Rawlison Butler. A Brief Guide to Service Levels and Service Credits

Transcription

1 Rawlison Butler A Brief Guide to Service Levels and Service Credits

2 Service levels are used as a means of encouraging good supplier performance and discouraging poor supplier performance. Introduction Service levels and service credits are common features of commercial contracts, particularly outsourcing agreements, large-scale ICT contracts and long-term supply agreements. Service levels are used as a means of encouraging good supplier performance and discouraging poor (ie lack of or defective) supplier performance. Service credits are the mechanism to financially compensate a customer for poor supplier performance. Before entering into a commercial contract, companies need to consider whether service levels and service credits should apply. In this brief guide, we consider how and when service levels and service credits should be used, and highlight some of the key considerations for businesses when negotiating and agreeing a service level agreement. What is the purpose of service levels? Essentially, the function of service levels is to enable a business to measure its supplier s actual service performance as against the required contractual performance levels. Where a supplier s performance drops below agreed performance levels, service levels are designed to ensure that the supplier swiftly rectifies their under-performance. Service levels usually address the most important or key elements of the services. This involves determining what the business critical functions are, and then setting a standard of performance in relation to those functions. Example A supplier who supplies, installs and commissions a new IT system may be subject to a service level that the system will once commissioned be available, say, 98% of the time, excluding or including scheduled maintenance and downtime. If the system operates for only 95% of the time in a given period, the supplier may be required to refund some of the charges paid for ongoing maintenance and support, or to provide service credits which the customer can offset against future maintenance charges. The idea of service levels is that they should be pitched somewhere between a carrot and a stick in other words, they should be sufficiently robust to ensure that the supplier performs to the required contractual performance levels and addresses any shortcomings, but not so harsh as to be seriously punitive and disincentivise or demotivate the supplier. It is important to ensure that any service levels imposed can be objectively and accurately measured. Also, any tools utilised to measure service levels need to be available and sufficiently accurate to perform that task. Service credits Where service performance is not at the required contractual performance levels, service credits will normally apply. Service credits may be in the form of monetary recompense or a credit or set off against or reduction in future payments due to the supplier. The idea of service credits is not to punish the supplier as such, but to incentivise the supplier to rectify poor performance. It is no good having service levels and service credits set at

3 It is not unusual for a supplier who is subject to a service credit regime to request a service bonus regime for excellent or exceptional performance over and above agreed service levels. a level where the supplier is constantly under-performing and having to make payments or provide service credits to the customer that will only serve to demotivate the supplier to such an extent that it is in neither party s best interests. In addition, it is not uncommon for suppliers to price the risk of having to pay service credits into its charges if the service level/ credit regime is heavily stacked against it. A variety of service credit mechanisms can be adopted, including: paying a service credit where a service level is breached where two service levels apply in respect of the same performance requirement, for example where there is both a required service level and a minimum (lower) acceptable service level, paying a service credit if either (i) performance falls below the minimum acceptable service level or (ii) assuming performance remains above the minimum acceptable, there are repeated or persistent failures of the required service level a scaled approach where service credits ramp up depending on the nature, severity and frequency of the service level failures. It is not unusual for a supplier who is subject to a service credit regime to request a service bonus regime for excellent or exceptional performance over and above the required contractual performance levels. However, the customer will often resist this on the basis that the supplier is being engaged to provide excellent performance as the acceptable standard. Also, a supplier may seek to include an earn-back provision, which enables the supplier to reduce its liability to pay service credits or earn back service credits that have been incurred, often by the supplier exceeding the required contractual performance levels. Some service level failures may give rise to more significant service credits than others, for example failures to deal rapidly with outages to business critical systems are likely to attract severe service credits. It is also usual to specify a service credit cap, often an annual, quarterly or monthly cap. There is often a pressure to agree that service credits are the sole financial remedy for a given service level breach, so that the supplier is not also subject to a damages claim for breach of a contractual obligation. Types of service levels Service levels usually measure the supplier s performance over a defined period: Example The IT system will be available for 98.5% of the time on a 24 x 7 x 365 basis. But they can also be used to measure specific events: Example The call centre will answer 97% of all calls received within [X] seconds or [Y] rings, and will respond to all enquiries within [Z] hours.

4 An SLA, or service level agreement, is a contractual document which sets out the service level and service credit regime. Key performance indicators or KPIs KPIs are often included alongside service levels they set required performance levels but do not usually give rise to service credits or other financial redress. However, it can be the case that some KPIs are turned into service levels on giving the supplier notice to that effect. What is an SLA? An SLA, or service level agreement, is a contractual document which sets out the service level and service credit regime. It may be a schedule to the main contract terms, or it could be a standalone agreement. Just how many service levels should be set and included within an SLA very much depends on the nature, scope and duration of the services being provided by the supplier. With a long-term contract, it is important to ensure that there is a proper review mechanism so that the service levels and corresponding service credits remain appropriate, and that there is an obligation on the supplier to make continuous improvements. Scoping service levels and service credits It is essential to set clear and unambiguous service levels and to define any terms used. For example, when using the term availability in respect of a service or system what does that actually mean? Does it include scheduled maintenance and other downtime? Does it mean availability at all times or only during certain specified hours? Does availability need to be at 100% or at a particularly high level during peak business hours and less so at other times? It needs to be apparent or obvious what the service level has been set for and how it will be measured. Service levels need to be: realistic and achievable measurable and contractually binding and enforceable. Also, different service levels may apply in respect of the same performance standard for example, a supplier may be required to provide services to a particular level of performance and to pay service credits where its performance falls below that level. But, its performance may be required to meet, as a minimum obligation, and not to drop below, a critical service level. Service credits and/or other remedies are likely to apply for any breach of the former, but failure to meet the critical service level may give rise to a serious breach of contract resulting in termination and (in addition to service credits) to a claim for damages. It may be the case that a service credit only applies in situations where the supplier has missed a service level on more than one occasion - for example, if it fails to achieve the service level in two consecutive months, or in any three months within a six or twelve month period. It is also possible to have a scale of service credits, which ramp up the more frequent and/or more severe the service level failure is. The supplier will not want to be responsible for service level failures due to factors outside of its control (such as a force majeure event), or because they are within the It is essential to set clear and unambiguous service levels and to define any terms used.

5 Given the long-term nature of many commercial contracts, it is essential to retain the ability to revisit. customer s control or are within the remit of one or more of the customer s other suppliers. Flexibility Given the long-term nature of many commercial contracts, it is essential to retain the ability to revisit, update and amend service level and service credit mechanisms, and to introduce new service levels and service credits, especially where new or external factors may impact service delivery or performance. Customers often want service levels to apply from the outset or shortly after the commencement of the services, but there is usually an acceptance that the supplier will need a little leeway before service credits can begin to apply. Provisions need to be built in to the SLA obliging the supplier to improve its performance after the initial transition period is over. There is usually a need to provide the supplier with some respite from service credits during that initial transition period, for example where the supplier takes on a first-time outsourcing or where it takes over from an incumbent supplier. Performance failures Usually (though not always) the supplier monitors and measures its performance against the agreed service levels, and reports any service failures or breaches. It is therefore vital to include appropriate obligations in the contract to ensure that the supplier does so and consider linking monitoring and reporting to a service level which itself also attracts a service credit if it is not provided. It is also important to build in monitoring, reporting and review processes to ensure that performance is kept on track and that any issues are spotted and resolved quickly. Sometimes a third party may be charged with monitoring and reporting the supplier s performance, but usually the supplier will be in the best position to do this. That said, it is a good idea for the customer to retain audit rights so that the supplier s facts and figures can be verified. The SLA may also oblige the supplier to investigate and establish the cause of any service level failure, and to implement a remedial plan to resolve the problem and ensure (as far as possible) that it is not repeated. If breaches are sufficiently serious, for example where failures of critical service levels occur, they may give rise to termination and/or a claim for damages. Liquidated damages and penalties Service credits are, in effect, a form of liquidated damages. That is, they provide a set financial remedy for a specific breach or failure which has been agreed by the parties. On the other hand, a breach of some other contractual obligation will normally give the non-breaching party a right to claim damages against the breaching party. The damages would be unliquidated (ie not fixed) until they are either agreed by the parties or assessed by the courts. In order to be enforceable under English law, liquidated damages have, until recently, needed to be a genuine pre-estimate of loss. Otherwise, they were void as a penalty and unenforceable. The rule against penalties only takes effect where the trigger for payment is a breach of contract (such as in the case of service credits). If the trigger is not a breach,

6 the sums payable are not damages and cannot offend the rule (eg a bonus that is payable for better performance). However, recent case law states that it is now a question of substance (as opposed to form), as to whether a clause will be a penalty. Accordingly, a sum is a penalty if it is unconscionable and extravagant when compared to any legitimate interest of the aggrieved party in performance (considering all legitimate interests, not just the damages a court would award for breach). Case law indicates that the following could therefore be valid: Commercially justified term - it has long been established that the courts should hesitate before they interfere in a commercial contract that has been agreed by two parties of equal bargaining power. In such cases, where the contract contains a clause which protects a legitimate interest of the aggrieved party and is not unconscionable or extravagant then it is enforceable Genuine pre-estimate of loss despite this now not being the correct test, a clause based on preestimated losses seems unlikely to be extravagant, unconscionable, or unjustified A term designed to deter breach until recent case law, a term whose main intention was to deter breach was always a penalty. However now, this is not always so and a payment may be intended to deter breaches and yet be justified depend on the facts of the case. Therefore, in light of recent case law it is still a good idea to ensure that there is a genuine attempt to preestimate loss. A pre-estimate of loss does not need to be accurate. It may be that the pre-estimate is made some considerable time before the occurrence of any breach giving rise to the payment of the service credits, and where significant changes may have occurred in the interim period that impact that pre-estimate. However, it is important that the parties have made a genuine attempt to assess the likely loss that may arise, and it is prudent to retain details of how the pre-estimate was determined, should there be a need to show a court that the pre-estimate was a genuine one and that the parties have not simply plucked a figure from the air. It is also important to ensure that the amount agreed is not excessive, as it will almost certainly not be enforceable. A service credit mechanism therefore needs to be drafted so that the service credit payments do not amount to a penalty. Customers should therefore consider agreeing a bonus for enhanced or early performance rather than a penalty for late or defective performance.

7 How RB can help Our extensive experience of commercial contracts, particularly outsourcing agreements, large-scale ICT contracts and long term supply agreements means that we are experienced in and well-placed to prepare, negotiate and advise you on the best and most appropriate service level and service credit regime for your particular contract. For further information, please contact: Lisa Downs Partner, Commercial E ldowns@rawlisonbutler.com T +44 (0) Disclaimer: This document is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking, or refraining from taking, any action as a result of the contents of this document. Rawlison Butler LLP is a Limited Liability Partnership registered in England (number OC318343) and is authorised and regulated by the Solicitors Regulation Authority. 01/17