Understanding Chargebacks

As much as any business welcomes a sale, a sale made using a credit card is not without an element of risk to the business. When a sale goes bad, the credit card companies – often at the prompting of the paying customer – may reverse the charge; i.e. they will charge back to the merchant the amount of the subject transaction. In this article, we take a deeper dive into what charge backs are, why and how they occur, what their impact is to the business, and what can be done to mitigate the chargeback risks.

What is a Chargeback?

A charge back is essentially a forced reversal of a credit card transaction, compelling the business to return the funds paid via credit card, to the paying customer’s credit card account.

Why (and How) Do Chargebacks Occur?

There are two main reasons why a charge back will occur (although there are other reasons as well):

1.            The customer initiates the chargeback.

Often preceded by an unresolved dispute between the customer and the business (perhaps a faulty product without being resolved by the business to the customer’s satisfaction; a refusal of the business to voluntarily return the customer’s money in exchange for the return of the product; a product was never ordered by the card holder but was charged to the card holder’s account – accidentally or fraudulently; a service was not provided as contemplated by the card holder; etc.), the customer contacts their credit card company and demands that they be credited back the amount of the credit card transaction in question. More often than not, the credit card companies will initiate the charge back, and forcibly take the disputed transaction amount away from the business and return it to the complainant customer, irrespective of the objections of the business. 

It is important to note that oftentimes, and unlike in a more traditional “return” situation, the customer has kept the product (or service) and benefits from the return of his / her money. Needless to say, this is highly problematic for the business, as the charge back results not just in a lost sale or lost profit, but in this circumstance, lost capital as well.

2.            The bank initiates the chargeback.

In a situation where the issuing bank suspects that a fraud has occurred or there has been a problem with authorizations or a processing error has occurred, the issuing bank, on its own volition and without prompting, may initiate a charge back to the business.

How is a Business Impacted by a Chargeback?

There are a few ways a business is impacted by charge backs. Outside of the obvious, where the business is out the amount of the transaction, and as stated above, is usually out the cost of the good as well), an additional impact to the business is that there is a separate charge (in addition to the credit card transaction amount) that the business pays – similar to a NSF fee for a bounced cheque. Finally, if a merchant sustains a high percentage of charge backs relative to their overall transaction volume, the credit card companies or payment processors may shut down the merchant’s ability to accept credit cards as a form of payment altogether. This can have a catastrophic impact on a business’ ability to operate and in some circumstances, may even force the business into bankruptcy

What Can Be Done To Mitigate Chargeback Risk?

If a merchant is willing to accept the benefits of payment by credit cards, the merchant must equally be willing to live with burden of the risk of Chargeback. All hope is not lost, however, as there are a handful of simple steps a business can take to mitigate the risk.

1.            Work with the customer

Generally speaking, the majority of customer disputes can be resolved by voluntarily issuing a refund to the customer. In so doing, the likelihood of the customer initiating a chargeback will be greatly reduced. Even if the business has a “no refund” policy in effect, it is prudent to weigh the risk of chargeback against voluntarily offering a refund to an irate customer.

2.            Verify the customer and follow PCI standards

Ensure that the customer’s ID and signature match the name and signature on the credit card. If the credit card is not signed on the back, avoid accepting the credit card as a form of payment (perhaps offer to take a debit card or cash, instead). These are guidelines mandated by the Payment Card Industry (PCI), so following them is good business practice in any event and required as a term of use of accepting credit cards.

3.            Check the card’s expiry date

Often overlooked, simply ensuring that the card being presented for the transaction is not expired.

4.            Encourage Card Present Transactions

Although not always practical or possible, encourage card present payments (as opposed to card not present transactions). “Card present” means that the cardholder is physically present at the point of sale, which is a much easier way to verify the authenticity of the cardholder and transaction in question.

5.            Third Party Verification Providers

Especially important for businesses operating in the E-Commerce space, third party service providers exist who will verify the credit card and give a thumb’s up or thumb’s down on accepting a particular card for a transaction, before releasing the product to the purchaser. These services are not free, however, so be sure to both research their benefits before engaging them and factor in their costs.

6.            Maintain Best Practices

As banks tend to favour the card holder in the event of a dispute, it is important to maintain strong and consistent business policies and practices in order to stand a chance to successfully fight off a chargeback. Clearly display store policies (especially in “no refund” stores), keep all signed receipts, take ID where possible, ensure staff is adequately trained, and use the most up to date terminal technology available.


Accepting credit cards as a form of payment inherently comes with the risk of chargeback. Chargebacks are a forced reversal of a transaction, returning the transaction amount to the cardholder, with that cost being absorbed by the business. Chargebacks have a detrimental and possibly catastrophic impact on the business; where an excessive number of chargebacks occur, this can lead to the termination of the business’s ability to accept credit cards, going forward. Chargebacks can be initiated by the customer or by the bank for a variety of reasons. Steps can be taken by the business to mitigate, but never eliminate, the risk of chargeback.

For more information about this topic or to have a complimentary rate review for your business anywhere in Canada or the United States, call PayLite Merchant Services toll-free at 1-877-671-1635 and speak to a representative.