Heartland Payment Systems Inc.'s merchant clients may be caught in the middle of a legal dispute between the merchant processor and VeriFone Holdings Inc., which provides payment terminals to most of Heartland's clients.

The two companies have sued each other, with VeriFone claiming that a still-in-development terminal design from Heartland infringes on one of its patents, and Heartland claiming that VeriFone is engaging in unfair trade practices.

VeriFone, of San Jose, said previously that it would no longer provide maintenance or updates to Heartland clients using its terminals after Dec. 31. But on Tuesday it appeared to reverse itself by offering to provide "alternative support" to them.

"It is imperative that VeriFone merchants continue to receive support to accept card payments without any disruption," Douglas Bergeron, VeriFone's chief executive, said in a press release.

Heartland, of Princeton, N.J., countered that the offer was "a disingenuous attack."

"Heartland is fully capable and will continue to be fully capable of servicing all of its customers," Bob Carr, its chairman and CEO, said in a press release.

"In fact, VeriFone is not able to support our customers. They can't because our customers operate on our proprietary payments processing platforms," Carr said. "Heartland is the only entity that can provide full service, including ongoing service of VeriFone terminals, to them."

To use the VeriFone support service in 2010, Heartland merchants must register with VeriFone by Dec. 15. Support will be free, VeriFone said, but replacement parts and premium services will cost extra.

"VeriFone is attempting to tamper with our customers in an irresponsible way," Carr said. "With these fraudulent claims, VeriFone is pursuing its own agenda of creating recurring revenue at the expense of merchants and consumers."

The companies are long-term partners, and VeriFone said it provides terminals to about 75% of Hearland's retail, restaurant and gas station clients.

However, the relationship has ruptured over the issue of encryption. VeriFone has already introduced encryption capabilities, and has claimed that a system Heartland is developing is based on technology that has been patented by VerifFone.

VeriFone is taking a protective stance, said Gil Luria, a vice president of equity research at Wedbush Securities Inc. in Los Angeles.

"Since Heartland has decided to use its own platform to provide end-to-end encryption, VeriFone is both concerned about the possible infringement of their intellectual property as well as a new entrant in the fastest-growing segment of payment terminals," Luria said. "The risk VeriFone is taking is that this type of action may alienate other customers in the U.S. and beyond."

The drive for encryption was triggered by a large data breach that Heartland disclosed in January and that continues to hurt its profits.

On Tuesday the processor reported a $13.6 million third-quarter loss, after posting net income of $13.4 million for last year's third quarter. A $35.6 million charge to cover costs related to the breach contributed to the loss. Revenue rose 4.2%, to $442.6 million.

Robert Baldwin Jr., Heartland's president and chief financial officer, told analysts during a conference call Tuesday that transaction volume at Heartland's small and midsize merchants was down 8.6% from a year earlier but was about 110 basis points "better than the second quarter." Heartland did not disclose its transaction volumes.

Its retail, hotel and electronics merchant categories were "worse than average, continuing recent trends, and petroleum remains weak given lower prices," Baldwin said, though restaurants, auto parts and entertainment-classified merchants generated some growth.

Mirroring recent reports of increasing debit card use, Heartland's debit card transaction volume grew 9% from the second quarter, Baldwin said.

"While transactions are up, the value of each transaction is down," he said. "This is due not only to smaller ticket sizes but also to the continued growth in debit share of our volume."

Visa Inc. and MasterCard Inc. debit transactions during the quarter grew by 8.3% from a year earlier, Baldwin said, "while credit volume contracted by 8.3%."

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