Potential Fallout From the Cap One-Discover Deal

Here’s how the two parties can ensure a smooth and successful combination for the long term.

The acquisition of Discover Financial Services by Capital One represents one of the largest financial services mergers in recent history. While the transaction has received regulatory approval and went into effect May 18, various stakeholders may experience adverse effects that could lead to disputes and litigation.

This article examines potential sources of conflict beyond antitrust concerns, focusing on affected parties and the nature of their potential claims.

Capital One’s acquisition of Discover will create the largest credit card issuer in the United States by loan volume and the sixth-largest bank by assets. While the deal received approval, including from the Comptroller of the Currency (OCC), the integration of these financial giants will likely create disruptions across multiple fronts.

That could lead to conflicts, disputes, and litigation, such as those that have emerged following prior payments-industry mergers.

Key Stakeholders, Potential Claims

Although in its initial stages, the merger of Capital One with Discover’s network—which can support enhanced debit and credit card acceptance capabilities for the combined companies—will unify (1) development and enforcement of card-acceptance terms and conditions, and (2) pricing for the new Capital One Discover program.

Associated modifications of contract terms, while necessary, could lead to breach-of-contract and other claims when for example:

• Merchants’ fee structures or payment terms are unilaterally modified.
• Existing contracts with either Capital One or Discover are unilaterally modified.

Integrating Discover’s and Capital One’s operations will create risks for data security, customer services, and compliance systems. For example, the web of processing systems for the integrated card network, card-issuing system, and banking system necessary to support the new credit and debit card organization will be more complex.

There will be greater risks of outages and errors, including loss of processing capabilities, misdirected settlement funds, inadvertent authorization, and settlement processing outages that may cause disruptions for merchants and consumers alike.

Indeed, the OCC’s conditional approval emphasizes the need for effective and sustainable corrective actions to address those likely compliance issues. Those could lead to breach of contract and other claims, including:

• Business interruption claims from merchants experiencing transaction delays.
• Disputes over responsibility for integration-related errors.

Network Access Changes

The network of combined companies will control the issuing and acceptance of cards, which will operate more like American Express than like Visa or Mastercard cards. The new network will be controlled by a dominant card issuer, able to develop terms and conditions, participation requirements, and acceptance requirements that are disadvantageous or discriminatory to other businesses that may seek to participate as an issuer or in another role in the new Cap One/Discover program.

This may lead to breach-of-contract and other claims, when for example:

• Independent payment processors face changed access terms.
• Third parties do not have full access to capabilities and advantages of the new network.

Existing Business Partners

Discover has network-participation rules, operating terms and conditions, and membership agreements that dictate the requirements for participating in the network. The combined Capital One/Discover organization will have control over setting interchange rates and network fees that could benefit the new program, or disadvantage existing partners.

Existing business partners will likely experience changes in fees and acceptance requirements within Discover, which could lead to claims for breach of contract and other claims arising from, for example:

Contract Renegotiation Disputes

• Existing vendor relationships are terminated or modified.
• Early termination fees or penalties are imposed.

Exclusive Relationship Conflicts

• Partners with exclusive agreements face changed circumstances.
• The combined Capital One/Discover organization seeks to exit existing arrangements.
• Stakeholders invoke change-of-control provisions.

Cardholders and Consumers

The new organization will combine several sets of consumer clients, including current Discover cardholders and Capital One cardholders. Some cardholders may have cards converted from competing networks to the Discover brand, resulting in a change in network access, account terms and conditions, rewards, and other program features.

Customer service and program support resources could be combined or eliminated, resulting in changes in account support and other operating-support features. These circumstances could lead to class-action consumer lawsuits, for example when:

Account Terms Modification

• Reward programs, interest rates, or fee structures change.
• Valuable card benefits are reduced.
• Cardholders claim inadequate notice of such material changes to account terms.

Privacy and Data Security Risks

• Data integration presents heightened security risks.
• Data security is breached during integration.
• Cardholders claim unauthorized sharing of consumer data between entities.

Service Quality Degradation

• Customer service is disrupted during integration.
• Cardholders claim account management errors during transition.
• Cardholders claim reduced service quality or availability.

Mitigating Factors and Risk Management

Changes to the card programs and network operations will not be immediate. However, the combined organization will face a number of hurdles. It must resolve issues identified by the OCC during its pre-acquisition review. In addition, several states have indicated they may challenge the acquisition despite conditional approval, and at least one consumer lawsuit has already been filed.

These are not expected to derail the merger, but highlight the need for the combined organization to proceed carefully, ensuring regulatory issues identified during federal review are resolved, avoiding further regulatory issues, and communicating effectively with consumer and business clients, network partners, and support vendors.

Communication Strategies should include:

• Transparent communication with all stakeholders about integration timelines.
• Clear disclosure of any changes to terms, conditions, and relationships.
• Dedicated channels for addressing concerns before they escalate to disputes.

Transition management should address:

• A phased integration approach to minimize disruption.
• Retention of key personnel during transition periods.
• Maintaining service levels during all phases of integration.

Contractual protections should include

• A review of change-of-control provisions in existing agreements.
• Negotiating amendments where necessary.
• Considering dispute-resolution mechanisms in new agreements.

While Capital One’s acquisition of Discover has conditional approval, the transaction’s size and complexity create significant risks of disputes between and among multiple stakeholders. Those may lead to litigation between business partners and consumer-protection lawsuits.

Proactively identifying and managing those risks will be essential to minimize such costly disputes and maintain stakeholders’ confidence throughout integration.

By anticipating potential claims and implementing thoughtful transition strategies, the Capital One/Discover organization can reduce its litigation exposure while successfully integrating these two financial-services giants.

—Howard Herndon, Managing Director, Prescentus, LLC and Senior Counsel at Womble Bond Dickinson (US) LLP;

—John Romer, Managing Director, Prescentus, LLC; Derek Edwards, Partner, Womble Bond Dickinson (US) LLP