Do your service credit clauses actually work?
A good service level and service credit mechanism is an extremely valuable tool for ensuring a good customer-supplier relationship.
Simply put, ‘service credits’ allow a customer to pay less if a supplier fails to meet the performance standards set in the service levels. It is not surprising then, that securing service credits which are usable and effective is key to any negotiation. Unfortunately, there is no ‘one size fits all’ when it comes to service level and service credit clauses – which makes sense because they need to fit the specific services being provided. As service credits are one of the key practical enforcement mechanisms in a contract, it is very important that they are reviewed carefully. Having drafted and negotiated many service level and service credit clauses for our clients, we’ve distilled some of our key learnings below and presented them to help those confronting service levels and service credits for the first time.
Types of Service Levels
There are 3 main types of service levels:
Continuous measurement is where a service is being constantly measured. If you are measuring availability, for example, the measure could be what percentage of the day a system or platform is available.
Event measurement is where a service is measured by certain events. For example, if a service goes down, how quickly does the supplier respond and resolve the down time? These often distinguish between P1, P2, P3 and P4 incidents with differing levels of severity. A P1 incident will require rapid response and resolution times whereas a P4 incident will not have the same degree of urgency.
Sample measurement is where the service is measured by taking a sample. An example for this is a customer satisfaction survey or checking samples of data.
In order for service levels to be monitored, it is extremely important that a supplier can easily measure performance and provide regular reports, typically on a monthly basis. To ensure this level of reporting, customers will often mark the failure to provide the report as a service level default which will result in a service credit being applied.
Service Credits
A service credit is the remedy for failing to meet a service level. Service credits are intended to be both:
a price adjustment to acknowledge that the customer has received less of the service than it expected according to the contract; and
an incentive to ensure that the service performance that the customer requires is maintained.
Service credits are often paid through the mechanism of a credit on the next invoice or a repayment where there are no further invoices due. Service credits should not be a liquidated damage and should never be a customer’s sole and exclusive remedy.
Drafting Service Level and Service Credit Mechanisms
As service levels are service specific, the first draft is often provided by the supplier. Below are our key drafting and negotiating tips for customers when considering the service levels and service credits:
How many service levels do you have? Too many service levels are not going to be practical. Managing them is time-consuming and your service credit will be diluted to the point it no longer serves as a performance incentive. If there are too many, it is a good idea to separate out service levels (that will attract service credits) and KPIs (which will not).
How do you measure the service? Including service levels without the ability to measure whether they are being complied with is pointless. The customer will be unable to hold the supplier accountable. Thought must be given to how the supplier is going to measure the service level.
Is the supplier required to notify the customer in the event of a failure? A customer is not always able to know whether there is a service level failure or not. We usually specify that the supplier must provide a monthly report on the service levels so that the customer can assess whether there has been a failure or not.
What happens in the event of a failure? In the event of a failure, the supplier has already suffered a service credit and may not have an incentive to restore the service. For this reason, it is useful to also include a provision that the failure will be restored within a certain time period, or that the service credit will increase the longer the failure persists.
What about maintenance? Unplanned or emergency maintenance should not be carved out of the service levels because it will effectively negate the service level. Unplanned or emergency outages are by their nature failures in the service. It is reasonable for the supplier to carve out planned maintenance but be sure to specify the notice periods required for planned maintenance, and the hours when planned maintenance can be performed.
How often do you measure service levels? This will depend on the service but be careful not to create obligations to measure them too often as this can become very complicated and time consuming to manage.
Have you considered the service windows? If the service level requires service hours or business hours, make sure they correlate to your requirements. For example, it would be problematic if the customer is expecting a service to be available 24/7 but service credits apply only to support provided during business hours.
Are there service credit holidays? Service credit holidays refer to periods where the supplier will have no applicable service credits. These are typically at the start of a contract and are generally not advisable. This is because the early phase of the relationship is critical in driving the right performance and cementing the right first impressions of the supplier. Failures at this early stage can create a negative impression of the supplier’s capability that can be very difficult to reverse - and this will be compounded by a lack of available remedy. If the supplier has a reasonable argument that there is a lack of historical service level data to allow it to commit to required service levels from day one, then implement a ramp up of the service levels, e.g. over a three month period, but keep the service credits in place for the lower levels of service as they ramp up to the required level
Can the customer terminate for service level failure? It is important to include a termination right for a serious or persistent service level failure and to define what types of failures will result in a termination right for the customer.
Response times vs Resolution times: Service level mechanisms sometimes provide a service level response time (i.e. that they need to acknowledge that there has been an incident) but fail to provide a resolution time. This is a very weak service level as there is no obligation on the supplier to actually fix the issue. Including resolution times, so that there is certainty on how long it will take for the issue to be fixed, will ensure a more meaningful remedy.
Is there an ‘At Risk’ Amount? An ‘At Risk’ Amount is an amount which caps the service credits in any month, or in other words, the total amount of the fees that the supplier has ‘at risk’. This means that suppliers only make available a portion of the fees which could be paid as service credits, as opposed to the total fees. The ‘At Risk’ Amount is usually expressed as a percentage of the fees for the period that the service credit will apply, e.g. 15% of the monthly fees. It is important to calculate what the ‘At Risk’ Amount actually is in real terms to determine whether it will in fact operate as an incentive. If the At Risk amount in real terms is low then the resulting service credit will also be low, which may cause the service credit mechanism to fail in its key objective of acting as a performance incentive.
A well written service level and service credit mechanism, which has been considered in line with the practical and commercial realities in a deal, will go a long way in ensuring that both the customer and the supplier achieve their objectives. Applying the principles set out here should help to achieve that.
The information and views contained in this article does not constitute legal advice. If you do require legal advice, please contact us on hello@lighthouse.law.
