VeriFone Holding Inc. and Heartland Payment Systems Inc. are embroiled in a legal dispute that was triggered by still-in-development encryption technologies and has led to charges of unfair competition, patent infringement and xenophobia.

Both companies are at the forefront of the movement to introduce end-to-end encryption into the payment card processing system; VeriFone is offering a product and Heartland is developing one.

VeriFone has claimed that Heartland's product is based on its patented technology, while Heartland has said that the San Jose terminal company is using its market dominance to unfairly block new companies from entering the field.

The two companies are longtime partners; Heartland offers VeriFone terminals to its merchant clients. However, the Princeton, N.J., processor announced last week that it would offer its encryption system through terminals made by VeriFone's rival Hypercom Corp.

Experts say the legal battle hinges on technology issues and business strategies, and could lead to a new revenue model for vendors of point of sale terminals.

The legal sparring dates back a month. In a Sept. 9 complaint filed in the U.S. District Court for the Northern District of California, VeriFone alleged that Heartland's in-development terminal infringes on a patent held by its VeriFone Israel subsidiary, related to an antitamper enclosure. The Heartland device uses technology supplied by Uniform Industrial Corp., a Taiwanese terminal company.

A week later, Heartland responded with its own suit, alleging that VeriFone was engaging in "bullyboy tactics" by threatening to no longer provide parts or services to Heartland clients using VeriFone terminals, unless the processor agreed to stop work on its own terminal.

Heartland has claimed that VeriFone wants an exclusive deal to supply it with payment terminals using advanced encryption technology.

Heartland has been a leading advocate of end-to-end encryption, after it disclosed in January that its network had been breached.

Gil Luria, an analyst with Wedbush Morgan Securities in Los Angeles, said there is more to the fight than just a patent fight. "This is part of the big-picture negotiation [between acquirers and terminal makers] over what the next generation of products is going to look like," he said. "Encryption, whatever form it takes, is a transformative technology."

Luria said that developing new encryption technology could give terminal makers leverage to shift their business model.

VeriFone "wants more of the gain from this new generation of products," he said. "They probably want a bigger piece of the pie."

Heartland, however, likely has little interest in giving more of its revenue to VeriFone, he said, and decided that a deal with Hypercom was more attractive.

Heartland's statement said VeriFone notified it on Aug. 11 that VeriFone would no longer provide terminals to Heartland or support existing ones on Heartland's network.

"VeriFone attempted to burden the marketplace and mandate an exclusive arrangement with us that would have taxed merchants with unnecessary additional fees," Heartland said.

VeriFone would not make executives available for an interview.

Heartland has said that there is more at stake than just a patent; in its suit it alleged that VeriFone wants to prevent foreign competitors from gaining ground in the United States.

According to its filing, "VeriFone's motive for this was clear: It did not want Heartland enabling the efforts of an Asian terminal manufacturer to enter the United States."

The complaint also said that VeriFone's chief executive, Douglas G. Bergeron, told Heartland's CEO Robert Carr, "I can't let you bring the Asians into North America. I want an unfair advantage. That's what I live for."

A VeriFone representative said the company had no comment on that claim.

In a statement, VeriFone said that its case against Heartland "is a simple case of intellectual infringement."

In an amended complaint, filed Oct. 13, VeriFone said Heartland's suit is "retaliation" for VeriFone's initial "suit seeking to enforce VeriFone Israel's patent."

Analysts said that the payments industry is still evaluating different types of encryption, and it is unclear what format might eventually take off. Currently, no one encryption technology stands out. "There are a lot of people confused about [encryption]. I can't recommend one solution over another," said Chuck Fillinger, an associate with Strawhecker Group, an Omaha payments consulting company.

Fillinger also said that end-to-end encryption only protects card data from the terminal to the processor, and not all the way through to the issuer. "That's only the first leg of the journey," he said. "There needs to be some standardization."