Guest Analysis: The Intersection of Payments and Money Transmission: A Look at The Agent-of-the-Payee Exemption

By Nicole Meisner, Jaffe, Raitt, Heuer & Weiss, P.C.

Think you can you avoid money transmitter laws through the agent-of-the-payee exemption? Not so fast. The exemption is not ubiquitous and it’s full of potholes—a recipe for disaster for companies reliant on this exemption while unwittingly engaged in unlicensed money transmission.

Money transmission laws are complex, burdensome, and vary state by state. For that reason alone, companies look for ways to avoid becoming subject to money transmission regulation.   Anyone involved in the funds flow for payments transactions should consider whether they need to be licensed as a money transmitter.

Those that may be involved in the flow of funds, such as fintechs, payment facilitators, marketplaces, payment services providers, and virtual wallet operators (referred to below as “processors”) may find themselves engaged in money transmission for their role in the payments stream between consumers and the businesses that provide goods or services to those consumers (referred to here as “merchants”).  Often, processors will seek to structure their operations in a way that removes them from the flow of funds to lessen the risk that they are engaged in money transmission.  When that is not a viable option, processors point to an exemption commonly referred to as “agent-of-the-payee” as the basis for why they should not be subject to money transmitter laws and regulations.  But before relying on this exemption, processors should carefully consider whether this exemption actually provides the protection they anticipate.

This article summarizes the agent-of-the-payee exemption and its various nuances, including the limitations of the exemption and some potential pitfalls processors should consider before relying on it.

What is the Agent-of-the-Payee Exemption?
Generally speaking, a state’s agent-of-the-payee exemption exempts entities that accept payments from consumers on behalf of a merchant, creditor, or biller from that state’s money transmission licensure requirement.  A common example of an agent-of-a-payee is a service that accepts utility bill payments from consumers on behalf of the utility company.  With the proliferation of online and mobile payments and regulators’ new focus on payment companies, the scope and application of the exemption is constantly being tested and expanded.

While the recognition of the exemption is a growing trend among the states, not every state recognizes it. In fact, only about half of the states do.  Of those that do, each define the exemption and its requirements for applicability a bit differently.  In addition, some require that companies seek approval for the exemption prior to operating and have specific criteria that must be satisfied in order to qualify for the exemption.

A processor may qualify for the agent-of the-payee exemption in one state yet find itself engaged in conduct that is regulated as money transmission in another.  Accordingly, processors wishing to qualify for the exemption should engage in a careful analysis of the laws, regulations, and regulator guidance in each state where it operates. Most states do not have a “physical presence” requirement, so processors should not only examine the law in states where it has a physical presence but also any state in which it does business, including any state to which it receives or sends money and any state where its merchants are located.

Agency Relationship
To qualify for the exemption under most state laws, the processor that is accepting consumer funds on behalf of a merchant and the merchant are required to enter into a written contract establishing an express agency relationship.  Some states have taken the position that in order for the exemption to apply, the agency relationship must be of a fiduciary nature—meaning the processor must have the power and authority to act on behalf of and bind the merchant.  Thus, in these states it’s likely not enough for the processor and merchant to merely claim the existence of an agency relationship.  Instead, they must go further and establish and implement the commensurate obligations, duties, and authorities which establish an express agency relationship.

Consumer’s Obligation Satisfied upon Receipt by Agent
The states’ primary reason for regulating money transmitters is consumer protection. So, most states require that the consumer’s funds be treated as received by the merchant when they are received by the processor for the exemption to apply.  Thus, once the processor accepts the funds from the consumer, the consumer’s obligation to the merchant must be deemed extinguished.  If the processor fails to provide the funds to the merchant, the merchant’s only recourse would be against the processor—not the consumer.  Further, the merchant would not be permitted to withhold the consumer’s goods or services or penalize the consumer in any way.  This is logical because under general principles of agency relationships, the agent is standing in the shoes of the principle.  So, if the consumer pays the processor who has an agency relationship with the merchant, he or she is deemed to have paid the merchant and should not be penalized if the processor fails to perform its obligations.

Processor (Agent) Must be Acting on Behalf of Merchant (Payee)
An important distinction for the agent-of-the-payee exemption is that the processor must be acting on behalf of the merchant, not on behalf of the consumer.  This distinction often creates confusion because the processor often directly interfaces with the consumer (sometimes in person and sometimes online) in order to accept the consumer’s funds on behalf of the merchant.  To simplify this requirement: the processor must be accepting funds on behalf of the merchant as opposed to sending money on behalf of the consumer.  This requirement is the reason that the agency contract between the processor and merchant is so critical—without the agency relationship established between the processor and merchant, it is difficult to demonstrate that the processor is acting on behalf of the merchant in accepting funds as opposed to acting on behalf of the consumer sending funds (i.e., bill pay).

Exemption Nuances
Some states have not addressed the agent-of-the-payee exemption, leaving open the possibility that the state may recognize the exemption in the future. Others have explicitly rejected the exemption.  Even where recognized, the future application of the exemption remains unclear.

For instance, California’s law expressly recognizes an exemption for transactions “in which the recipient of the money or other monetary value is an agent of the payee pursuant to a preexisting written contract and delivery of the money or other monetary value to the agent satisfies the payor’s obligations to the payee.” However, in February 2019 California’s Department of Business and Oversight issued an invitation for comment on rulemaking related to the scope of the exemption.  The invitation for comment reveals that the regulator has identified various areas of the exemption where rulemaking may be appropriate and that it is examining the scope of the exemption to determine whether to impose limitations in its application.

Another state regulator has limited the application of the exemption to transactions in which there is an obligation for payment already outstanding.  Thus, processors for merchants that accept funds in advance of the payment obligation (for example, for lodging or short-term vacation rentals, hotel stays, etc.) could not qualify for the exemption if the processor accepts the funds before the payment obligation is due to the merchant.  Other states have limited the exemption to transactions for “goods and services” and there has been dispute over what constitutes “goods and services.”

Further, some states require a processor to receive prior approval from the regulator through a written request in order to avail itself of the exemption.  This approval must be provided before the processor begins operating in that state. If a processor relies on the exemption prior to receiving approval, it will likely be found to be engaged in unlicensed money transmission.

Common Law Principles of Agency
In another twist, some states have found a statutory exemption to be unnecessary, opining that the conduct is excluded from the definition of money transmission all together.  These states take the position that under general principles of agency law, an agent acts on behalf of its principal and is not an independent legal actor.  So, when a processor receives money on behalf of the merchant, the processor is receiving money as the merchant.  It follows that the processor should not be deemed a money transmitter because it is not accepting funds from one person for the purposes of transmitting them to the merchant. Instead, it is accepting funds while standing in the shoes of the merchant.

In these states, a processor’s receipt of funds as an authorized agent of the merchant renders the exchange of funds a two-party transaction between the processor (standing in the shoes of the principal as its agent) and the consumer.  Under general agency principles, the transaction is completed once the processor receives payment.  Thus, these states have found that because the processor does not receive money in exchange for a promise to make it available at a later time or different location, it’s not involved in money transmission.   The legal responsibility of the merchant to the consumer remains, even if the funds are in the hands of its processor.

Conclusion
The application of the agent-of-the-payee exemption is not simple or consistent.  Often processors will unwittingly engage in unlicensed money transmission because the states in which it operates do not recognize the exemption or because the states limit the exemption in a way that does not exempt the processor’s conduct.  Before relying on the agent-of-the-payee exemption, processors should be mindful of the exemption’s limitations and seek legal counsel from attorneys well-versed in payments and money transmission issues.

Nicole is an attorney who concentrates her practice on payment legal issues, representing payment facilitators, marketplaces, fintech companies, money transmitters, and merchant acquirers. You may reach her at: [email protected]

The above is intended as general information only and should not be construed as legal advice or as creating or soliciting an attorney-client relationship. You should consult your attorney for guidance with respect to any particular issue or legal inquiry.