By James Forrest

We have talked extensively in this space about the need for businesses to have a solid set of contract templates in place to mitigate risks related to third parties (customers, vendors, employees, etc.).  Among the most important contracts within this set is the customer contract, a document that when properly drafted and executed, can lay a foundation for a successful relationship as well as manage future risk if a relationship sours.

For service companies, a common contractual framework is a master services agreement (MSA) coupled with a statement of work (SOW).  The MSA usually contains some of the more important legal terms, while the SOW gives the business the autonomy to write in pricing terms and the scope of the services to be performed.

Key elements of a MSA can include sections on excluded services, confidentiality, warranty, payment, limitation of liability, forum, etc.

With regard to warranty, a MSA may state that the services will be performed in accordance with industry standards or that the company will use its commercially reasonable efforts to perform the services in accordance with certain criteria or specifications.  On the other hand, a good MSA will memorialize certain exclusions.  For example, a sales training company may protect itself by limiting its warranty with regard to its client company’s post-training sales results (i.e., the client’s performance stems from a variety of factors outside of the training company’s control).

A sound MSA will also contain limitation of liability and indemnification provisions.  Properly drafted indemnification provisions can shift the allocation of substantive risk from one party to another.  A limitation of liability provision can in some instances drastically reduce the contractual liability of one party and can often lead to reduced insurance premiums if incorporated into the company’s standard contracting protocol.

Lastly, payment terms are critical.  A MSA should include language regarding the prompt payment of invoices, the accrual of interest on overdue amounts, and the ability of the service company to recoup its costs of collection in the event the company is required to retain counsel to pursue undisputed debt.   These provisions empower the service company to not in essence be a bank for its customers and will increase realization on AR (and the timing of collection).

In our next installment, we’ll discuss the key drivers of the Statement of Work.