Credit Card Settlement Could Stymie PayPal's Retail Plans

A provision within the hotly contested settlement between merchants and credit card networks could potentially slow PayPal's bid to become more widely accepted at grocery stores, restaurants and other retailers.

That's because under terms of the proposed settlement, retailers may assess a surcharge on consumers who pay with plastic to help offset the cost of processing noncash transactions.

Retailers that choose to do so must assess the surcharge on all types of electronic payments — including PayPal, which currently prohibits merchants from surcharging its clients. And unless terms of the settlement are changed — or PayPal adjusts its no-surcharge policy — retailers would have little choice but to shut PayPal out, attorneys for retailers say.

"The upshot is, if you surcharge Visa and MasterCard then you either must surcharge PayPal the same way…or don't take PayPal." says Douglas Kantor, a lawyer for the National Association of Convenience Stores.

Few industry experts expect larger retailers to assess surcharges because doing so is more likely to turn off buyers than get them to switch to cash. But smaller merchants that face limited competition — like doctors' offices or specialty retailers — might be more inclined to add the surcharge to offset swipe fees, industry observers say.

PayPal is currently accepted at only a handful of retailers, including Home Depot, but it has plans to expand through a partnership with Discover Financial Service (DFS) that would let consumers use PayPal at roughly 7 million U.S. merchants where Discover is accepted.

Kantor says he believes MasterCard and Visa pushed for the surcharge provision in an effort marginalize PayPal and other smaller players trying to make further inroads in payments.

"Paypal is a tiny player that doesn't set the market," he says. "Visa and MasterCard set the market and their rule prevents competition."

A PayPal spokesman did not respond to a request to discuss the consequences of the proposed settlement. MasterCard (MC) and Visa (NYSE:V) officials declined to comment.

In July, Visa and MasterCard and the largest banks proposed a roughly $7 billion settlement with U.S. retailers over a long-standing lawsuit stemming from the processing fees the networks charged retailers.

Almost instantly merchants cried foul, accusing the payment networks of refunding the equivalent of two months of interchange fees to any one merchant, while in the process releasing themselves from a wide-range of future litigation.

Most recently, the National Restaurant Association, one of 19 named plaintiffs in the lawsuit, announced that it rejected the proposed settlement.

The settlement is hardly a done deal. It still requires the approval of U.S. District Judge John Gleeson in Brooklyn, which could potentially set off a chain of legal events that could drag out its implementation. Even then, the decision could end up being hampered by additional litigation.

The effect of the PayPal provision could also be limited.

Ten states, including California, Florida, Texas and New York ban surcharging because it's viewed as anti-consumer, says Eric Grover, principal at payments consulting firm Intrepid Ventures. In those states, merchants would not even have the option to surcharge.

In the remaining states, PayPal could always change direction and choose to permit surcharging if it means gaining more of a foothold within retail outlets.

One unlikely outcome is that terms of the settlement will be changed to prohibit surcharging.

"The merchant lobby has been clamoring for two things: the right to surcharge and a reduction in card-acceptance fees, by whatever means, price controls, litigation, or regulatory intervention," says Grover. "They weren't going to get a credit-card interchange reduction with teeth as part of a settlement. It appears they're going to get surcharging."

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