Negotiating service agreements

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Corporate Update

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Business relationships supported by a mutually beneficial and comprehensive underlying contract are far more likely to be successful in the long-term. Therefore, service providers should approach the negotiation of each service agreement as if the long-term success of that particular business relationship relied solely on it. As we have seen over the past few weeks, the future is unpredictable and things can change very quickly. In such a dynamic business world, there is considerable value for service providers in the protection afforded by a well-drafted service agreement.

An effective service agreement is important for two reasons. First, those agreements help the service provider in its day-to-day business of providing services and getting paid. Second, agreements that protect the service provider’s business and assets make it a more desirable target for investment or acquisition.

Like any contract, the service agreement should be clear on the fundamental business terms: who is doing what, and when, where and how are they doing it? These terms may be directly addressed in a single-purpose services contract, or may be addressed in a master services agreement with multiple project-specific work orders or statements of work entered into from time to time. Regardless of the contract structure, a service provider, or someone negotiating on their behalf, should keep the following general advice in mind when setting up a new service agreement or updating an old one with a customer.

Do define the scope, specifications and service levels. Clearly identify the services that the service provider will provide and any specific deliverables or end results, as well as any interim or final timetable or delivery schedule. Address what the customer has to provide for the service provider to be able to perform the services, and be clear that the service provider is not responsible for delays or non-performance if the customer doesn’t provide those things.

Don’t assume that the parties will figure out applicable specifications, metrics, key performance indicators and service levels as the relationship progresses. Set out objective goals!

Do be clear about payment. Clearly set out the invoicing, payment terms, disbursement obligations and billing periods. Consider requiring an up-front deposit to help with cash flow and to screen out customers who are unlikely to pay in the end. Be clear about when and if the service provider will refund pre-paid fees.

Don’t be deterred from setting up strict payment enforcement mechanisms at the risk of losing a customer. Include contractual provisions to help deal with a customer who doesn’t pay, such as reserving the right to charge interest on overdue payments, having the right to suspend services, making the customer responsible for repaying collection expenses (such as legal fees), and obtaining security where appropriate and possible.

Do clarify who can terminate the agreement, on what grounds, and what happens on termination. Both parties should be able to terminate for a material breach that is not cured within a specified period (e.g. 30 days). It is also common to allow one party to terminate if the other party becomes bankrupt or insolvent. Termination for convenience is more problematic, and may not always be appropriate. Finally, clarify what obligations apply on termination.

Don’t neglect to consider liability issues that can arise down the line. One of the agreement’s most important functions is to allocate risk and liability between the parties. Ultimately, the goal is not to completely eliminate all risk, but to ensure that risks are appropriately identified and that there is a mechanism in place to address them. Disclaimers, indemnities, insurance and limitations of liability can, and should, be used to appropriately allocate risk under the agreement:

  • Disclaimers: Representations and warranties can be deemed or implied by statute or at common law, even if they are not expressly set out in a contract. It is good practice to set out whatever representations or warranties the service provider wishes to give with respect to its products or services (including the available limited remedies), and expressly disclaim all other representations or warranties so that they cannot be imputed into the contract. Moreover, try to limit the service provider’s monetary liability for breach to direct damages by expressly excluding indirect, special, incidental or consequential damages arising from breach, as well as specific losses like business interruptions, lost profits, etc.(which depending on the circumstances could be considered direct or consequential damages).

  • Indemnities: An indemnity is a contractual obligation by one party to be responsible for certain loss, damage or liability incurred by the other party. Indemnities are often heavily negotiated, and as a matter of course the service provider should try give as few indemnities as possible. Try to limit any indemnity that the service provider does give by carving out liability arising from the customer’s own negligence or intentional misconduct.

  • Insurance: Customers may wish to specify what insurance is required, and in what amounts, for comfort that the service provider can meet its indemnity obligations. If the agreement requires insurance, make sure the specified coverage and amounts are reasonable. Review the insurance provisions carefully, and seek feedback from the insurer.
  • Limitations of liability: The service provider should cap its total liability under the agreement. Cap mechanisms vary – it can be a fixed amount, a variable amount (e.g., total fees paid under the agreement, or fees paid in a specific period or under a specific statement of work), the insurance maximum, etc. If possible, make the limitation of liability apply to all liability arising under the agreement, including indemnity obligations.

Do protect the business. Intellectual property (IP), confidential information, personnel and business relationships are important parts of a business. The service provider should strive to protect them all through its service agreements:

  • IP ownership: Each party will want to retain its existing IP - the service provider should make sure to specifically carve out its pre-existing IP and residual knowledge from anything owned by the customer. Where applicable, the service agreement should also address new IP that may be created during the relationship. Keep in mind that there is no one-size-fits-all solution, however, as a rule of thumb, avoid joint ownership of IP as it creates a host of complex issues.

  • Confidential information: If the parties will be exchanging or will have access to confidential business information, include provisions about the protection and use of that confidential information, the types of information that are excluded from those obligations, what happens if the recipient is compelled to disclose the other party’s confidential information, and the terms of the applicable obligations. If the services also involve the disclosure or use of personal information, then the agreement should address applicable privacy laws.

  • Personnel and business relationships: Consider a non-solicit provision that prohibits the customer from hiring away the service provider’s employees, contractors or agents during the agreement or for a given period after termination. Also consider broader provisions prohibiting the customer from soliciting the service provider’s customers or potential customers for the purpose of competing with the service provider’s business. Customers may ask that these sort of restrictive covenants be mutual.

Service agreements do not have to be complex documents, but considering the various issues discussed above will help service providers ensure their service agreements are thorough and provide the necessary protection.

This article is meant to be a general discussion and is not legal advice. You should not use or otherwise rely on its contents without obtaining qualified legal advice.