Service-Level Agreement Basics

Given the broad use and relative importance of service-level agreements (SLAs) in a variety of contexts, in this blog post, we provide an overview of the basics of SLAs and what they should address. An SLA is an important part of any contract with a provider of technology-based products or services. Customers and providers use SLAs to establish performance expectations for a wide variety of services, ranging from software-as-a-service (SaaS), maintenance, hosting, support, or other cloud-based services, to delivery of tangible goods.

An SLA sets out the provider’s performance obligations with respect to the services it provides to the customer in measurable and objective terms via defined service-level requirements. 

1.  Elements of a service level

• Service scope: Definition of what services are covered by the service levels.

• Performance requirement: Definition of what performance is required for the measured activity. Think of it as the substance of what specifically must be done to have performed the service level (the “what” of the equation).

• Performance standard: Definition of the performance standard. Think of this as proportion of the time (or some other means of measurement like percentage of transactions) for which the performance requirement must be met in order for the service level to be achieved.
  
  • Often this is expressed as a percentage of the time the provider has performed the measured activity in accordance with the performance requirement.
  • The provider may designate certain exceptions or carve-outs to the performance standard (e.g., windows during which not meeting the performance standard is excused).

2.  Measurement of a service level

• Measurement period: Definition of the time period over which the service level is measured (e.g., hourly, daily, monthly).

• Means of measurement: Reporting or other means of measuring whether the above elements have been achieved. The provider is typically responsible for measuring the service levels and reporting on a regular basis (e.g., monthly) on actual performance against the service levels.
  
  • The parties should avoid subjective standards that are susceptible to conflicting interpretations, such as “reasonable efforts.”
  • The customer may want to specify how the service levels are reported and require the provider to carry out trend analysis on problems that are occurring.
  • Failure to provide a service-level report on time, or at all, may legitimately result in a service credit (see below) since the customer does not have the necessary means to assess whether the relevant service levels have been met without a service-level report.

3.  Remedies for failure to achieve service levels

Remedies for failure to achieve service levels are typically: (a) fee reductions or service credits against fees incurred, and (b) ultimately, termination for repeated failures.

a.      Fee reductions or service credits against fees incurred

Service-level requirements are keyed to a specific formula for calculating fee reductions or service credits that the provider must issue to the customer if performance falls below the required service level. The fee reductions or service credits can be weighted based on relative importance. Service credits are usually expressed as a percentage of fees for the applicable service, to be credited against future charges to the customer if the provider fails to meet a service level.

• Optional to include:
  
  • “At risk” amount: The percentage of the fees payable over a specified time period that are subject to service level credits.
    
    • Example: “The maximum percentage of Fees payable over a Contract Year that are subject to the Service Level Credits is 30% of the sum of that Contract Year’s monthly recurring fees.”
• Weighting factor: Apply a percentage value to each Service Level (total of all percentage values corresponding to the Service Levels should add up to 100%).
  
  • Example: “If Provider does not achieve any of the Service Levels, Fees payable hereunder will be reduced in an amount equal to the product of: (i) one-twelfth of the Annual At-Risk Amount, multiplied by (ii) the Weighting Factor for the Service Level that was missed.”
• Multiplier applied to weighting factor (if service level credits and “at risk” amount is applied): The percentage of the “at risk” amount that is attributable to the service level for purposes of calculating service level credits.
  
  • Example: “If there is a failure as to a single Service Level in 2 or more consecutive Measurement Periods or as to any Service Level within any 3-month period, then the Weighting Factor will be multiplied by 2.”

• Pro-provider terms that customers with greater leverage may be able to avoid:
  
  • Limitation of service credits to a stated cap (for example, the total amount of fees otherwise payable for the services during the period when the service-level failure occurs).
  • Earn-backs: The parties might agree to a mechanism for the provider to earn back some or all credits imposed due to failure to meet service levels if its average performance over the course of a specified time period (e.g., a year) meets or exceeds the required service level.

• Service credits are typically applied to (deducted from) charges in the next invoice after they are incurred, but the parties may agree to apply them on an annual basis, deducting the total amount of service credits from the first invoice of the contract year.

• To enhance the likelihood that service credits will be enforced, remedies generally should reflect a reasonable estimate of the customer’s injury for the corresponding service-level failure and constitute compensatory liquidated damages rather than a penalty for non-performance.

• Exclusive remedy: Customers want to preserve the right to pursue other remedies under the master agreement (such as damages and termination) if the provider fails to meet service levels. On the other hand, providers want the service credits to be the customer’s only remedy for service level failures.
  
  • Pro-customer example: “The Service Credits shall not be considered liquidated damages or Customer’s sole and exclusive remedy for Provider’s failure to meet Service Levels."