I agree with your line of thinking. Otherwise the door is wide open to deprive you of the security and lien you have for the work provided on his vehicle. In fact the customer theoretically has parts in his vehicle that you bought and paid for.
Has the charge-back already occurred or are they asking your permission to do the charge-back?
Every legal matter is fact specific, and there are often nuances in every case. This is intended for comment only, and does not create an attorney client relationship.
Whether the customer was "right" is a loaded question.
He may be able to do this under the Truth in Lending Act (I say 'may' because there are some elements that need to be met that weren't addressed in your post) allows a cardholder to assert claims or defenses against the card issuer when the cardholder is unable to resolve a dispute with the person/business who accepted payment by credit card for the services/goods provided.
However, that doesn't mean that the dispute is resolved, but you will likely have to take action in order to get the payment you're entitled to.
The prosecutor may have decided that he could not prove the requisite intent to get a conviction for Theft, and it is the prosecutor's discretion as to whether or not to bring criminal charges.
You can, however, bring a civil lawsuit against the customer to recover the amount owed, as well as your costs and attorney's fees. Depending on the amount of claim, you may be able to bring your suit in small claims.
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I think you are correct in your assessment. Simply object to the challenge forwarded to you by the customer's credit card company and demand payment. The company will end up paying you if you put forward decent letterand exhibits of what transpired and costs incurred. The ex employee can then fight with the CC company.
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