Blog by Pasricha & Patel, LLC

Service Agreements – Five Critical Provisions

Categories: Commercial Transactions , Corporate Law , Software Agreements , Technology Law

By: Amandeep S. Cheema, Esq.

As a busy business owner, you juggle many responsibilities. However, slowing down to review key provisions in service agreements can save you from costly surprises, inadvertent breaches of contract, and potential legal fees.

For the purposes of this blog, a “service contract” is any written agreement between a service provider and a client outlining the terms and conditions for the provision of services, including scope, duration, and payment terms.

Here are five critical clauses worth paying close attention to in almost every service contract:

1. Invoice and Payment

Understanding the payment and invoicing obligations of each party is crucial. Look for details on payment schedules, late fees, and discounts for early payments.

For instance, it is common for more sophisticated IT/software agreements to incorporate a “discount rate” for early payment. This means that if the client will receive a predetermined discount if he pays within a certain time window after receiving an invoice. Although this is generally seen as a client friendly term, it can have both strategic and destructive consequences for the service provider. For example, a 2% discount for payments made within 10 days can significantly impact the cash flow of the service provider.

Further, it is always worth to double-check if the agreement specifies the acceptable methods of payment and addresses the procedure for potential disputes in invoice. Finally, it is also important to confirm the payment obligations of the client upon termination for any reason.

2. Representations and Warranties

Representations and warranties are essentially certified statements of truth made by each party to an agreement. These provisions are the backbone of trust in any agreement. Representations are factual statements about the service or product, while warranties are promises about its future performance. Inaccurate representations and misstated warranties can activate costly disputes in the future.

Some common representations and warranties include:

  • Authority and Binding Agreement
  • Compliance with laws
  • No Conflict
  • Licenses and Permits
  • Financial Solvency
  • Accurate Reporting
  • Use of Subcontractors

Other representations and warranties can be tailored to specific industries to address unique concerns and requirements. For instance, in Software as a Service (SaaS) agreements with sophisticated clients, it is not uncommon for the service provider to be required to warrant that all aspects of their services—including software performance, data storage, and maintenance and technical support—are conducted exclusively within the United States. This provision can be particularly challenging for IT service providers who rely on offshore teams for their backend operations. Such requirements may necessitate significant operational adjustments and increased costs, making it a critical point of negotiation in SaaS contracts.

3. Indemnification; Limitation of Liability

Indemnification clauses specify who is responsible for covering costs if something goes wrong. For example, if a service provider damages the property of a client while performing services, the indemnification clause should dictate the responsibility of the service provider to cover repairs and other costs incurred by client. In another scenario, if a client provides inaccurate data to a service provider which in turn causes monetary damages to a third party client, a well written indemnification clause should shield the service provider from incurring any losses from a third party lawsuit by shifting the burden to the client.

Limitation of liability clauses often cap the type and/or amount of damages one party has to pay if they breach the contract. For example, a well written limitation of liability clause will define the maximum payout owed to the client in the event the service provider is held liable under the contract for any reason. This amount is usually limited to the fees the client has paid under the contract as of the date of event that triggered the liability.

4. Non-Solicitation, Non-Compete, and Other Restrictive Covenants

These clauses protect your business interests by restricting the service provider from soliciting your clients or competing with you. For example, a non-solicitation clause might prevent a marketing firm from poaching your clients for a set period after the contract ends. A non-compete clause could restrict them from offering similar services in your market.

You can find detailed blogs on our website regarding these provisions.

5. Assignment

The assignment clause determines whether the rights and obligations of the contract can be transferred to another party during the term of the agreement, and whether consent of the non-assigning party is required. For example, if your service provider sells their business, can the new owner continue to provide services under the existing agreement? What if the sale of business is only a change of control rather than an asset sale?

From the perspective of a service provider, you want to avoid requiring any type of consent for an assignment, especially if you plan to sell your business in the future. Assignment clauses are some of the most scrutinized and consequential provisions during the due diligence process of an M&A transaction. A buyer will always be particularly concerned about the continuity of client relationships after the purchase of the business. Assignment clauses determine whether contracts with clients (and also suppliers, vendors, and other parties) can be transferred to the new owner without requiring additional consents or renegotiations. If key contracts contain strict anti-assignment provisions, the buyer risks losing important business relationships post-Closing.

From the perspective of a client, it may be worth ensuring you have the right to approve any assignment to avoid being stuck with an unqualified or unsuitable service provider. This clause can potentially protect you from unforeseen changes that could impact the quality and continuity of the service.