Negotiation Considerations For Performance Guarantees And Service Level Agreements

A discussion regarding the use of performance guarantees and service level agreements to establish contractual metrics that allows both customer and vendor the opportunity to assess objectively the other party’s performance under the contract.

Shelley R. Thomas Today’s manufacturing companies increasingly are outsourcing both traditional technology and cloud-based IT services to vendors in an attempt to reduce costs and while improving productivity. The following is a discussion regarding the use of performance guarantees and service level agreements (or “SLAs”) to establish contractual metrics that allows both customer and vendor the opportunity to assess objectively the other party’s performance under the contract. 

  • Documenting Performance Guarantees. Any items that are the subject of performance guarantees — e.g., specific functionality, security obligations, deliverables, reports, etc. — should be clearly documented in detail in the contract. While this concept seems somewhat obvious, it is not at all uncommon to receive a contract that only contains broad, general statements with respect to the product and its performance, i.e., “Vendor agrees to provide the application/service.” These types of statements lack the specificity required to document performance guarantees and, if a dispute arises, the parties quickly may learn that the expectations of the customer and the vendor are very different. 

Because most contracts in this area contain language that expressly excludes the incorporation of any statements made or materials provided before the contract was signed, failure to document these critical details within the four corners of the contract leaves the customer or vendor with little recourse if a product does not meet those undocumented expectations as there is no language in the contract that the customer can clearly point to as a failure in performance by the vendor and breach of the contract. Bottom line, if there are specific features, functionality, outcomes, obligations of either party, or results that were essential to either party in entering into the contract, both parties’ best interest is served by expressly detailing these items in the contract to prevent future misunderstandings between the parties. 

  • Service Level Agreements. For software-as-a-service or cloud-based applications and services, SLAs are the most common tool used for documenting and measuring the performance of the product. SLAs and other performance requirements can include, among other things, uptime requirements, response time goals, and ROI goals. As with performance guarantees, the parties should document carefully the SLAs in a specific and measurable way in the contract. For example, with respect to uptime requirements, a contract provision that simply states that an application will be “available,” leaves the customer uncertain as to how much down time to expect and the vendor unclear on the customer’s expectations and its obligations to meet those expectations. Instead, consider assigning a specific metric to the uptime availability over a defined time, such as a guarantee that the application will be available 99.9% of the time each contract month.

Steele ClaytonWhatever metric is chosen, the parties should be sure that they are comfortable with the corresponding exclusions and limitations that go along with the guarantee. Using the previous example, 99.9 percent uptime means that there can be 3.5 hours of downtime each month that does not count against the SLA. The parties should also consider agreeing to appropriate exclusions and limitations from the SLAs, which generally include planned downtime (for which the vendor should provide notice and be limited to a specific number of hours per month during non-peak hours), outages caused by forces beyond the vendor’s control (i.e., third-party failures, denial of service attacks, forces of nature, etc.) and even the customer’s or its agents’ acts or omissions. The parties also should consider contract language that requires reporting that tracks compliance with the SLAs so that the customer and vendor can assess performance.

Documenting the expectations of the parties is only one critical piece of the negotiations. Another critical piece of the negotiations is determining how a dispute will be resolved should one arise in the future. The following bullets touch on two items to consider.

  • Forum for Resolution. The customer and vendor may wish to resolve their dispute privately and confidentially. Arbitration allows the parties to set their own ground rules on who will hear and decide the dispute as well as how the proceeding will be conducted. An arbitration proceeding is private not open to the public. However, an important consideration is the parties’ willingness to limit their ability to appeal an adverse decision. In most jurisdictions, the grounds for challenging an arbitration award are much more limited than the grounds for appealing a trial court decision. Further, the rules for resolving a dispute in court are well established, and a party can allow a jury to decide the outcome or, by agreement in the contract, elect to have a bench trial in which the trial court judge hears and resolves the dispute. Regardless of the parties’ preference, it is important to consider these issues before the contract is signed.
  • Remedies. The parties may find it helpful to include contractual remedies in the event performance guarantees or SLAs are not met. Agreeing to a remedy ahead of time allows the customer and vendor to enter the relationship with a clear understanding of their respective liability should the relationship go astray. Examples of contractual remedies might include (1) service-level credits in the form of a refund or discount of a certain percentage of the fees paid by the customer each time an SLA is not met, (2) repair, replacement, or re-performance of the applicable product or service, at the vendor’s expense, when features, functionality, and other aspects of the products do not perform as expected; (3) termination and refund rights; or (4) step-in rights that permit a customer to temporarily utilize alternative providers at the vendor’s cost. If the remedies in the contract are exclusive – meaning that the only recourse is to accept the stated remedy – the parties should consider carefully whether the remedy will in fact make them whole should a contract dispute arise.

Steele Clayton and Shelley Thomas are attorneys in the Nashville, Tennessee office of Bass, Berry & Sims PLC.

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