The What, Why and How of SLAs, aka Service Level Agreements (part 2)

Every company uses technology vendors, such as Software-as-a-Service providers, to provide critical components of their business operations. One pervasive issue in technology vendor agreements is the vendor’s commitment to the levels of service the customer will receive.  A representation to use commercially reasonable efforts to correct product defects or nonconformity with product documentation may not be sufficient for a customer relying on a technology vendor’s service for a mission-critical portion of its business. In this situation, the vendor may offer (and/or a customer may require) a contractual commitment as to the vendor’s levels of service and performance, typically called a “Service Level Agreement” or “SLA.” Service Level Agreements (SLAs) ensure there is a meeting of the minds between a vendor and its customer on the minimum service levels to be provided by that vendor.

In Part 1 of this post, I walked through uptime and issue resolution SLAs.  In this second part, I cover other types of technology SLA commitments, SLA remedies, and other things to watch for.

Other Types of Commitments in SLAs

Other common types of SLAs in technology agreements include latency SLAs and customer service SLAs.

Latency SLAs. “Latency” is the time it takes for a server to receive a server request, process it, and send a response. For example, when you load a webpage, a server request is sent to a web server to deliver the webpage, the server processes the request, and sends a response with the code to render the page in the user’s web browser. Latency can be affected by a number of factors, including the geographic location of servers, network/Internet capacity, and server optimization. For companies using a vendor to provide services as part of its client-facing systems (e.g., an address verification service), minimizing latency to ensure a high level of performance is critical. A latency SLA is a commitment to a maximum roundtrip response time for a vendor server request. Latency SLAs typically exclude the time it takes to get from the customer’s server to the boundary of the vendor’s network, and vice versa (as this is outside of the vendor’s control).

Customer Service SLAs. In some vendor relationships, ensuring the prompt provision of customer support is a critical component of the relationship. For example, if a vendor is providing support to a customer’s clients or employees, or is providing level 2 escalation support, customer support SLA commitments may be important to the customer to ensure a high level of service.  Customer support commitments often include commitments on time to first response (the time from the submission of a request to the time an agent opens the support ticket to begin working on it); time to resolution (total time needed to resolve the issue); average speed to answer (the percent of calls answered within a maximum time, e.g., 85% of calls within 30 minutes, or percent of emails answered within a maximum time, e.g., 90% of emails within 4 business hours); and/or abandonment rate (the maximum number of calls being abandoned in queue before a support agent picks up the call).

SLA Remedies

In order to ensure the service level commitments made by a vendor have teeth, the SLA should have remedies available to the customer in the event of a failure to meet one or more SLA commitments. The remedies are often the most heavily negotiated section of the SLA. There are a variety of remedies that can be applied in the event of a SLA failure.

Service Credits. One of the more common forms of remedy is a service credit, often a percentage of fees paid by the customer for the period in which the SLA failure occurred.  For example, if a vendor fails to meet a 99.9% monthly SLA, a service credit equal to a percentage of the monthly fees paid by the customer would be applied to the next monthly invoice.  A credit is often provided on a tiered basis, up to 100% of the fees for the relevant period based on the size of the SLA miss. Vendors may want to include language ensuring that if multiple credits are available for the same reporting period (e.g., a credit for failure to meet the uptime SLA as well as the issue resolution SLA), only the greater credit will apply.  The credit is usually applied to the next invoice, or if there will be no additional invoice, paid directly to the customer.  For a service credit related to an uptime SLA commitment, instead of a percentage of fees some vendors will offer a credit equal to the fees earned by the vendor during the period of time during which the Service was unavailable during the previous measurement period (or an average of the amount during previous measurement periods), under the theory that the credit is an accurate reflection of the actual fees that would have been earned by the vendor had the service been available in compliance with the SLA.  Customers should carefully consider what fees are used to calculate the credit – customers will want this to be as inclusive as possible.

Termination. In the event of a SLA failure, another remedy commonly offered by vendors is a right to terminate. Vendors typically put restrictions around the exercise of this right, e.g., termination is the sole and exclusive remedy available; termination is limited to the service subject to the SLA failure, not the entire service agreement; it is offered on a “use it or lose it” right which can only be exercised for a period of time following the measurement period in which the SLA failure giving rise to the termination right arose; or the right to terminate is only triggered by multiple failures, such as failure to meet its SLA commitments in three (3) consecutive months or any two (2) out of three (3) consecutive calendar quarters. Customers should carefully consider whether the limits on these rights are appropriate (e.g., ensure that “sole and exclusive remedy” applies only to a SLA failure, and would not preclude the customer enforcing its rights and remedies for any other breaches of the vendor agreement; ensure a right to terminate extends to the entire service agreement if the affected service component is a significant portion of the value of the relationship to the customer; etc.)

Other creative remedies. Vendors and customers should consider whether other creative remedies for a breach of the SLA, such as waiver of fee minimums, waiver or imposition of other contractual obligations, or provision of additional services (e.g., a certain number of free hours of professional services), may be an appropriate remedy for the customer and an appropriate motivator for the vendor to meet its SLA commitments.

Closing Thoughts – Things to Watch For

  • Remember that most vendors are trying to provide as close to 100% uptime as possible, and the best possible service they can to their clients. A SLA is intended to be a floor on performance, not a ceiling.
  • Some vendors do not include a SLA in their standard service agreement, instead letting customers ask for one. In my experience, less customers will ask for a SLA than you’d think.  It’s always a good idea to ask a vendor to ensure they include their SLA with the service agreement at the outset of the contract negotiation process.
  • If the vendor will not agree to include a SLA, ask them why.
    • In some cases, vendors will not provide a SLA with credits to all but their largest clients, relying on the fact that as a multi-tenant platform all clients receive the benefit of the SLAs provided to their largest clients. In this event, customers should consider whether to fight for a direct SLA or rely on their commitments to larger clients (which commitments may change over time).
    • If you can’t get a SLA from a vendor, customers should consider whether to push for a termination for convenience right (and refund of prepaid but unaccrued fees) in the event they are dissatisfied with the service levels they are receiving from the vendor.
    • Customers should also ask whether the service is truly a mission-critical service. If not, it may be worth considering how hard to fight for the SLA, or if the customer can offer to concede the SLA to win on another open negotiation point of greater importance.
  • Customers should watch for language in the vendor agreement that gives the vendor the right to unilaterally change terms of the agreement, instead of having changes mutually agreed upon. This unilateral right is often broad enough to allow a vendor to change the terms of the SLA as well. If so, customers may seek to limit the scope to exclude the SLA, or ensure that the agreement includes a termination right as described above.

Eric Lambert has spent most of his legal career working in-house as a proactive problem-solver and business partner. He specializes in transactional agreements, technology/software/e-commerce, privacy, marketing and practical risk management. Any opinions in this post are his own. This post does not constitute, nor should it be construed as, legal advice. He is a technophile and Internet evangelist/enthusiast. In his spare time Eric dabbles in voice-over work and implementing and integrating connected home technologies.

The What, Why and How of SLAs, aka Service Level Agreements (part 1)

Every company uses technology vendors, such as Software-as-a-Service providers, to provide critical components of their business operations. One pervasive issue in technology vendor agreements is the vendor’s commitment to the levels of service the customer will receive.  A representation to use commercially reasonable efforts to correct product defects or nonconformity with product documentation may not be sufficient for a customer relying on a technology vendor’s service for a mission-critical portion of its business. In this situation, the vendor may offer (and/or a customer may require) a contractual commitment as to the vendor’s levels of service and performance, typically called a “Service Level Agreement” or “SLA.” Service Level Agreements (SLAs) ensure there is a meeting of the minds between a vendor and its customer on the minimum service levels to be provided by that vendor.

At a high level, a SLA does three things:

  1. Describes the types of minimum commitments the vendor will make with respect to levels of service provided by the vendor;
  2. Describes the metrics by which the service level commitments will be measured; and
  3. Describes the rights and remedies available to the customer if the vendor fails to meet their commitments.

In many cases, a SLA is presented as an exhibit or appendix to the vendor agreement (and not a separate agreement). In others, a SLA may be presented as a separate document available on a vendor’s website.  Think of the former as a customer-level SLA which is stated directly in (and quite often negotiated on a customer-by-customer basis as part of) the service agreement with that customer, and the latter as a service-level SLA which the vendor wants to apply equally to every user of its service.

In this two-part post, I’ll explain the contents of, reasons for, and important tips and tricks around technology SLAs.  Part 1 will cover uptime and issue resolution SLAs.  Part 2 will cover other types of technology SLA commitments, SLA remedies, and other things to watch for.

Common types of commitments in SLAs

The most common types of commitments found in technology SLAs are the uptime commitment and the issue resolution commitment.

Uptime SLA Commitment

An uptime commitment is generally provided in connection with online services, databases, and other systems or platforms (a “Service”). A technology vendor will commit to a minimum percentage of Service availability during specified measurement periods.  This percentage is typically made up of nines – e.g., 99% (“two nines”), 99.9% (“three nines”), 99.99% (“four nines”), 99.999% (“five nines”), etc.  Some SLAs will use “.5” instead of “.9”, for example, 99.5% or 99.95%”.   Uptime is typically calculated as follows:

(total minutes in the measurement period - minutes of Downtime in that period) / Total minutes in the measurement period

Definitions are key. The right definitions can make all the difference in the effectiveness of an uptime SLA commitment. Vendors may gravitate towards a narrower definition of “Downtime” (also called “Unavailability” in some SLAs) to ensure they are able to meet their uptime commitment, e.g., by excluding a slowdown that makes the Service hard (but not impossible) to use. Customers should look carefully at this definition to ensure it covers any situation in which they cannot receive substantially all of the value of the Service. For example, consider the difference between Unavailability/Downtime as a period of time during which the Service fails to respond or resolve, versus a period of time during which a material (or non-material) function of the service is unavailable. The SLA should define when the period of Unavailability/Downtime starts and ends, e.g., starting when the vendor first learns of the issue, and ending when the Service is substantially restored or a workaround is in place; customers should look at this carefully to ensure it can be objectively measured.

Mind the measurement period. Some vendors prefer a longer (e.g., quarterly) measurement period, as a longer measurement period reduces the chance a downtime event will cause a vendor to miss its uptime commitment. Customers generally want the period to be shorter, e.g., monthly.

Consider whether the uptime percentage makes sense in real numbers. Take the time to actually calculate how much downtime is allowed under the SLA – you may be surprised. For a month with 30 days:

  • 99% uptime = 432 minutes (7 hours, 12 minutes) of downtime that month
  • 99.5% uptime = 216 minutes (3 hours, 36 minutes) of downtime that month
  • 99.9% uptime = 43.2 minutes of downtime that month
  • 99.99% uptime = 4.32 minutes of downtime that month

One critical question customers should ask is whether a Service is mission-critical to its business.  If it’s not, a lower minimum uptime percentage may be acceptable for that service.

Some vendors may offer a lower uptime commitment outside of business hours, e.g., 99.9% from 6am to 10pm weekdays, and 99% all other times. Again, as long as this works for a customer’s business (e.g., the customer is not as concerned with downtime off-hours), this may be fine, but it can make it harder to calculate.

Ensure the Unavailability/Downtime exclusions are appropriate. Uptime SLAs generally exclude certain events from downtime even though the Service may not be available as a result of those events. These typically include unavailability due to a force majeure event or an event beyond the vendor’s reasonable control; unavailability due to the equipment, software, network or infrastructure of the customer or their end users; and scheduled maintenance.  Vendors will often seek to exclude a de minimis period of Unavailability/Downtime (e.g., less than 5/10/15 minutes), which is often tied to the internal monitoring tool used by the vendor to watch for Service unavailability/downtime. If a vendor wouldn’t know if a 4-minute outage between service pings even occurred, it would argue that the outage should not count towards the uptime commitment.

Customers should make sure there are appropriate limits to these exclusions (e.g., force majeure events are excluded provided the vendor has taken commercially reasonable steps to mitigate the effects of such events consistent with industry best practices; scheduled maintenance is excluded provided a reasonable amount of advance written notice is provided.  Customers should watch out for overbroad SLAs that try to exclude maintenance generally (including emergency maintenance).  Customers may also want to ensure uptime SLAs include a commitment to take reasonable industry-standard precautions to minimize the risk of downtime (e.g., use of no less than industry standard anti-virus and anti-malware software, firewalls, and backup power generation facilities; use of redundant infrastructure providers; etc.)

Don’t overlook SLA achievement reporting. One important thing customers should look for in a SLA is how the vendor reports on SLA achievement metrics, which can be critical to know when a remedy for a SLA failure may be available. Vendors may place the burden on the customer to provide notice of a suspected uptime SLA failure within a specified amount of time following the end of the measurement period, in which case the vendor will review uptime for that period and verify whether the failure occurred. However, without proactive metrics reporting, a customer may only have a suspicion of a SLA failure, not actual facts. Customers using a mission-critical system may want to consider asking for proactive reporting of SLA achievement within a certain amount of time following each calendar month.

Issue Resolution SLA Commitment

Of equal importance to an uptime commitment is ensuring that a Service issue (downtime or otherwise) will be resolved as quickly as possible.  Many technology SLAs include a service level commitment for resolution of Service issues, including the levels/classifications of issues that may occur, a commitment on acknowledging the issue, and a commitment on resolving the issue.  The intent of both parties should be to agree on a commitment gives customers assurances that the vendor is exerting reasonable and appropriate efforts to resolve Service issues.

Severity Levels. Issue resolution SLAs typically include from 3-5 “severity levels” of issues.  Consider the following issues:

Impact Example Classification
Critical The Service is Unavailable
High An issue causing one or more critical functions to be Unavailable or disrupting the Service, or an issue which is materially impacting performance or availability
Medium An issue causing some impact to the Service, but not materially impacting performance or availability
Low An issue causing minimal impact to the Service
Enhancement The Service is not designed to perform a desired function

Issue resolution SLAs typically use some combination of these to group issues into “severity levels.”  Some group critical and high impact issues into Severity Level 1; some do not include a severity level for enhancements, instead allowing them to be covered by a separate change order procedure (including it in the SLA may be the vendor’s way of referencing a change order procedure for enhancements). Vendors may include language giving them the right to reclassify an issue into a lower severity level with less stringent timeframes. Customers should consider ensuring whether they should have the ability to object to (and block) a reclassification if they disagree that the issue should be reclassified.

Acknowledgment Commitment. Issue resolution SLAs typically include a commitment to acknowledge the issue. As with the uptime SLA, the definition of the acknowledgment timeframe is important (when it starts and when it ends). A vendor will typically define this as the period from the time it is first notified of or becomes aware of the issue to the time the initial communication acknowledging the issue is provided to the customer.  Customers should look at the method of communication (e.g., a post to the vendor’s support page, tweet through their support Twitter account, an email, a phone call from the customer’s account representative required, etc.) and determine if a mass communication method versus a personal communication method is important.

For critical and high impact issues, vendors (especially those operating multi-tenant environments) will often not offer a specific acknowledgment commitment, instead offering something like “as soon as possible depending on the circumstances.”  The argument for this is that for a critical or high impact issue, a vendor wants all available internal resources triaging and working the problem, not reaching out to customers to tell them there is a problem. In many cases, this may be sufficient for a customer provided there is some general acknowledgment provided to a support page, support Twitter account, etc. to alert customers that there is an issue. In others, a customer may want to push for their account representative, or a vendor representative not involved in triaging the problem such as an account executive, to acknowledge the issue within a fixed amount of time, putting the burden on the vendor to ensure it has appropriate internal communication processes in place.

Resolution Commitment. Issue resolution SLAs also typically include a time commitment to resolve the issue. One important thing to focus on here is what “resolve” means.  Vendors may define it as the implementation of a permanent fix or a workaround that temporarily resolves the problem pending the permanent fix; in some cases, vendors may also define it as the commencement of a project to implement a fix.  Customers should ensure that a vendor promptly implement a permanent fix if a workaround is put in place, and that failure to do so is a failure under the SLA. Many vendors are reluctant to provide a firm issue resolution timeframe, as the time required to resolve or implement a workaround is dependent on the issue itself, and are often unwilling to negotiate the resolution commitment or commit to a fixed timeframe for resolution.  Customers should ensure the resolution commitment is reasonable and that the vendor is doing everything it can to correct issues.  For example, for critical and high impact issues, consider an issue resolution commitment of “as soon as possible using continuous diligent efforts” – as long as the vendor is working diligently and continuously to fix the issue, they’re in compliance with the SLA. For lower impact issues, consider a commitment to implement a fix or workaround in the ordinary course of business.

In part 2, I’ll cover other types of technology SLA commitments, SLA remedies, and other things to watch for.

Eric Lambert has spent most of his legal career working in-house as a proactive problem-solver and business partner. He specializes in transactional agreements, technology/software/e-commerce, privacy, marketing and practical risk management. Any opinions in this post are his own. This post does not constitute, nor should it be construed as, legal advice. He is a technophile and Internet evangelist/enthusiast. In his spare time Eric dabbles in voice-over work and implementing and integrating connected home technologies.

The New Revenue Recognition Standards Are Coming – Will You Be Ready?

Most companies measure their financial performance by the revenues and other compensation they earn through their business operations, which in many cases means the sale of goods or provision of services. Knowing when to recognize the proceeds from a sale of good or provision of services as revenue is therefore critical to financial reporting. For many years, two different rules by two different standards organizations governed revenue recognition:

  1. The Financial Accounting Standards Board (“FASB“)’s Accounting Standards Codification (“ASC“) provide US generally accepted accounting principles (“GAAP“), including those governing revenue recognition. Under the current GAAP revenue recognition rule in ASC 605, revenue recognition varies by industry and in some cases by transaction, which makes revenue recognition a complex and difficult exercise in many situations.
  2. The International Accounting Standards Board (“IASB“)’s International Accounting Standards (“IAS“) provide an international standard for financial statements and accounting. Under the current international revenue recognition rule known as IAS 18, revenue recognition also varies by industry and transaction type, but IAS 18 provides less guidance than ASC 605 making it harder for companies to recognize revenue in a consistent fashion. The IASB is the successor to the International Accounting Standards Council (“IASC“) which originally promulgated the IAS.

Beginning in 2001, the IASB began replacing the IAS with new International Financial Reporting Standards (“IFRS“). In 2002, the FASB and IASB began collaborating on developing an improved. stronger, more robust, more useful, more consistent revenue recognition standard to make revenue recognition simpler and easier to consistently apply. This collaboration bore fruit 12 years later in May 2014, when the FASB and IASB released a converged revenue recognition standard titled Revenue from Contracts with Customers, codified as ASC 606 by FASB and IFRS 15 by IASB. Since 2014, there have been a few amendments (and implementation delays) by the FASB and IASB, and there have been a few small areas where the standards have diverged (e.g., the definition of what “probable” means). Despite this, for the most part the goal of a unified revenue recognition standard remains intact. These new standards will go into effect in December 2017 (for ASC 606) and January 2018 (for IFRS 15). All this background can be summarized in the following table:

A tabular representation of the history behind the ASC 606 / IFRS 15 revenue recognition standard.Here’s what you need to know about the new twin revenue recognition standards (for simplicity, this analysis is based on ASC 606):

How Revenue Recognition Works Under ASC 606/IFRS 15

To recognize revenue under the new standard, companies must do 5 things: (1) identify a customer contract, (2) identify the distinct performance obligations under that contract, (3) determine the transaction price (expected revenue), (4) allocate the expected revenue to the performance obligations, and (5) recognize allocated revenue when (or as) each performance obligation is satisfied. As stated in ASC 606, “an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” As we go through each step, keep this visual representation in mind:

ASC 606 Revenue Recognition DiagramStep 1 – Identify the contract(s) with a customer. The first step of the revenue recognition process is to identify a contract, i.e., an agreement creating enforceable rights and obligations among two (or more) parties. A contract must be signed or otherwise approved by the parties, must have identifiable rights and payment terms, have commercial substance, and it must be probable that one party will receive the revenue or other consideration expected from the performance of its obligations (e.g., provision of goods or services). Remember that a contract does not have to be in writing to be considered a contract for revenue recognition purposes – oral or implied contracts may satisfy these requirements.

Step 2 – Identify the contract’s distinct performance obligations. For goods and services contracts, a “performance obligation” is promise to transfer a good or provide a service to another party. A “distinct” performance obligation is one that benefits the recipient alone or with other readily available resources (e.g., delivery of a computer that is usable with power and Internet access obtained separately) and can be identified separately from other obligations under the contract (e.g., a company is delivering 5 computers, delivery of all 5 computers should be combined into a single performance obligation). A series of distinct performance obligations that are substantially similar can still be treated as individual performance obligations (e.g., delivery of a new computer at the start of each quarter during a calendar year, 4 new computers total). In a services agreement such as a SaaS contract, implementation obligations and the provision of services may be separate obligations. A SaaS company may look at its distinct performance obligation as providing a service each day during the term of the Agreement, so each day would be a distinct performance obligation.

Step 3 – Determine the transaction price. The “transaction price” is the expected payment and other consideration to be paid/provided in return for satisfaction of the performance obligations. Financial consideration can usually be grouped into fixed (stated in the contract) vs. variable (contingent on the occurrence or non-occurrence of a future event). For variable consideration, companies should look at the expected value taking into account the potential for changes in the variable payment component. If compensation for a performance obligation will be deferred, and not paid contemporaneously with the satisfaction of the performance obligation, the present value of the deferred compensation should be considered. Non-cash compensation (e.g., bartered goods or services) should be measured at fair value, or if not available the standalone selling price. Other consideration such as coupons or vouchers may need to be deducted from the transaction price. For SaaS companies that use a tiered pricing structure and monthly or annual minimums, calculating the expected revenue can be tricky (e.g., by using a probability-weighted methodology).

Step 4 – Allocate the transaction price to the performance obligations. If your contract has one performance obligation, you’re already done with this step. If not, the next step is to allocate the transaction price among each distinct performance obligation, i.e., to separate the transaction price into each discrete “piece” of consideration a party expects to receive from satisfying the associated performance obligation. This can be done by allocating the standalone selling price (i.e., the price at which the good would be sold separately) to the performance obligation, or where that standalone price is not available, the selling entity should estimate it by utilizing as many observable data points as possible to come up with the best estimate possible. ASC 606 includes examples of estimation methods. If a company provides a discount, the discount should be allocated proportionally among the expected revenue for the performance obligations to which the discount applies.

Step 5 – Recognize allocated revenue when (or as) the performance obligations are satisfied. The final step is to recognize each allocation of the transaction price as each distinct performance obligation is satisfied (i.e., the promised good or service is transferred to the recipient). For physical assets, transfer occurs when the recipient obtains control of the asset. For services, a performance obligation is satisfied when the benefits from the provider’s performance are received and utilized, the provider’s performance creates and/or enhances an asset in the recipient’s control, or the provider’s performance creates a payment right without creating an asset with an alternative use to the recipient (e.g., a company is contractually restricted from using a provided service for other purposes). Performance obligations may be satisfied on a specific date (e.g., for delivery of goods) or over a specific time period (e.g., for delivery of services). If satisfied over a time period, revenue may be recognized based on the progress towards satisfying the performance obligation.

Get Prepared Now

While it may seem like there is plenty of time to prepare for the implementation of the new revenue recognition standard, there’s a lot of work that needs to be done to be ready, including the following:

  • Learn the details. It’s important to note that this article represents a very high-level summary of the new revenue recognition standard. Having a more in-depth understanding of the new standard and how it applies to your company and its costing models/contracts is critical. There is an abundance of articles, seminars, and other publicly-available materials available on ASC 606 and IFRS 15. Also, talk with your accounting firm on what they have done as a firm to prepare, and their recommended action plan for your business – they may have some great materials they can provide to get you and your company up to speed.
  • A lot of work be done proactively. Conduct a proactive review of existing contracts, contractual obligations, and other revenue sources that may be classified as a “contract” subject to the new revenue recognition standard. Analyze each to determine the distinct performance obligations, and determine the transaction price. Work with your accountants to allocate the transaction price among the performance obligations.
  • Review (and update if necessary) contract templates. Accounting should partner with Legal and Sales to review sales proposal templates and contract templates describing or creating performance obligations. Review all standard variations of pricing offered to clients to identify any issues under the new revenue recognition standards. Consider whether warranties, returns language, or other contractual terms create distinct performance obligations and how they can be satisfied. Make any updates as necessary to ensure your templates align with the new standards going forward.
  • Create a plan. Assign a resource to manage the process of preparing for the new standard. Consider creating a cross-departmental group to meet regularly to discuss progress and assign tasks. Consider what internal education will need to be done to prepare employees and groups for the new standard, what changes to internal or third party systems may be required, what additional disclosure requirements may be required, whether internal policies will need to be updated or created, and what changes may be needed to internal processes. Secure the support of executive sponsors, such as the CFO and CEO. If you have personnel who were involved in rolling out SOX compliance in the early 2000s, talk to them about lessons learned to avoid repeating the mistakes of the past.

Eric Lambert is Assistant General Counsel and Privacy Officer at CommerceHub, a leading cloud services provider helping retailers and brands increase sales and delight shoppers through supply solutions to expand product assortment, demand solutions to promote and sell products on the channels that perform, and delivery solutions to enable rapid, on-time customer delivery. Any opinions in this post are his own. This post does not constitute, nor should it be construed as, legal advice. Eric works primarily from his home office outside of Minneapolis, Minnesota. He is a technophile and Internet evangelist/enthusiast. In his spare time, Eric dabbles in voice-over work and implementing and integrating connected home technologies.

6 Contract Templates Every Company Should Have at the Ready

One of my favorite sayings is “opportunity is equal parts luck and preparation.” In other words, being proactively prepared for an opportunity puts you in a better position to take advantage of one when it comes along. When a business opportunity arises that requires a contract or other legal document, being prepared includes having a well-written template ready to go. It can help avoid missing critical terms and points when rushing to draft a document for the opportunity, minimize the time and effort required to respond, and turn a “fire drill” into a routine but urgent request. Conducting business on a handshake agreement, or on a hastily drawn-up set of terms, to save time can backfire if the opportunity turns into a dispute. Having a well-drafted, legally binding agreement in place ensures the parties both understand their rights and obligations in connection with a business opportunity, and gives your company the protection it needs if and when the need arises.

Here are six contract templates every company should have drafted and ready for use when the opportunity arises. If your company does not have in-house counsel, consider whether having outside counsel prepare some or all of these templates for you is a worthwhile investment. If you have (or are) in-house counsel, check to ensure that you have up-to-date versions of these agreements in place. Consider whether to take this opportunity to freshen them up.

1) Mutual and unilateral NDA templates

Companies use non-disclosure agreements (aka “confidentiality agreements” or “NDAs”) for protective, contractual, and strategic purposes. NDAs ensure there are adequate (and binding) protections for your confidential information before you share it with another party. If your company has trade secrets, failing to put confidentiality obligations in place with third parties who have access to your trade secrets can cost you your trade secret protection. NDAs may also satisfy a contractual obligation to a third party (e.g., not to disclose a company’s confidential information unless the recipient is also subject to written confidentiality obligations). They can help ensure that a third party is truly interested and serious about discussions with your company. (I discussed the why, when and how of NDAs in depth in a previous LinkedIn article.) If your company and a prospective business partner want to “pull back the curtain” to share confidential information as part of discussions about a proposed relationship, you’ll want to have an NDA template ready for use.

Companies should have a minimum of two NDA template “flavors” at the ready – mutual (where both parties are providing confidential information to the other) and unilateral (where only your company is sharing confidential information). Use the template that best matches the actual disclosures occurring, and avoid putting a mutual NDA in place where you don’t expect (and don’t want) confidential information from the other party. For example, if you want to share financials and future business plans with a candidate for employment, a unilateral NDA is likely your best bet. Some companies use other flavors of NDAs as well (e.g., a specific version for M&A opportunities, one for interview candidates, etc.)

NDAs should also be drafted as fairly as possible – the last place you want to get bogged down in negotiation is over the NDA (tripping up your business discussions before they even start). Consider avoiding contentious language such as residuals clauses and first-party indemnities in your NDA templates. Also consider having your NDA template as a PDF with fillable form fields to minimize negotiation and simplify the process of completing the NDA.

2) Professional Services/Independent Contractor Agreement template

Every company, big and small, uses subcontractors, vendors and service providers (collectively, “contractors”). Contractors are often brought in where a company needs additional support or services its employees cannot provide (or want to outsource), where it needs subject matter expertise it does not have, or where it needs to temporarily augment its existing personnel or other resources. There are many benefits to using contractors, from avoiding the need to pay payroll-related costs to having the ability to “target” spend on subject matter expertise when needed. Having a written agreement in place with your contractors, and a template Independent Contractor Agreement (also called an “ICA” or “Professional Services Agreement”) ready for use, is critical to protect your company’s rights.

Most ICAs are a master set of terms governing each work engagement, and use “statements of work,” “work orders,” or “project assignments” for each discrete project (collectively, “SOWs”). Among other things, ICAs typically cover the scope of work performed; the independent contractor relationship between the parties (misclassification of independent contractors by companies is a current “hot button” issue for the IRS); testing, acceptance and ownership of deliverables; payment terms, expenses and taxes; representations, warranties and remedies around the work and/or deliverables; and insurance. SOWs generally include sections on the scope of services, in-scope and out-of-scope items, deliverables, timeline and milestones, fees (e.g., time and materials, not to exceed amount) and payment schedule, and change order procedure.

Companies may also want to consider using the core provisions of their ICA to create a set of “Vendor Terms & Conditions” that exist on a URL on the company’s domain. Companies can incorporate Vendor Terms & Conditions by reference into a vendor’s purchase order or invoice, with language ensuring a term in the Vendor Terms & Conditions governs over any conflicting terms in the vendor’s own terms, to avoid the need to negotiate every services order or contract. This can be a simple and cost-effective way to ensure a base set of standard risk allocation and other terms apply to each vendor even where the vendor spend or vendor size does not warrant the use of significant Legal or Procurement resources.

3) Employee Confidentiality and Inventions (and Non-Solicit and Non-Compete) Agreement and Employee Offer Letters

As a condition of employment, most companies require their employees (1) to maintain the confidentiality of the company’s confidential and proprietary information, and any similar information of the company’s clients, vendors and service providers, that the employee may receive or have access to during the term of his/her employment, and (2) to agree that the company owns any inventions or other “work product” created by the employee in connection with his/her employment. Some companies also require employees to agree, during the term of employment and for a period of time afterwards, not to solicit the company’s clients or employees, and/or to not compete with the company on behalf of another company (these are known collectively as “restrictive covenants”). To ensure these obligations are in place and legally enforceable, every company must have a well-drafted Employee Confidentiality and Inventions Agreement (or “ECIA”).

The ECIA is the type of agreement that is worth a little of outside employment counsel’s time to ensure it is both well-written and legally enforceable. If your company has offices or employees in multiple states, the laws around the enforceability of these types of agreements, especially restrictive covenants, differs widely. For example, in California, restrictive covenants are generally void, but in other states such as Minnesota, restrictive covenants can be enforceable if they are reasonable in time and scope and satisfy other legal requirements such as supported by consideration and supporting a legitimate employer interest. Consideration itself is an important consideration that varies from state to state — you may not be able to enforce a new (or updated) ECIA against existing employees unless it is supported by additional non-token consideration provided to the employee. Also, NDAs and partner agreements often require that a company only disclose the other party’s information to employees who have a need to know the information and are bound by written obligations of confidentiality to protect it, and a properly worded ECIA can satisfy this requirement.

Companies should also have well-drafted employee offer letters. The offer letter is signed by the company and agreed and acknowledged by the new employee, and contains both a summary of the employment terms and important protections for the company. A well-drafted and properly worded offer letter can help avoid later issues if there is dispute over terms such as the details of the employment offer or the employee’s conduct. Companies should have separate offer letter templates for exempt and non-exempt employees. Consider including, among other provisions, the start date; the title of the position and name/title of the supervising employee; the base salary and payment cycle; probation period language; information on vacation & holidays, benefits, and equity grants (if applicable); pre-employment screening requirements; and continuing obligations (e.g., there are no existing restrictive covenants that would prevent the candidate from working for the company; the candidate will not bring any confidential or proprietary data from a former employer onto company systems; etc.). Ensure the offer of employment is labeled “contingent” so that in the event of an issue, the applicant was not truthful on the employment application, you have the right to revoke it where allowed by law. Offer letters should also be reviewed by outside employment counsel to ensure they comply with the state laws applicable to your business.

4) Business Referral Agreement

Companies looking to grow their business may happen upon a person or company willing to refer potential clients to them (e.g., a company in a complimentary business whose clients may also be interested in your company’s products or services, or a person with deep connections in the industry who can facilitate introductions with executives at some of your company’s top sales targets), typically in return for a bounty per referral or a percentage of the fees earned by the company from the referred client. When a referral opportunity arises, have a business referral agreement template ready for use.

A business referral agreement typically covers the process of submitting a lead and any rights of the company receiving the lead (the “recipient”) to reject it; the time frame for the recipient to close a business transaction with the referred lead; the fees payable for referring the lead, and the payment frequency and terms; what assistance the referring company will provide to the recipient in closing the business (if any); and audit rights to ensure the referral fees paid are accurate.

As with NDAs, consider having both a mutual referral template (where both parties are referring leads to the other) and a unilateral template (where a party is referring leads to your company only).

5) Letter of Intent/Term Sheet/Memorandum of Understanding

When negotiating a new business opportunity, there is often pressure to get something on paper as quickly as possible, even before the deal is fully negotiated. One way to do this is through a letter of intent (also called an “LOI” or “term sheet”) or memorandum of understanding (“MOU”). A LOI or MOU can act as a “snapshot in time” of the anticipated terms of the definitive agreement as of that date, highlighting both where the parties have already come to agreement and where further negotiation is needed. If done incorrectly, a LOI thought to be non-binding by one party could be held to be a legally enforceable agreement. Having a properly worded LOI or MOU template at the ready can help evidence the parties’ intent to move forward with negotiations and ensure they keep the focus on finalizing the terms for, and negotiations on, a definitive agreement, while protecting your company’s rights to walk away if a definitive agreement cannot be reached.

A LOI and MOU differ primarily in form: a LOI is typically in the form of a letter, where a MOU is typically in the form of a legal agreement. LOIs and MOUs typically include terms that can be grouped into two sections:

  • Non-binding terms. These are a summary of the terms that the parties intend, as of the date of the LOI or MOU, to include in the definitive agreement. When putting non-binding terms into a LOI or MOU, consider using non-binding terms such as “would,” “should,” and “may” instead of “will” and “shall.” Also consider a catch-all provision stating that all obligations in the non-binding section are prospective only and will not apply to the parties unless and until embodied in a definitive agreement to be negotiated and signed by both parties.
  • Binding terms. Many people believe that a LOI or MOU is completely non-binding, but that’s almost always not the case. The most common binding term is a commitment by both parties to continue negotiating in good faith toward a definitive agreement, and a statement that either party may cease negotiations at any time. Other binding terms to consider for your LOI or MOU include exclusivity or standstill obligations (e.g., the parties will negotiate exclusively with the other for a period of X months); confidentiality obligations or a reference to the existing NDA in place between the parties; non-solicitation obligations; and general legal boilerplate such as choice of law and an integration clause. Also include a statement that except for any binding terms, the LOI or MOU does not create (and is not intended to create) any binding or enforceable agreement or offer. Ensure the binding and non-binding terms are in separated sections.

I prefer to use a letter of intent when it’s non-binding (e.g., as a term sheet), with our without a commitment by the parties to continue negotiating in good faith. I use a memorandum of understanding when summarizing non-binding deal terms coupled with binding obligations. Whether you use a LOI or MOU, ensure it is signed by both negotiating parties.

6) Settlement and Release Agreement

Sooner or later, your company will have a dispute with a client, customer or vendor over fees, performance of obligations, use of deliverables, etc. Most often, business disputes are resolved by the parties without the need for formal dispute resolution such as mediation, arbitration, or litigation. When a dispute is resolved, it can be important to have a settlement template ready to memorialize the parties’ full and final resolution of the dispute, and to state any obligations the parties have to each other in connection with the resolution of the dispute. Without a well-written and legally enforceable settlement and release agreement, the parties may find that the settlement of a dispute is not as full or final as originally thought if one of them seeks to enforce the settlement terms.

Settlement templates generally include a description of the dispute being settled; the consideration to resolve the dispute (e.g., waiving certain accounts receivables, payment of an amount by one party to another) and any contingencies (e.g., payment must be received within 10 days); a release by both parties of any claims related to the dispute (ensuring this is properly worded is one of the most critical parts of the settlement agreement); confidentiality language; a non-disparagement clause if appropriate; and other appropriate legal boilerplate. There are state-specific requirements for settlement and release agreements, so consider having local counsel review your template to ensure it will be enforceable.

The easiest settlement agreement template to have at the ready can be used for the resolution of run-of-the-mill business disputes such a billing dispute. For significant or complex disputes or settlements to resolve pending or threatened litigation/arbitration and releases in cases of employee terminations, consult an attorney to ensure your template fully and completely covers the complexities or nuances of the specific case.

Eric Lambert is Assistant General Counsel and Privacy Officer at CommerceHub, a leading cloud services provider helping retailers and brands increase sales and delight shoppers through supply solutions to expand product assortment, demand solutions to promote and sell products on the channels that perform, and delivery solutions to enable rapid, on-time customer delivery. Any opinions in this post are his own. This post does not constitute, nor should it be construed as, legal advice. Eric works primarily from his home office outside of Minneapolis, Minnesota. He is a technophile and Internet evangelist/enthusiast. In his spare time Eric dabbles in voice-over work and implementing and integrating connected home technologies.

Don’t Overlook These 6 Important Contract Clauses

Managing the review and negotiation of contracts involves regular stack ranking of projects. With many agreements to review and other job responsibilities for both in-house counsel and business counterparts alike, the value or strategic importance of the agreement often determines the amount of attention it receives. Given this, attorneys and their business counterparts generally do not have time for a “deep dive” into every nook and cranny of an agreement under negotiation. They focus their available resources on the big-ticket items — obligations of the parties, termination rights, ownership, confidentiality, indemnification/limitation of liability, and the like — and may only have time for a cursory review (at best) of other contract terms that appear in most agreements, called the “legal boilerplate.”

If you have a little extra time to spend on an agreement, here are six clauses that are worth a closer review. Why these? If worded improperly, each of these clauses can have a significant adverse impact on your company in the event of an issue or dispute involving that clause.

(1) the Notices clause. Failure to provide timely notice can case major issues. So can failing to receive a notice that was properly served. If mail can take some time to be routed internally, consider avoiding certified or first-class mail as a method of service. Personal delivery and nationally or internationally recognized express courier service (FedEx, UPS, DHL, etc.) with signature required on delivery are always good choices. Notice by confirmed fax or by email to a role address (e.g., “legal@abc.com”) are also options to consider, either as a primary method of notice or as a required courtesy copy of the official notice. Use a role and not a named person in the ATTN: line – if the named person leaves, routing of the notice may be delayed. Consider requiring that a copy of every notice be sent to your legal counsel. Consider whether to make notice effective on delivery, versus effective a fixed number of days after sending (whether or not actually received). It is also worth considering making notice effective on a refused delivery attempt – the other side should not be able to refuse a package to avoid being served with notice. Ensure delivery is established by the delivery receipt or supporting records.

(2) the Dispute Resolution clause. Ensure the agreement’s dispute resolution mechanism (litigation vs. arbitration), and any dispute escalation language, is right for your company given the potential claims and damages that could come into play if you have a dispute. Make sure you’re OK with the state whose law governs the agreement (and ensure it applies without regard to or application of its conflicts-of-laws provisions). If neither home state law is acceptable, consider a “neutral” jurisdiction with well-developed common law governing contracts e.g., New York. Ensure you’re OK with the venue — consider whether it is non-exclusive (claims can be brought there) or exclusive (claims can only be brought there), and whether a “defendant’s home court” clause might be appropriate (a proceeding must be brought in the defendant’s venue). Finally, ensure the parties’ rights to seek injunctive relief — an order to stop doing something, such as a temporary restraining order or injunction, or an order to compel someone to do something — are not too easy or hard to obtain. In some cases, whether a party needs to prove actual damages or post a bond in order to obtain an injunction can play a critical role.

(3) the Order of Precedence clause. If your agreement has multiple components (e.g., a master services agreement, separate Terms and Conditions, incorporated policies from a web site, service exhibits or addenda, statements of work, project specifications, change orders, etc.), which piece controls over another can become critically important if there is a conflict between the two (e.g., liability is capped in Terms and Conditions, but unlimited in a Statement of Work). Ensure the order of precedence works for you. Consider whether to allow an override of the order of precedence if expressly and mutually agreed to in an otherwise non-controlling contract component. Don’t forget about purchase orders — they often have standard terms which can conflict with or override the contract terms unless they are specifically excluded. If you are negotiating a SaaS agreement, consider how acceptable use policies, terms of use, and other online policies may relate to the agreement. Watch out for other agreements/terms incorporated by reference, or on the other hand, consider incorporating your standard terms and having them control in the event of conflicting terms.

(4) the Assignment/Change of Control clause. If consent to assignment or a change of control is required, the clause can create significant headaches and delays during an M&A closing process or during a corporate reorganization. A client or vendor with “veto power” could leverage that power to get out of the contract, or to obtain concessions/renegotiated terms. Consider whether to include appropriate exclusions from consent in the event of a reorganization or change of control, but keep a notice requirement. Consider whether a parental guaranty is an appropriate trade-off for waiving consent. Also consider whether consent is needed in a transaction where the party continues to do business in the same manner it did before (e.g., change of control of a parent company only).

(5) the Subcontractor clause. Ensure you have approval rights over subcontractors where necessary and appropriate, especially if they are performing material obligations under the agreement or will have access to customer data or your systems. A service provider may not be willing or able to give an approval right to a subcontractor providing services across multiple clients, but may be OK with approval of a subcontractor providing services exclusively or substantially for your company. Include the ability to do due diligence on the subcontractor; remember that subcontractors can be an attack route for hackers seeking to compromise a company’s network. Ensure a party is fully liable for all acts and omissions of the contractor. Consider pushing security obligations through to the subcontractor. Require subcontractors to provide phishing training.  Consider limitations on what obligations of the other party can be subcontracted.

(6) the Non-Solicitation clause. Consider limiting a non-solicitation clause to those employees key to each party’s performance under the agreement, and other named personnel such as executive sponsors or corporate officers. Most often, neither party can live up to a clause that covers every employee at the company. Ensure there are appropriate exclusions for responses to job postings, recruiter introductions, and contact initiated by the covered party. Consider whether the clause prevents soliciting an employee as well as hiring them, and whether you want to restrict one or both.