Contract LawOutsourcing & Projects

Service Levels: Part 1 – Service Level Credits and Risk Assessment

service level credits

Service Level Credits and Service Levels – Long Term IT Projects

Service levels (SLAs) and service level credits are very important when planning long term IT projects for your business. Service levels are one of a number of issues for parties to a commercial contract to consider, which are distinct from the end product of the services. Governance processes, mechanisms and relations are much more important in a seven year system develop, build and integrate contract than they would be for, say, a one-off purchase of hardware. Before entering into a long-term technology contract you should consider addressing the following in the contract:

  • clauses providing for ongoing operational, technical and executive governance meetings between the parties;
  • a mechanism to measure, review and improve the supplier’s service performance; and
  • a change management process to enable the parties to amend either operational documents, such as the project management plan, or the contract itself.

In this series of articles I will examine the issues customers should turn their minds to when evaluating and beginning to draft a robust service level regime and service level credits for an IT contract.

Service Levels and Self-Help Remedies

A service level is a contractual mechanism that defines the level of service that a party, normally the supplier, must meet or achieve. If the supplier fails to meet or achieve that level of service the other party, normally the customer, can claim a self-help remedy. Contracts and service level agreements (SLAs) contain varying terminology that describes the service levels and self-help remedies.

As part of its ongoing service obligations the contract should require the supplier to measure and report on its service performance at an agreed frequency. The parties can agree to include specific details regarding the number of service levels, how those service levels will be measured and reported on, and corresponding self-help remedies if one or more of the service levels are not met.

Self-Help Remedies: Service Level Credits and Milestone Payments

A services-type contract will usually set out a number of service levels that the supplier must attain. If the supplier does not meet a service level specified in the contract the customer will be entitled to claim a service level credit (also know as a service credit or service level rebate).

In a project-type contract there are other types of self-help remedies available that are not directly linked to service levels. A project-type contract will usually set out deadlines or milestones that the supplier must meet with payment amounts linked to the supplier achieving those milestones. If the supplier’s fails to meet a specified deadline this will entitle the customer to withhold a milestone payment.

Examples of Self-Help Remedies

Some practical examples of contractual self-help remedies include:

  • In a carriage services contract the supplier fails to resolve a data link outage within 1 hour so the customer can claim an agreed amount (for example 2% of the monthly charges) as a credit against a future invoice from the supplier.
  • In a project contract to build an IT system the supplier fails to achieve a key milestone to complete the design documents on time. In this case the customer will be able to withhold payment of all or a portion of the applicable key milestone payment amount.

Enforceability of Self-Help Remedies

As highlighted in one of my previous articles, if a court holds that a contractual self-help remedy is a penalty, the provision will be void and unenforceable. As such, when negotiating a self-help remedy the parties must make sure that they draft the provision carefully so that it is not deemed to be a penalty. Whether a court consider a self-help to be a penalty clause will depend upon the individual facts. However, there is some judicial guidance on the best drafting approach. For example, the clause must not be “extravagant and unconscionable in amount” or “out of all proportion”.

Records and Audit Rights

From a legal perspective, the party who may wish to avail of the contractual self-help remedies should ensure that accurate service level and service credits records are kept. Usually, a customer will include a clause in the contract that requires the supplier to record the basis on which the service levels credits are calculated and ensure that the service level credits reflect the calculations in the contract. It is not unusual for customers to also require annual audit rights so that they, or their appointed third-party auditor, can inspect whether the supplier has kept accurate records in relation to the measurement of service levels and calculation of service level credits.

Risk Assessment for Service Levels and Service Level Credits

Service levels and service level credits should ideally be tailored to meet the particular circumstances of a contract and services. However, often suppliers will offer their standard service level agreement (SLA). If the supplier agrees to provide you with a customised offering, the customer should carefully consider the possible damage that may flow from a breach of the applicable service level. A customer may wish to conduct an initial risk assessment to help inform itself of the service levels and self-help remedies that would be appropriate. In a typical risk assessment exercise the customer identifies key supplier obligations, estimates the likely risk breach of that obligation and makes as accurate as possible assessment in connection with the damage that it may suffer as a result of that breach.

Practical example – Risk Assessment of an IT System

In this example a supplier is tendering to develop an IT system for a customer. Before the customer begins contractual negotiations it should undertake a risk assessment of the stages where the project is likely to go wrong. This will help inform it of the service levels and self-help remedies (including service level credits) that are appropriate.

  • Development of the system – Often customers find that at the beginning of the project a key risk is the failure for the supplier to meet the customer’s desired timeframe, which has a knock on effect on the other milestones. These may be external factors (such as a large sporting event) or internal factors (such a deadline for completion that has been promised to the CEO or board of the company).
  • Acceptance testing – Once the system is built the supplier and/or the customer will have to run a number of tests and checks to ensure the system is operating in accordance with the agreed specifications and acceptance criteria. The key risk here may be a failure for the system to pass all acceptance tests within the required timeframe.
  • System operation – Even if the system is up and running there may be bugs or other errors that occur in the software or hardware that affect the service performance. A customer’s initial risk assessment may identify that it is crucial for the system to be available for a certain percentage of time in a month. This could even be 100% availability if the customer is a large bank or airline and, accordingly, the customer may wish to claim significant service credits if the availability falls below this.

Conclusion

Service levels and service level credits are a useful way to help ensure that the supplier delivers the agreed level of service. The parties can review service level reports at weekly or monthly governance meetings to form a view of how the supplier is performing. Ideally, service levels and service level credits should be customised to meet the particular circumstances of a contract and services. To help achieve this, a customer may wish to conduct an initial risk assessment to help inform itself of the service levels and self-help remedies (including service level credits) that would be appropriate. As part of this process, the parties should also evaluate whether a self-help remedy is the most appropriate remedy. There may be other remedies that are much appropriate such as a bank or parent company guarantee or an insurance policy.

 

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