Chargeback fraud: what is it, how to prevent and fight it

Businesses of all sizes and stripes, from large corporations straddling multiple continents to side hustle ideas brought to life via laptops, kitchen tables and copious cups of tea, increasingly rely on card not present transactions to generate revenues.

These are payments taken from customers who aren’t there in person, such as transactions made through online payment gateways, or card payments over the phone. Setting yourself up to receive money this way has never been easier, and – depending on your business type – it may well be fundamental to your operating cash flow. 

But there is an issue related to remote payments which should be on every entrepreneur’s radar, and that’s chargeback fraud. It’s a term that still isn’t quite as well known as it should be, considering the impact it can have on small business finances.

Before delving into how to prevent chargeback fraud, we’ll first answer the key question, “What is a chargeback?”. We’ll then lay out the different forms this fraud can take, and explain the steps you can take to minimise the risk to your business.

What is a chargeback?

A chargeback is when a customer claims that a debit, credit, or prepaid card purchase was unsatisfactory or illegitimate, and puts in a formal request to their bank or card issuer to reverse the payment so they can get their money back. 

If a chargeback is carried out successfully, the bank or card issuer refunds the full amount to the customer, and deducts the same amount from the business which the customer had originally purchased from.

From a business owner’s point of view, chargebacks are far less desirable than customers cancelling orders or requesting refunds. Here’s why.

Lack of control

Both refunds and chargebacks result in you losing the money you made from the original transaction. However, refunds and cancellations only involve you and the cardholder, and are carried out according to the specific terms and conditions of your business. This means you remain in control of the process. 

Chargebacks, on the other hand, are out of your control, being carried out by banks and card issuers which independently assess the legitimacy of the chargeback claim. 

Plus, unlike with refunds, you’ll have no warning when it comes to chargebacks, with the money usually deducted from your account before you’re able to dispute the chargeback. It goes without saying that if a high-value sale is reversed out of the blue in this way, it can seriously disrupt your cash flow for a given time period.

More expensive

Cancellations and refunds generally only result in you losing the amount that the customer originally paid for a product or service, together with any processing fees. The financial impact from chargebacks tends to be worse, for a few reasons.

First up, if a transaction involves physical items, they will usually be returned as part of the refund process. By contrast, there’s no guarantee you’ll get your items back with a chargeback, especially in the case of chargeback fraud. 

So, as well as having the retail price of the items debited from your business account, you’ll also lose the money you spent buying the items yourself from your supplier (or the money and time spent on creating them, if your business specialises on things to make and sell).

On top of this, your bank or card issuer will also typically issue a chargeback fee, which can be anything between around £15 to triple digits. 

More time consuming

Whether you’re exploring business ideas from home or managing your own high street shop or food and drink outlet, you’ll want to spend your time focusing on things that can help your enterprise thrive – whether that’s planning how to create a USP for your business, undertaking a competitor analysis, or coming up with marketing strategies for small business success. 

What you don’t want is the distraction of challenging chargebacks which are unreasonable or outright fraudulent. The process of defending a disputed transaction can stretch for weeks or months, and require trawling through your business records to amass evidence in your favour.

Harms reputation

Unless they feel particularly let down (or you’re dealing with a particularly difficult client or customer), cancellations and refunds shouldn’t put a dent in your reputation as a business. 

Unfortunately, the same can’t be said for chargebacks. Incurring multiple chargebacks, even fraudulent ones, will increase your chargeback ratio. This is expressed as a percentage and shows the proportion of sales that have resulted in chargebacks.

Chargeback ratios over 1% can lead to businesses being subjected to closer scrutiny by banks and card networks, possibly triggering higher chargeback fees and penalties. 

What is chargeback fraud?

While chargebacks can be a headache for business owners, they do provide financial protection for consumers. 

Thanks to the existence of the chargeback process, anyone who owns debit, credit or prepaid cards can feel safe in the knowledge there’s a process for getting their money back if:

• Criminals steal their card details and make unauthorised purchases.

• The purchased products or services don’t match their descriptions, and the business doesn’t provide a refund for whatever reason.

• The purchased products turn up faulty or damaged, or don’t arrive at all, and the business doesn’t provide a refund for whatever reason.

• The business makes an error, for example charging twice for the same purchase, or continuing to charge after a subscription is cancelled, but doesn’t rectify the situation for whatever reason.

However, the chargeback process can also be used incorrectly or outright exploited, in what’s known as chargeback fraud or friendly fraud. The use of the word “friendly” here is a bit misleading, as it simply refers to the fact that it involves the legitimate cardholder, rather than an unknown third party who’s stolen someone’s card details.

Chargeback fraud is when a customer makes a chargeback claim even though the transaction was valid and the business did nothing wrong. It can be broken down into two main types.

Unintentional chargeback fraud

Although the word “fraud” generally implies malicious intent, this isn’t always the case when it comes to chargeback fraud. A customer may trigger a chargeback because of an honest mistake or misunderstanding. Here are some scenarios where that might happen.

A transaction isn’t recognised

A chargeback claim might be made when a customer doesn’t recognise a transaction on their bank or credit card statement, either because they forgot making the purchase or the business has used a billing descriptor which doesn’t match their brand name. 

Say for example you’ve set up a limited company called XLQ Retail Ltd to pursue a number of passive income ideas under different trading names, including an online store called Ragamuffins, selling cat-themed clothes.

A customer buys a very cool skirt emblazoned with cats. It’s delivered on time, and they’re delighted with their purchase. However, weeks later the customer receives their credit card statement which lists the transaction under your official registered name, XLQ Retail Ltd, rather than Ragamuffins. 

Unless the value of the transaction rings a bell, the customer might well assume there’s been an error, and go on to trigger a chargeback.

A family member has used their card

Friendly fraud can take place as a result of family fraud, which is where a family member makes a purchase using a debit, credit or prepaid card without the cardholder’s knowledge.

This might be deliberate debit or credit card fraud by a cardholder’s family member. Or, a child might be using the cardholder’s phone and make purchases at any online stores the cardholder is logged into, without really understanding that they’re essentially committing identity theft.

In any event, it may mean you get hit with a chargeback claim from the cardholder when they realise what’s happened, even though the transaction itself went without a hitch.

The customer misunderstands chargebacks

A customer might not realise that chargebacks are intended as a last-resort recourse for illegitimate or flawed transactions, and instead mistakenly view chargebacks as an alternative to requesting refunds. 

Say you’re interested in creative ways to make money, and decide to sell homemade ceramics online. A customer purchases a fruit bowl, but it goes AWOL at the delivery depot and never arrives. The customer drops you an email asking what’s happened, but it gets shunted to your spam folder and you never see it. 

At this point, the frustrated customer may claim a chargeback, in the misguided belief that it’s a faster, simpler alternative to rectifying the situation than trying to contact you again.

Intentional chargeback fraud 

Invalid chargebacks can also be triggered by customers who are fully aware they have no grounds to do so. Here are some examples of deliberate chargeback fraud scenarios.

The customer is a cyber shoplifter

Arguably the most egregious type of chargeback fraud is when a customer buys something online with the express intention of making a chargeback claim after the ite, arrives, so as to effectively get it for free. This is often described as “cyber shoplifting”.

Let’s imagine you’ve been brainstorming ideas for second income generation and decide to supplement your main job by selling handcrafted jewellery online. You get an order for a necklace, which you duly dispatch. 

A few weeks later, the money paid for the jewellery disappears from your account, with your bank giving you the bad news that the customer has lodged a chargeback, claiming the necklace was never delivered. 

At this point, you might decide to dispute the chargeback. However, another entrepreneur in your shoes might take the customer at their word, or regard the dispute process as too much of a hassle for what is just a hobby that makes money. This allows the customer to get away with card not present fraud.

The customer refuses to accept refund terms

If a customer realises they aren’t able to get a refund on an item, they might resort to a chargeback to have their money returned anyway, despite knowing full well they’re abusing the process in doing so.

Let’s go back to the example above, where you’ve started an online business selling jewellery, and someone buys a necklace. In this alternative scenario, the customer decides the necklace isn’t for them, but doesn’t get around to requesting a refund until after your business’s no-questions-asked cooling-off period of 30 days has elapsed.

Even though you’ve done the right thing and managed customer expectations by clearly stating your refund policy on your website and sales emails, this customer feels aggrieved that you won’t overlook your rules for their benefit. Determined to get their money back, they trigger a chargeback. 

How to prevent chargeback fraud

You might only be looking to make extra money alongside your full time job, or you might be pursuing bigger business opportunities to forge a new career as your own boss. 

Either way, if you accept cashless payments for your products and services, then knowing how to prevent and fend off chargeback fraud is as important as, say, knowing how to do a competitor analysis or how to identify your target market.  

Here are the rules of thumb for:

• Lowering the risk of chargeback fraud

• Handling chargeback fraud

Lowering the risk of chargeback fraud

There’s little a business owner can do to prevent intentional friendly fraud like cyber shoplifting, as this kind of chargeback fraud involves legitimate transactions by authorised cardholders who flout the rules after they make a purchase.

But the good news is you can take steps to lessen the likelihood of falling victim to unintentional friendly fraud, as well as true fraud (where unauthorised purchases are made using stolen card details). 

1. Use payment methods which guard against fraud

Being able to accept a range of online payment methods helps with customer acquisition and staying competitive, but it’s crucial that these methods are secure. 

There should be robust payment security protocols in place to automatically vet each transaction that comes your way. These include Address Verification Service (AVS) and CVV checks which confirm that the real cardholders are using the card details in question.

2. Ensure your product/service descriptions are on point

If a customer feels the product or service they’ve purchased doesn’t match their expectations, they may request a refund, which of course you don’t want. But an even worse outcome is if they feel aggrieved enough to trigger a chargeback. 

This falls into the category of friendly fraud as the initial transaction was valid, and you can cut the risk of it happening by being as clear as possible about what your business offers. 

Say you’re making money online by selling online courses in your specialist field. You should ensure the course description specifies exactly what customers will get for their money, including how many hours of video and how many downloadable resources are part of the package, and what subjects you’ll cover.

Or, say you’re interested in small business ideas where you sell items on marketplaces or your own online store. In this case, ensure each product description is absolutely accurate and doesn’t exaggerate the attributes of the item, and that photos are genuinely representative.

3. Be clear on how refunds work

As we discussed earlier, customers may request chargebacks because they either misunderstand your policy on refunds, or simply see chargebacks as a viable or simpler alternative, thereby committing unintentional chargeback fraud.

That’s why it’s important to make your cancellation and refunds policy crystal clear on both your website and any relevant communications with customers. For example, details of refund timeframes, and how refunds are requested, can be included in sale confirmation emails.

4. Use an identifiable billing descriptor

Remember that friendly fraud often occurs when customers spot a transaction on their bank or credit card statement which they don’t connect to the business they’ve bought from.

So, whether you’re a sole trader, or working through a business partnership or limited company, one of the most effective ways to lower the chances of friendly fraud is by having a billing descriptor which is either the same as, or very similar to, your customer-facing trading name.

5. Maintain great customer service

Chargeback fraud, whether intentional or not, can often stem from a lack of communication between a cardholder and a business.

Maintaining good customer service by being attentive to your customers, responding promptly to queries, and resolving technical problems as they arise can go a long way to preventing situations from escalating into unwarranted chargebacks, and even boost customer loyalty.

If you have employees, top-tier customer service should be an integral part of your workplace culture. When training employees, you should emphasise how efficiently and politely handling complaints on time, whether via email, phone or social media, can help reduce friendly fraud.

Handling chargeback fraud

Even if you’ve carefully considered the question of how to prevent chargeback fraud and have all necessary precautions in place, spurious claims can still come your way. 

Fortunately, you’ll be able to dispute the claim through a process called representment, which involves submitting an official rebuttal to your bank or payment processor, summarising the chargeback claim and why you believe it to be invalid. 

You’ll also have to submit any evidence you have that the transactions was legitimate, including:

• Emails, texts and social media messages you may have exchanged with the cardholder, which verify they made the transaction and received the product or service.

• Emails and other communications confirming delivery of products.

• Screenshots or URLs of product listings and descriptions.

• Details of your refund policy.

• Details of authentication checks carried out on the transaction.

• Any relevant receipts or invoices.

For example, imagine a customer has triggered a chargeback claiming they were misled into a purchase, and the product they received didn’t meet their expectations. 

You might dispute the claim by submitting the original product description and product photos on your online store, proving you presented it accurately to the public. You might also highlight your refund policy to show that the customer needlessly sidestepped that process to make an illegitimate chargeback claim. 

Being able to quickly access evidence regarding transactions is key to quickly disputing and resolving cases of chargeback fraud. Staying on top of your small business bookkeeping, securely storing records of sales and keeping business and personal finances separate will make it easier to put together your bundle of evidence during representment.