Difference between Chargebacks and Disputes
From a consumer standpoint, it may seem fairly intuitive: it’s when you see a charge on your credit card statement that shouldn’t be there, so you tell your bank it’s an invalid charge and you don’t intend to be held liable for it. At that point, the dispute may become a chargeback—but not necessarily. All chargebacks are born from disputes, but not every dispute turns into a chargeback.
The law, the card networks, and the banks all have a vested interest in making sure the credit card payments process is seen as fair, safe, and well-regulated by consumers. Disputes are taken seriously, and all stakeholders have rules and policies in place that are designed to provide consumers with rights and protections against fraud, theft, and misuse of their payment cards.
To clarify what we mean when we talk about credit card disputes, and how disputes can involve the chargeback process, it might help to take a step back and look at the entire process from start to finish.
An Overview of Payment Card Disputes
Most disputes begin when a cardholder looks at their statement and sees a charge that they did not recognize (although sometimes cardholders will dispute charges that they’ve knowingly made, if they later learn information that makes them believe they were defrauded or otherwise improperly charged).
Most charges will have identifying information included on their line in the credit card statement, so that cardholders can contact them with questions if they don’t recognize or agree with the charge. Cardholders are always supposed to attempt this before disputing the charge with their issuing bank.
If the cardholder cannot reach or come to an agreement with the merchant, their next step is to contact their issuing bank. The bank will try to help them obtain more details about the source of the charge, and ask if they were able to contact the merchant to resolve things. If the cardholder maintains that they were unable to do so and wish to dispute the charge, the issuing bank will give the cardholder a temporary credit and contact the merchant’s acquiring bank with a retrieval request for more information. This is the point at which the dispute becomes a chargeback.
Most of the rules governing chargebacks have been developed by the big card networks: Visa, Mastercard, American Express, and Discover. Once a chargeback has been initiated, banks and merchants must follow these rules carefully in order to ensure a fair and correct decision.
The first thing that happens when a dispute becomes a chargeback is that it will be assigned a reason code. Each card network has different reason codes, but they all amount to a simple numeric indicator that explains the reason for the chargeback. While these reasons can get quite specific, many of them can be categorized as either fraud (charges made against stolen cards or credentials), or authorization and processing errors. The rest, which Visa calls “consumer disputes,” deal with disagreements and confusion between the cardholder and the merchant, and tend to be less straightforward to resolve than disputes originating from the other two categories.
When a dispute becomes a chargeback, the merchant is automatically liable. That means that if the merchant wants to fight the chargeback and keep their money, they have to provide evidence that the charge was legitimate. If they ignore the chargeback, it will automatically be decided in favor of the cardholder.
Although banks will sometimes exchange information that allows them to resolve chargebacks in the merchant’s favor very early in the process, by the time the merchant receives notice of the chargeback it is too late for that and the merchant must either acknowledge and accept it or make an affirmative choice to fight the chargeback (which, confusingly, might be referred to as “disputing” the chargeback itself).
Representment and Arbitration
If a merchant chooses to fight a chargeback, it will proceed to one or more additional phases of the chargeback process: representment and arbitration.
Representment refers to the merchant fighting the chargeback by “re-presenting” the disputed charge, along with their argument and evidence that the charge was valid in the first place. The issuing bank will review the evidence and this time they will make a decision based on the merits of the claim, instead of automatically assigning liability to the merchant.
After a decision has been made on the representment, that might be an end to the dispute, but there’s still an opportunity for any of the affected parties to appeal it further, to the judgment of the card networks.
The first step in this appeals process is called “pre-arbitration,” in which the banks get one more attempt to work things out on their own. If this fails, the case proceeds to arbitration. The appealing party will have to pay a hefty fine to the card network—as much as $650, or possibly more—and the card network will review the evidence and make a final decision, ending the dispute and closing up the chargeback.
Dangers of a High Chargeback Ratio
When arbitration fees can run into the hundreds of dollars, it might seem like arbitration is only a good idea when you’re fighting a very high-value chargeback. However, it’s vital to remember that the true cost of a dispute is far more than the dollar amount subject to chargeback.
In addition to the sunk operational and marketing costs you’re trying to recover when you fight to reverse a chargeback, there’s another aspect of chargebacks that can have a significant impact on your bottom line, but indirectly: your chargeback ratio.
Merchants who get a lot of disputes are risky customers for payment processors to take on. To encourage good business practices that prevent chargebacks, all reputable payment processors have a “chargeback threshold" that their merchants are not to exceed. Usually, it’s about a 1% ratio of chargebacks to total revenue. Merchants who go over that threshold may have their accounts terminated. At that point, the only way for them to continue processing credit card payments is to sign up with an expensive “high risk” payment processor.
Any time you have a conflict with a customer over a transaction that has already occurred, you’re in the middle of a dispute. The good news is, not every dispute will impact your revenue. When customers come to you first, before contacting their bank, you have a golden opportunity to resolve the situation in an amicable way that will make the customer happy. That benefits your relationship with that customer, your overall reputation, and best of all, it prevents a nasty chargeback from occurring.
When disputes do turn into chargebacks, remember that it is always in your best interests to fight them to the best of your ability. Fighting chargebacks helps you learn about why they’re happening, what pain points your customers are experiencing, and what you can do better in the future to stop similar disputes from happening again.