Everything You Need to Know About Liquidated Damages in Payment Processing

The term “liquidated damages” is something a merchant never wants to see or hear. 

Generally speaking, there are two instances where liquidated damages come into play—when you’re signing a merchant agreement and when you’re trying to cancel a merchant account. 

If you see a liquidated damages clause in a new merchant agreement prior to signing, you still have time to opt-out or get it removed from the contract. But if you’re trying to cancel a contract and your processor says you owe liquidated damages, it could be a costly scenario for your business.

Regardless of where you stand, this guide has you covered. We’ll explain everything you need to know about liquidated damages, including what they are, how they work, and how they’re calculated. You’ll also discover how to detect a liquidated damages clause in your contract, what to do if you’re bound by liquidated damages, and how to avoid liquidated damages. 

What Are Liquidated Damages?

Liquidated damages are a type of early termination fee in payment processing. They’re assessed when a business tries to cancel a merchant agreement earlier than the agreement’s end date.

A liquidated damages clause entitles the processor to be compensated for how much they expect to earn over the lifetime of the merchant agreement. 

Unlike other early termination fees, which might be billed as a flat penalty for terminating a contract, liquidated damages are much more expensive. Liquidated damages can cost businesses tens of thousands, if not hundreds of thousands, of dollars for canceling a contract early.

Due to the massive penalty fees associated with liquidated damages, it can be nearly impossible for a merchant to get out of an agreement early. 

How Are Liquidated Damages Calculated in Credit Card Processing?

Liquidated damages are calculated by taking the average monthly processing fees and multiplying them by the remaining months on the contract.

For example, let’s say you’re locked into a five-year contract with a credit card processor. You decide that you want to cancel your contract after three years, but the merchant agreement has a liquidated damages clause. If your average monthly processing fees are $5,000, then the processor takes the average and multiplies it by the remaining 24 months on the contract. 

In this scenario, you’d owe $120,000 in liquidated damages. 

The exact liquidated damages calculations vary slightly with each processor and contract clause. Some may use the last 12 months of processing fees to calculate the average, and others might use six. Other liquidated damages clauses might be voided if the merchant stays with the processor for a predetermined amount of time before attempting to cancel or switch processors. 

How to Detect a Liquidated Damages Clause in a Merchant Account Agreement

If you think there is a liquidated damages clause in your merchant account agreement, do not sign it!

Signing a merchant agreement with liquidated damages can make it nearly impossible to cancel your contract early without paying hefty sums of cash. So if you’re currently in the process of negotiating with a new merchant account provider, make sure you read the contract closely and comb through the fine print to see if there’s a liquidated damages clause. 

In some cases, the clause will be easy to spot. If you see the words “liquidated damages” anywhere on the contract, it’s a big red flag. 

But it’s also worth noting that many processors can be tricky and almost intentionally deceptive. This means that an early termination clause won’t always be so obvious, and you could be shocked to discover that you have one in your contract when you try to cancel a contract. 

It’s common for liquidated damages to be buried in the fine print of a “Terms and Conditions” section of a merchant agreement, and it’s typically found somewhere in the “Termination” section of the contract.

Here’s an example of contract verbiage you might find in an agreement that doesn’t outright say “liquidated damages” in the copy:

If the client terminates this agreement within three years of the start date, the processor will suffer operational damages. Due to this, the client agrees to pay an early cancellation fee of $450 or the average monthly processing fees charged to the merchant for the past 12 months (or less time if the merchant hasn’t reached 12 months) multiplied by the remaining months of the contract, whichever is greater. 

At first glance, it looks like you’d only owe $450 for canceling early. While this isn’t ideal, it wouldn’t cripple the business or prevent you from switching processors. 

But upon closer inspection, you’ll see phrasing like “or the average monthly processing fees charged to the merchant for the past 12 months multiplied by the remaining months on the contract, whichever is greater.” 

That’s a liquidated damages clause, and it’s always going to be greater than $450. 

Here’s something else to keep in mind—never take the word of your sales rep. 

It’s a shame that this has to be said. But you’d be surprised how many merchants are surprised to hear that they owe liquidated damages. They say, “My rep told me I can cancel anytime and won’t owe anything!” 

But the only thing that matters is what’s in the contract. 

Here’s another shady trick to be aware of. Sometimes a salesperson will hand-write “no termination fee” on an application. But the application is not a contract, and the contract might explicitly state that the sales rep does not have the authority to waive termination fees. 

In other instances, the rep might be allowed to waive termination fees. But the liquidated damages clause is listed elsewhere and doesn’t fall into the same category as other fees. 

What to do If You Signed a Merchant Agreement With Liquidated Damages

If you’ve recently discovered that your current merchant agreement has a liquidated damages clause, don’t panic. While this isn’t ideal, the clause itself doesn’t change your current operations. You’ve previously been using this processor to facilitate credit and debit card payments, and you can continue using them to process payments moving forward. 

It’s not advisable to cancel your contract with the plan to fight liquidated damages fees. Unfortunately, these contracts are usually iron-clad, and it’s typically a losing battle. 

That’s why it’s better to get liquidated damages clauses removed from your merchant agreement prior to signing it. 

So what should you do if your contract contains liquidated damages?

First, identify how much longer you have on the contract. If you’re 30 months into a 36-month contract, you’ll likely be able to stick it out for another six months. 

Second, find out if you have an auto-renewal policy. Many auto-renew clauses revert to the original terms of the contract—meaning you’d likely be bound to liquidated damages again if the contract renews. If this is the case, you usually have up to 30 days before the contract ends to opt out of the auto-renew. 

You don’t have to switch payment processors when you opt-out. Your processor doesn’t want to lose your business. So instead, this is a good time for you to ask that the liquidated damages clause get removed from the renewal contract. 

If you’re having trouble understanding the terms of your merchant agreement, reach out to our team here at Merchant Cost Consulting. We know all of the tricks that processors use to take advantage of merchants, and we’ll help you identify any shady clauses in your contract that can be negotiated upon renewal. 

How to Avoid Paying Liquidated Damages Fees

You can avoid paying liquidated damages fees by not signing a merchant agreement with early termination fees or by sticking with your processor through the entirety of the agreement. 

If a merchant agreement contains a liquidated damages clause, you’ll almost always have to pay it if you try to terminate the contract early. 

While it can be frustrating if it feels like you can’t switch processors, a quick shift in your priorities can resolve this issue. 

Most merchants only try to opt out of a contract early because they think they can get cheaper credit card processing elsewhere. But this is a big misconception. 

Other payment processors will always quote you at a lower rate than your current processor in an attempt to get your business. But before you know it, those rates will rise—and you’ll end up paying the same fees, if not more, than your previous agreement. 

It’s so much easier to just negotiate your rates directly with your existing processor. If you can lower your processing rates, the liquidated damages fees become irrelevant because you’ll have no reason to cancel. 

Final Thoughts on Liquidated Damages in Credit Card Processing

Liquidated damages aren’t fun. They can cost merchants anywhere from $10,000 to $100,000 or more. 

If you see a liquidated damages clause in a merchant agreement, don’t sign it. But if it’s too late and you’ve already signed, it’s not the end of the world.

You only pay liquidated damages if you cancel your contract early. But you won’t need or want to cancel early if you can lower your processing rates—and that’s where we come in.

Here at Merchant Cost Consulting, we save our clients money on credit card processing without forcing them to switch processors. We’ll audit your statements and merchant agreement to identify any liquidated damages clauses, early termination fees, or other unnecessary fees that can easily be avoided. 

Then we’ll negotiate those rates directly with your processor on your behalf. 

Our results speak for themselves. If you read this case study, you’ll learn the story of a business that had an $85,000 liquidated damages clause in its processing contract. After working with Merchant Cost Consulting, we helped them avoid this fee and helped them save $275,000 in processing fees in just one year. With savings like this, the liquidated damages clause became a moot point in the contract.