About the author

Dan is a fractional GC, a specialist commercial technology lawyer and a legal technologist. He works with organisations of all sizes from seed finance to international enterprise.

Dan’s experience is focused mainly in the software development and fintech sectors and in the automotive and advanced manufacturing industries.

The most basic remedies in cloud-based “as-a-service” agreements typically involve service level agreements (SLAs) and related service credits.

SLAs are an objective way of monitoring key elements of the service. See our separate post here on SLAs.

Where SLAs are missed, service credits can provide a financial mechanism for compensation to a customer without resorting to formal dispute resolution procedures.

Legal status of service credits

Under English law, service credits may either constitute a form of liquidated damages or may be deliberately structured as a price adjustment mechanism.

Where structured as liquidated damages, i.e. where service credits apply for a particular and clear breach of contract, service credits are potentially unenforceable if deemed to be contractual penalties, i.e. if the remedy is so far out of proportion to the breach that it is “extravagant, exorbitant or unconscionable”.

Where customers are in a powerful enough bargaining position to demand a severe service credit regime, well-advised customers (as beneficiaries of the service credits) may seek commitments from the provider that the service credit regime provides a proportionate remedy for the relevant SLA shortfall (thereby minimising the risk of a court striking down the service credit regime as penal) – providers are of course well advised to avoid such statements.

Where a service credit does not constitute a breach of any explicit commitment in the agreement, however, as may be the case by design or simply by accident, for example where the SLA regime is recorded and maintained in a non-contractual document separate from the central agreement, the service credit cannot technically fall foul of the rule on penalties (since that rule would only applies to breaches of contract).

In that case, the service credit would be deemed simply to be a price adjustment mechanism and therefore no constraints apply on the severity of the service credit and the credits are simply a matter for negotiation between the parties in the eyes of the law.

Some customers may otherwise deliberately and explicitly state in the agreement that ongoing charges payable under the agreement are to be varied in accordance the service credit regime, thereby deliberately setting the service credit regime on a price adjustment basis.

Service credits in practice

In some circumstances, cloud providers may be happier incurring small monthly service credits rather than being forced to spend larger amounts to fix the underlying issue, for example where an automated application makes regular, minor clerical errors but is expensive to replace or upgrade.

For that reason, well-advised customers will typically seek contractual provisions or reasonable endeavours clauses relating to specific service levels and provide rectification plans for failing to meet a desired service level over time.

At a certain point, SLAs become an inadequate remedy for recurrent or significant breaches or failure to meet SLAs. At that point, customers typically expect to be able to bring contractual damages claims where, for example, performance drops below a certain defined point in any measurement period or a certain value of service credits becomes payable in any given contractual year.

Well-advised providers will ensure there are additional dispute resolution mechanisms in place, enveloping the service credit regime, to ensure that efficient resolutions can be reached without the time and expense of protracted litigation.

Bonuses and incentives

One of the many criticisms of service credits is that they incentivise restricted service provision by focusing the mind of the provider on meeting specified SLAs and avoiding service credits rather than providing outstanding all-round service.

By way of alternative, or in addition to service credits, providers may suggest bonus or incentive arrangements whereby, if the provider exceeds certain SLAs, more positive financial outcomes may be available.

A stick and carrot approach is typically adopted by well-advised and experienced customers matching more severe service credits to key negative SLAs and bonus or incentive rewards to positive KPIs.

About Clearlake

Clearlake Law provides fractional general counsel services to organisations across multiple technology sectors doing business in the United Kingdom.

Please feel free to reach out directly to the author of this post, Dan Stanton, on dan.stanton@clearlake.law or 0204 570 8741.