks) and card associations in Hong Kong.  Replies were received from 15 card issuers and 1 credit card association.  The Council has also reviewed the respondent card issuers' websites and cardholder agreements undertaken detailed analysis of the problems and limitations of the chargeback mechanism in operation.

Lack of clear and consistent application methods and procedures

According to the survey, all the respondent card issuers do provide chargeback protection to their cardholders, but there is a lack of clear and consistent application as to methods, procedures and time limits for raising chargeback requests.  Some card issuers require the cardholder to contact a call centre and obtain a dispute form; some require the cardholder to first resolve the dispute with the retailer and/or liquidator before raising a chargeback request.  As regards the prescribed time limits for raising chargeback requests, some are begin from the transaction date or expected delivery date whereas others from the date of statement issued, such time limits range from 60 days the shortest to as long as 540 days.

Lack of chargeback mechanism transparency

The survey finds that although cardholder agreements mention that cardholder may raise a dispute or apply for a refund within prescribed time limit, card issuers' websites or other communication channels do not have specific chargeback provisions or application guidelines.

The Council notes the fact that chargeback mechanism is provided by contractual arrangements among financial institutions, and this makes it difficult for consumers as a non-party to learn the details of it.  There is no provision in the cardholder agreement specifying that the card issuer is under an obligation to raise a chargeback claim on behalf of the consumer.

Uncertainty in chargeback protection

Since there is no provision in the cardholder agreement specifying that the card issuer is under an obligation to raise a chargeback claim on behalf of the consumer, the matter depends entirely on the discretion of card issuers.  Without open guidelines, consumers are uncertain about the circumstances under which the card issuer may raise a chargeback claim for them and much less certain about whether their transactions are protected by chargeback mechanism.

Lack of protection for IPPs

The report also notes that not all transactions involving credit cards are protected by chargeback mechanism.  IPPs are loan agreements between the card issuer and the cardholder which are different from typical credit card transactions and therefore are not covered by chargeback protection.  If a retailer closes down, consumers using IPPs are likely to suffer the double loss as they are still bound to pay off the amount by instalments even though they cannot enjoy the service/goods for which they paid.

Analysis of overseas experiences and recommendations

This report examines the operation of chargeback and relevant laws and regulations in EU, the UK, the USA, Australia, Mainland China and Singapore, and finds that inadequate transparency of chargeback is a common problem in many jurisdictions.  To strengthen chargeback protection, the Council calls on card issuers, Hong Kong Monetary Authority (HKMA) and liquidators to increase transparency of the chargeback mechanism by increasing dissemination of information, improving the system, providing training to frontline staff and establishing a proper service pledge.  Meanwhile there is also a need for the Government to consider the introduction of connected lender liability by legislation to strengthen consumer protection further.

Enhance supervision and increase transparency of chargeback mechanism

According to the Council's report, consumers' adequate understanding of the procedural requirements of raising a chargeback request to the card issuer under specific circumstances within a prescribed time limit is the prerequisite for the chargeback mechanism to be effectively functioned in retailer insolvency.  Last year, the UK Law Commission proposed to formulate an industry code of practice for card issuers to follow and issue a chargeback guide for consumers.  In Australia, the Code of Banking Practice and the Guidance Note on Chargeback issued by the Australian Bankers' Association and Code Compliance Monitoring Committee require the banks to provide in their cardholder agreements and websites general information on chargeback.

The Council recommends that card issuers including banks inform cardholders about chargeback information in the cardholder agreements and on card issuer's website, and to provide a chargeback guide on how a consumer may raise a chargeback claim for a greater transparency of the mechanism.  At the same time, it is important to provide training to frontline staff to ensure that they are knowledgeable about chargeback and its procedures, and raise a chargeback claim against the acquirer for the consumer pursuant to the scheme rules upon receiving a request.

HKMA may consider issuing regulatory guidance to card-issuing banks to ensure that they implement the improvements measures recommended above.

Furthermore, the Council recommends liquidators and other related professional members in dealing with consumer creditors in the course of liquidation to provide the public with more information about chargeback.  Such information includes reminding consumers who have made prepayments by credit cards to request their card issuers to submit a chargeback claim on their behalf, and posting a notice on the retailer's website indicating that the retailer is already closed down or in liquidation together with hyperlinks to the card issuers' chargeback website.

Study the introduction of connected lender liability by legislation

To further enhance the interest of consumers, the Council recommends the government to make reference to the UK's Consumer Credit Act and introduce connected lender liability through legislation, so that connected lender is jointly liable for retailer's breach of contract.  This allows consumers (including those who use IPPs) to recover credit card prepayments from card issuers directly in the event of retailer insolvency, without the need of resorting to the winding-up process.  It is proposed that the liability of card issuers may be limited to the amount of the credit provided to the consumers.

Although the chargeback mechanism is a long-established mechanism, the survey reveals that its operation has much room for improvement.  By virtue of this report, the Council wishes to generate public discussion and call for the concerted efforts of card issuers, HKMA, liquidators and the Government to improve protection for consumer prepayment by credit cards, so that consumers can use credit cards with greater confidence and protection.

Sources: Consumer Protection on Prepayment and Retailer Insolvency - Review of Chargeback and Beyond