Negotiating any part of a service level agreement (SLA) can be tricky, but perhaps none is more so than penalties. It is at this point, where rosy promises of performance are linked to stark dollar amounts, that hackles rise.
“It’s always very touchy,” says Susan Meyer, a senior attorney in the Technology Transaction group of law firm Latham & Watkins. “Providers hate to have penalties incorporated into SLAs.”
Some companies simply avoid the issue: A 2001 survey of external providers and IT organizations found that 32% of SLAs did not establish penalties. One reason for this is naïvete, says Richard Sturm, president of Enterprise Management Associates, which ran the survey. “Customers often accept whatever the vendor offers,” he says.
Meyer concurs: “My clients are continually surprised at the extent to which standard agreements can be negotiated.” She says that although vendors prefer to avoid penalty clauses, such provisions can promote healthy relationships by allowing recourse in a controlled manner.
Meyer recommends a stepped structure for penalties, in which missed targets incur fines, and a certain number of misses within, say, a month, gives the customer the right to terminate. Vendors especially dislike escape clauses, but it may be one of the most important parts of an SLA, she says, recalling what happened after Web host Exodus filed for bankruptcy last September.
“People were caught with nonnegotiable contracts, no penalties and no service,” says Meyer. Such situations have become more common, unfortunately. “We’ve seen extraordinary events where one or two companies are the only ones left in their field,” she says, leaving customers with few alternatives.
But the troubled economy can have positive ramifications for customers. With fewer deals to close, vendors are more open to negotiating SLAs, including penalty clauses. And according to John Bonello, a partner at Washington, D.C., law firm Eidson & Bonello, some types of vendors—application service providers (ASPs) in particular—are beginning to see penalty clauses as a benefit rather than a concession.
“ASPs on a stable footing see SLAs as a marketing tool,” he says. “Some are even including a penalty section [in their standard agreements] to show how confident they are in their services.”
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