While it may not be the most common scam out there, at CardFellow we regularly field questions from people asking about opening a merchant account for someone else in your own name.
Officially termed “credit card factoring” or “credit card laundering,” this type of misrepresentation is illegal. You could end up with fines, lawsuits, and more.
Under no circumstances should you sign up for a merchant account for someone else’s business in your name, or allow another business to use your business’ merchant account. Let’s look at what factoring is, how you might be asked to do it, and why it’s never a good idea.
- What is credit card factoring?
- Merchant Cash Advances
- Unauthorized Use
- Setting the Stage
- Your Role
- Why is it illegal?
What is credit card factoring?
There are actually two types of credit card factoring; one is illegal, one is not.
At the most basic level, credit card factoring means using a merchant account for a purpose other than stated at the time the account was opened or by parties not authorized to use the account. Merchant cash advances are legal “factoring” while setting up a merchant account for someone else is illegal.
Credit card factoring is also different than “invoice factoring,” which involves receiving money for your outstanding invoices from a third party. When your customers aren’t paying invoices or have long net terms but you need the funds sooner, companies that offer invoice factoring will pay you the amount of your invoices, less fees, and collect the money later. (Either from you, when your customer pays, or directly from your customer, depending on the circumstances and agreements you make with the invoice factoring company.) Invoice factoring is typically legal, though whether it’s a good idea is up to you to determine on a case-by-case basis for your business.
Merchant Cash Advances
Technically, merchant cash advances are a type of credit card factoring, as they involve obtaining money in advance for future credit card sales. With a merchant cash advance, the business that holds the merchant account can choose to “sell” a portion of its future credit card revenue in exchange for a lump sum up front.
Merchant cash advances typically require less documentation than loans, and don’t follow a traditional interest-based repayment structure. Instead, the advance is repaid automatically over time through a deduction of funds from credit card sales.
Merchant cash advances are typically a legal use of factoring, and not what we’re discussing in this article.
For more information see: Should I Get a Merchant Cash Advance?
The second type of credit card factoring refers to use of the merchant account by a business other than the one for whom the account was approved and opened. There are a few common ways that are not ill-intentioned where this could happen, but are still not allowed. For example, a small business sharing office space or a storefront with another business owner might not see a problem with allowing the second business owner to run transactions through their account.
While you didn’t mean any harm, you’re not allowed to use your merchant account that way. If you work closely with another business and want to share machines, you’ll need to each have a merchant account. Then, you can choose equipment that allows “multi-merchant” capabilities, where transactions run under different merchant accounts even though you use the same credit card machine.
Other seemingly-innocent situations that are actually credit card factoring include setting up a merchant account for an in-person business and then using it for an online business or running the merchant account holder’s credit card through the merchant account to get cash.
Remember that you can only use your merchant account for the specific business for which the processor originally approved it. The original application includes how you take cards. You can’t simply start accepting online payments if you set up an account for swiped payments.
While these situations are expressly not permitted, they also aren’t the scams that some fall prety to. Rather, factoring scams occur when someone wants you to open a merchant account for their business in exchange for a cut of the sales. Let’s take a closer look at typical scenario in which you may be approached to open a merchant account for someone else as part of a factoring scam.
Setting the Stage
In many cases, the person suggesting credit card factoring is a friend of a friend or otherwise seems legitimate. The person wants you to open a merchant account in your name. They’ll state that they are not able to open an account for some reason. Typical reasons they claim may include:
- I have poor credit
- We already have an account, but our processor limits how much money we can process
- We have too many chargebacks for one account
These justifications may be somewhat accurate, or they may be complete fabrications, depending on the person. It’s worth noting that even with poor credit or little business history, almost every legitimate business can find a credit card processor willing to work with them.
The person approaching you about the merchant account will want you to open one for them. They may refer to you as a “signer” and state that businesses regularly use multiple signers to secure merchant accounts. You’ll fill out paperwork, and in some cases the person may tell you that they will set up an LLC in your name so that you’re “legitimate.”
From there, the original person will run transactions through the account, give you a cut of the sales, and keep the rest. They’ll tell you that it’s a great way to earn money for doing nothing. In some cases, they may tell you that you can open multiple accounts to make more money.
They’ll likely also advise you that you can only do this temporarily before a processor closes accounts. They’ll also claim that account closures are a normal part of the processing cycle.
Some transactions run through your account may be legitimate transactions. However, they could also be transactions using stolen credit cards submitted fraudulently. The person asking you to open an account will of course tell you that the transactions are legitimate and they’re a real business, but you’ll have no way of knowing.
In addition to breaking the law, there are financial risks to opening a merchant account for someone else as a “signer.” Since your name is on the account, you’ll be responsible for any chargebacks. In more extreme versions of this scenario, a business will run up tens of thousands of dollars (or more) in illegitimate transactions. Then they close up shop and disappear before you know about the chargebacks. Once those chargebacks come rolling in, you’re unable to locate or contact this person, and you’re on the hook with the processor.
Some people try to downplay this risk. They may tell you that processors require reserves to cover themselves in the event of chargebacks. While reserves are a real thing and a restriction that processors sometimes impose, it in no way absolves you from responsibility.
Related Article: Understanding Rolling Reserves.
Another risk is that your processor can place you on the Terminated Match File or “Match List.” It’s extremely difficult or impossible to get a merchant account in the future while you’re on the Match List. If you plan to start your own business down the road (or if you already have one) a place on the list will put a serious crimp in your plans.
Depending on the circumstances of your particular situation, processors may be able to sue you or take other legal action regarding your fraudulently opened account.
Why is it illegal?
Credit card factoring is illegal because it’s a form of laundering – obscuring the source of a transaction. It’s essentially the digital version of money laundering. This makes it susceptible to moving money obtained illegally. Additionally, you’re misrepresenting yourself and fraudulently completing an application for services. You’ll likely be breaking your contract with the processor as well.
Bottom line: Never allow a business that isn’t yours to use your merchant account to accept payments. You should never accept a credit card for another business’ transactions.
You say there are actually two types of credit card factoring; one is illegal, one is not. Which one is not illegal?
Merchant cash advances, which are discussed in the early part of the article.
Someone is using our business name to process credit card payments. I found out today when a potential customer showed me her Capital One statement with a payment to us! She says it was a payment to our competitor. How can they use our name? What does this mean?
If the name isn’t trademarked they can probably use it. Your best bet here is to check in with a licensed attorney.
There is someone advertising a ‘business’ on craigslist processing transactions for merchant accounts that go over their limits. Does this also fall under the illegal factoring umbrella ?
Most likely. If it involves signing up for a merchant account to handle another business’s transactions (or ‘overage’ or whatever they call it) then yes, that would not be allowed.
What was the name of the company?
I unfortunately have been sucked in by the CL scam mentioned below. I am unsure of how to proceed. I would like to expose this organization. I have processed thousands of dollars for them. Can you offer any advice? I don’t know if these transactions that I processed were valid or not. No proof either way, but am glad that I found that the actual business model is illegal thanks to your article. What should I do?
Sorry to hear that. I’d suggest that you speak with an attorney to determine the best course of action.
Someone did this exact thing to me. I finally found out what the business model is, thanks to your article. Has this been a recent scam or has it always been around? Hoping this person get what’s coming to them.
Sorry to hear that you had this happen to you.
We’ve fielded questions about this scam for several years, so it’s not brand-new, but I can’t say how long it has been happening. Please feel free to share the article to help get the word out!
-Ellen from CardFellow