Service Agreements: Common Contractual Errors

  • February 24, 2021
  • Anjana Bhaskaran, General Counsel, Box of Crayons, Inc.

Reviewing and negotiating service agreements is a work of art. There are important nuances to a service agreement that may not be immediately obvious. Most contractual non-compliance issues arise as a result of the parties not understanding the nature and kind of services provided thereunder. Accordingly, understanding these nuances is important if the parties to a contract wish to maintain positive relationships with each other.

Many large organizations choose vendors based on a strict selection process.  These organizations often require the vendors to accept their contractual terms “as is” as a pre-condition to entering into a contract. These terms are typically drafted based on a set of “catch-all” clauses that should apply to a majority of that company’s vendors who are assumed to all come from a particular industry. What goes unnoticed by both the large organization and the vendor is the lack of distinction between the services provided by different vendors. Terms that would normally apply for a service provider providing information technology services, for example, would be unlikely to sit well with a vendor providing physical raw materials or other similar goods. Unfortunately, this disconnect may not addressed by the negotiating parties and the large companies with greater clout can impose such terms on a smaller vendor.  This poor practice in drafting can often be to the detriment of all parties.

Companies who adopt this practice often argue through their non-legal procurement teams that sphere-head these selection processes, that the vendor should not delete or edit a specific provision and should leave it “as is” since the provision does not apply to a particular “service”. This argument is unreasonable for a few reasons. Firstly, if a particular provision is irrelevant to the services, allowing it to remain in a contract could cause interpretational issues when there is a conflict between the parties after the agreement has been executed. Recall that as a common law principle, a contract is looked at “as a whole” to determine the purpose and intent of the parties and not removing inapplicable terms may dilute the intent of the parties. The gap created by inapplicable and/or irrelevant terms being left in or not properly edited can also lead to long and unnecessary negotiations around typical operational clauses like warranties, warranty period, acceptance and delivery processes under the same agreement. When time, effort, and manpower are the most valued assets of a company, spending several hours on inapplicable terms can be detrimental to all parties and can lead to an unpleasant vendor / client experience.

With that in mind, here are some examples of common errors that are likely to be overlooked while reviewing and negotiating a service agreement and some possible solutions for the same:

  1. Description of Services – As noted above, it is critical for the drafting lawyer to understand the nature of services that are being provided under the agreement. It is a good practice to define “Services” specifically since some service could simply be a “deliverable” to which ownership does not pass; while some could be a “work product” that is created solely for the client, making the ownership transfer more explicit. Some services could be developmental services calling for upfront investment without ownership transfer. As step one, providing clarify about “what services are being provided” allows the parties to assess risk versus reward in a contract and on being in clear on who is obligated to do what for whom and who is entitled to receive what from whom.

Certain other terms on warranty, acceptance, delivery and shipping, insurance and cancellation entirely depend on the nature of services. Therefore, an appropriately drafted “Description of Services” provision can be helpful when interpretational issues arise between the parties.

  1. Legal Compliance Requirements – The negotiating parties should understand legal and regulatory compliance requirements in each others’ jurisdictions and in relation to the Services being provided in order to avoid including inapplicable requirements in the service agreement. There are generic terms and conditions that reference import / export laws, anti-bribery and kickback laws, hazardous waste management laws and their compliance requirements, which, if included, could be entirely irrelevant if the vendor is handpicked from within the same jurisdiction as the purchaser of the service. Vendor due diligence as part of the pre-contractual process plays a critical role in assessing specific legal requirements that apply to a vendor's business. These are typically included in “boilerplate terms” which can make it hard for some vendors and business owners to contract or engage in business activities with larger organizations who insist on using these standard form “as is” contracts.
  2. Force Majeure – Many lawyers came to realise that the services agreements reviewed by them in the past either did not have a force majeure clause or did not cover the term “pandemic” the moment COVID-19 was declared to be one. The main objective of a force majeure clause is to protect parties from any untoward set of circumstances that is beyond their reasonable control.  A force majeure clause can be drafted in different ways.  One of the ways of drafting a force majeure clause can result in a party being excused from performance for a defined time period or terminating the contract altogether immediately.  How the clause is drafted and what can or should be included depend on the need for the services provided and a consideration of how critical those services are to the operation of the business receiving and contracting for the services. There is also a common law principle on frustration of contract. Per this principle, in the absence of a force majeure clause in a contract, court might excuse either party from performance of its obligations under the contract where it becomes physically or legally impossible to perform them. Some ways to mitigate the risk of the other party being excused from performance are:
  3. to include a “consultation and mediation” clause that would allow both parties to sit across the table and discuss next steps in the event of a force majeure or unexpected situation.; sometimes, a consultation solves even more problems than we could have thought it would;
  4. to check for insurance requirements and ensure where possible that the service provider has good coverage for business interruption;
  5. to ensure that the Vendor has a business continuity plan in place to manage and cover certain reasonably foreseeable situations;
  6. to have a strong vendor on-boarding process that allows the service receiver an opportunity to run a set of checks and balances in selecting a vendor; and
  7. while nobody can think of all possible situations, a risk assessment can also be helpful and can minimise loss as much as possible for both parties.

Apropos to this clause, COVID-19 has created a unique situation where there is a dire need for certain services to be a part of day-to-day business activities (like helpdesk, support etc.); however, in many cases, the first employees to be let go by businesses are the front-line service workers. Addressing the right to terminate or obligation to keep a certain level of front-line service people could help to avoid a loss of essential services for the purchaser, but at the same time result in service levels having to be maintained at a level that is beyond what a vendor can manage.Careful consideration of the force majeure clause that reflects unique needs of a purchaser and the actual abilities of a vendor is important. This pandemic may have brought home the issue for both parties relying on boiler plate “as is” terms.

  1. Term and Termination – Many vendors think of long-term contracts as a positive sign that the clients would like to continue doing business with them. This may be true in theory, but, in practice, if the client sets up a master agreement and fails to sign statements of work (which authorizes the  provision of services by the vendors and enables them to get paid for such services), the vendor may not have an effective “business relationship” established. The vendor may be forced to meeting its obligations for such client, while not being paid. For this reason, it is important for parties to discuss and strategize an upfront commitment, advance payment provisions, signing of statements of work simultaneously with the master agreement and if all else fails, negotiating a shorter term or having an exit clause for the provider in the event there is no live statement of work for a defined period of time.

The above solutions may not apply to every scenario when it comes to drafting and negotiating a service agreement. The parties will have to look at each of these on a case-by-case basis to determine what works best for them.  The terms should be reviewed, understood and considered by both parties before the contract is signed, especially if an “as is” agreement is presented.

About the author

Anjana Bhaskaran is the General Counsel at Toronto-based Learning & Development company Box of Crayons, Inc.

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