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SLAs (Part 2): service credits

In the first post on SLAs (http://macs-legal.com/slas-service-levels/), I looked at service levels for remotely hosted (or cloud) services,

and what both customers and suppliers should be thinking about when negotiating them.  In this post I look at the consequences of service levels being breached and, in particular, the use of service credits, principally insofar as they relate to suppliers and customers of remotely hosted services.

General

A supplier’s failure to meet an agreed service level will normally constitute a breach of contract, entitling the customer to be compensated for losses it has incurred as a result of the service level failure.  To avoid discussions as to whether the customer has suffered a loss, and if so how much compensation the customer should be entitled to, the parties can agree in advance what fixed amount of compensation (or, in legal speak, liquidated damages) will be payable by the supplier in case of a service level breach.  Because the payment is usually satisfied by way of a monetary deduction from the supplier’s next invoice or by crediting the customer with additional services, these payments are usually referred to as service credits.

Not all bad news for suppliers…

Customers like service credits.  They are generally straightforward to quantify, and they dispense with the need to prove that service level failure has actually caused the customer loss.   And whilst suppliers may be reluctant to agree to service credits – particularly where they believe that a failure to meet a service level is unlikely to cause the customer any actual loss – service credits are not all bad news.  Not only do they offer a degree of certainty as to what happens if the supplier does fall short in its performance, but they may also allow the supplier to avoid more draconian consequences in case of a service level failure, ie a sizeable damages claim and/or termination of the services agreement.  There may also be an opportunity for the supplier to increase revenues by upgrading the SLA, and possibly to demonstrate how its performance of the services is better than that of its competitors.

Service credits and penalties

Unless the service credit represents a genuine pre-estimate of the customer’s loss as a result of a service level breach, there is a risk that it will constitute a penalty.  Under English law, penalties are deemed to be contrary to public policy, and will not be enforced by the English courts.  The fact that the customer’s actual loss is significantly more (or less) than the value of the service credit does not mean that the service credit is necessarily a penalty, provided that at the time the value of the service credit was negotiated and agreed it constituted a genuine pre-estimate of the customer’s loss.

Matters to be considered

When negotiating and agreeing service credits, customers and suppliers may want to think about the following:

  1. Grace period:  Should the supplier’s liability to pay service credits be subject to an initial grace period, to allow the services to be “bedded in”?
  2. Caps:  What, if any, monetary cap should apply to the service credits?  If more than one type of service credit is available to the customer, should the total service credits be subject to an aggregate cap?  Are service credits subject to any general liability caps under the services agreement?
  3. Multiple service credits:  If applicable, should the customer be able to claim multiple service credits in respect of the same default?
  4. Sole remedy:  Does the service credit constitute the customer’s sole remedy in respect of the breach?  Or does the service credit, in effect, operate as a prepayment in case the customer’s losses exceed the value of the service credit?  If the service credit does constitute the customer’s sole remedy, is there a point at which this principle stops applying, and the customer is entitled to other remedies available under the services agreement, eg termination and/or the right to sue for damages?
  5. Service credit earn-back: Should the supplier have the opportunity to “earn back” service credits if, following an accrual of service credits, the supplier’s performance then exceeds a specified level?  Should this principle apply even if service credits have not accrued, entitling the supplier to increase the charges for the services?
  6. Claiming service credits:  What is the process for claiming service credits?  Is the customer obliged to provide evidence to support a service credit claim, and if so whose responsibility is it to collate the relevant service level performance?  Is there a time limit for claiming service credits?
  7. Penalty:  Is the value of the service credit and/or the way that it is calculated vulnerable to challenge as a penalty, ie does it constitute a genuine pre-estimate of the customer’s loss?