Outsourcing agreements SLAs and penalty / liquidated damages – the price!

Outsourcing agreements SLAs and penalty / liquidated damages – the price!

Giulio Coraggio 

SLAs schedules and penalty/liquidated damages clauses are usually the core of outsourcing agreements so after having discussed about liability and termination clauses we will try to cover these provisions.

One of the first issues that arise in drafting outsourcing agreements is who has to draft the service level agreements (SLAs) and the battle is between lawyers and the IT team of the supplier and of the recipient of the service to take the lead. However, my experience is that a considerable team working activity is required and lawyers need to make an effort to speak the same language as engineers since otherwise it will be difficult to reach a result that adequately protects the parties and meets the needs of the recipient of the service. 

And indeed for SLAs it is quite rare that is possible to rely on previously drafted agreements since they have to be drafted taking into account the peculiarities of the business of the recipient of the service including for instance some statutory or market driven levels of service. The review and the understanding (or at least a high level review and understanding) by lawyers of technical documents and a very deep knowledge of the business of the recipient of the service considerably helps on the drafting of the SLAs but this rule is valid for the drafting of the entire outsourcing agreements .

Also, for this reason it is often mentioned that outsourcing agreements are very close to joint venture arrangements as both parties work together for a common result that in most of the cases means the success for both of them and such cooperative approach starts from the negotiation of the agreement and continues for its entire term.

The above is valid when the amount of liquidated damages/penalties triggered as a consequence of the breach of SLAs is determined as well. The drafting of such clauses needs to take into account that punitive damages are prohibited under the laws of several jurisdictions including Italy. Likewise, in countries like Italy if the amount of contractually agreed liquidated damages is excessive compared to the actual damages suffered as a consequence of a breach, the value of such liquidated damages might be reduced by courts despite of the wording of the clause so vanishing the efforts of long negotiations on the matter.

On the contrary, it shall be taken into account that depending on the wording of liquidated damages/penalty clauses, they might operate as a liability cap preventing to seek for additional damages in case of breach even if adequately proven in a dispute. Therefore they might represent a risk for the recipient of the service.

Finally, the above clauses might not be effective in absence of a detailed enforcement proceeding contractually agreed e.g. the setting up of an internal committee made of representatives of both parties in charge of reviewing a potential breach and identifying the party responsible for that, ensuring that any action aimed at limiting the potential damages suffered and, if necessary, enforcing the liquidated damages is often extremely important.

All in all, SLAs and penalty/liquidated damages clauses can have a number of hidden risks which can be overcome only through a strong cooperation between all the parties involved such as managers, commercial and IT persons as well as lawyers. 

What is your view on the above? Feel free to contact me, Giulio Coraggio, to discuss, also follow me on my Facebook page,Google+ or Twitter and become one of my friends on LinkedIn.

Reference:http://www.gamingtechlaw.com/