Structural Failure: IT Services Agreements and Litigation Risk

Issue May/June 2022 June 2022 By Christopher J. Cunio, Nicholas D. Stellakis and Florian Uffer
Complex Commercial Litigation Section Review
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From left: Christopher J. Cunio, Nicholas D. Stellakis and Florian Uffer

It is a business’s worst nightmare. After the business transaction is negotiated, formalized and executed, after the celebrations are over and work begins, the parties’ relationship hits the wall. The business matter is now in the hands of the litigators, who immediately spot why the dispute arose — terms that were overlooked in the formalization of the deal. In this article, the authors, consisting of two litigators and a transactional attorney, consider lessons learned from real-life disputes involving complex information-technology services agreements. 

A thorough and well-drafted agreement is the best tool to prevent and resolve the inevitable disputes that occur in business relationships. It sets forth the essential rules for the parties and often provides the matrix for resolving disputes. But sometimes important provisions are neglected, either because the parties (i) did not foresee the particular problem that arose, (ii) provided incomplete rules to govern such a problem, or (iii) included everything essential to govern the dispute but did so in a disjointed way.

In this article, we discuss complex commercial services agreements and the peculiar pitfalls they present. These pitfalls stem from their structure and the complex subject matter they envision, a subject matter that, as a result of the exponential evolution of technology, becomes more and more intricate as new and untested technology components are incorporated. At their highest level, these agreements often involve some form of a master agreement that sets forth the general legal terms governing the parties’ relationship. This is the legal backbone for the deal. Below the master agreement are “statements of work,” which are the main technical component of these agreements. SOWs typically include deal-specific terms and detail the deliverables to be provided, the scope of work, the vendor’s performance standards, payment and deliverables schedules, and the parties’ project-specific responsibilities. Critically, SOWs either incorporate the master agreement by reference or are themselves incorporated into the master agreement. Often, parties also enter into service-level agreements, which lay out the metrics by which the vendor’s performance is measured and provide for remedies or penalties should service levels not be achieved. While there are other technical building blocks to commercial services agreements, their introduction is not necessary for the purposes of this article.

SOWs, SLAs and other technical documents are the embodiment of the contemplated business deal, as they govern the services’ implementation and the parties’ day-to-day obligations. They are therefore heavily negotiated, and rightly so. But what often gets second-class treatment is what holds it all together: the master agreement. When a dispute arises, the terms of the master agreement can be critical. The parties can be burned not only when they fail to understand those terms and how they relate to the technical documents, but also when the master agreement omits important terms. This article describes some examples, drawn from the authors’ experience, where a party overlooked the master agreement to its detriment and where the master agreement omitted terms important in litigation.1

The ultimate lesson here is not just one for the parties. It is for deal counsel as well. Bringing in a litigator as an adjunct to the agreement-drafting process can in many situations help the parties understand the rules that will govern a dispute that might arise and help deal counsel foresee what additional provisions are advisable to minimize pain in the event of a dispute.

Acceptance and payment terms

The setting is a dispute arising from a contract to deliver computer and associated management services over multiple years. The subject matter is complex, requiring implementation of new technology and transition from an existing vendor. A dispute arises when the implementation of the promised services is repeatedly delayed, leading the customer to dispute invoices and withhold payment, in turn leading the vendor to declare a breach and demand millions in damages. But the master agreement provides that, as a condition precedent to the vendor’s right to send invoices, the vendor is obligated to notify the customer that a particular service had been implemented, which would trigger a period for the customer to test the service and either accept it or reject it. Because the vendor never sent any such notices, and because the sending of the notices was a condition precedent to invoicing, the vendor took nothing but the full brunt of failing to give the master agreement the attention it required.

The remedy of cure

Many factors outside the vendor’s control can affect its performance. Vendor form agreements therefore often include a right-to-cure provision, allowing the vendor to avoid being in breach by repairing or replacing any non-conforming deliverables. Vendors sometimes want this to be the customer’s sole and exclusive remedy for such non-conformance.

In our example, the customer resists such a remedy limitation — as it should, because the vendor’s deliverables are often critical to the customer’s business, and the customer will sustain losses while waiting for a vendor to fix a critical deliverable. The parties’ relative leverage determines how receptive the vendor is to the customer’s revision. The exclusive-remedy language in the master agreement is tweaked in the customer’s favor, such as by shortening the cure period or requiring the vendor to furnish substitute deliverables until it provides a permanent fix. The vendor may think that it has retained the safety of the exclusivity of the repair-or-replace remedy, but this may not be correct. The vendor may overlook the burdens that these customer-friendly revisions impose on it, burdens that may impede the vendor’s willingness or even ability to cure when the vendor is out of compliance (as it almost always is at some time in these complex transactions). The exclusivity of the remedy may thus fail of its essential purpose, M.G.L. c. 106, § 2-719, exposing the vendor to potentially unlimited monetary damages. 

Of course, this scenario can unfold differently. The customer, relegating the terms of the master agreement to an afterthought, can agree to a broad, exclusive right to cure and then be stuck waiting for the vendor to repair or replace its deliverable.

In either case, the vendor or customer might have avoided its plight had it consulted a litigator at the deal-making stage.

Venue; choice of law; service of process

Venue and choice of law are issues familiar to any litigator. It is surprising, then, that these provisions receive so little attention in commercial services agreements. Counsel misses a significant opportunity for their clients if they fail to address venue and choice of law. It is not just that these provisions can be used to the clients’ advantage; the absence of these provisions can lead to much time and expense wasted on litigating what could have easily been spelled out. 

Litigators are likely less familiar with the need for a provision governing service of process. Commercial services agreements frequently involve foreign entities. Anyone who has had to serve process using the Hague Convention or the laws of the foreign party’s country of residence will appreciate how time-consuming and costly these are. The specifics depend on the amount of paperwork required, but service of process through the Hague Convention can easily take longer than three months and usually costs a party more than $5,000, which includes fees for service by a foreign authority and fees for translating every document included with the summons. A well-drafted provision stipulating to jurisdiction and service of process per Federal Rule of Civil Procedure 4(d), however, permits the serving party to sidestep this burdensome process. Indeed, the U.S. Supreme Court clearly stated that “parties to a contract may agree in advance to submit to the jurisdiction of a given court, to permit notice to be served by the opposing party, or even to waive notice altogether2 (emphasis added). Especially in cross-border transactions, the master agreement should contain such a critical provision.

A Building Is Only As Tall As Its Foundation Is Strong

In conclusion, the complex nature of commercial services agreements requires parties and their counsel to concentrate their efforts on the drafting of the transactions’ technical and business components (SOWs and SLAs). But parties cannot lose sight of what might happen if the deal goes awry and therefore must ensure that the general legal terms governing their relationship provide a strong foundation for future success. Indeed, no matter how well-engineered a transaction is from a business and technical perspective, its potential for both parties remains correlated to the strength of its foundation. 

Christopher J. Cunio is a partner in Hunton Andrews Kurth’s commercial litigation group who has handled a number of disputes involving information-technology services contracts.

Nicholas D. Stellakis is counsel in Hunton’s issues and appeals practice group.

Florian Uffer is an associate in Hunton’s global technology and outsourcing practice group, assisting clients with outsourcing and technology transactions, and other commercial contracting matters.

1. While the authors draw on their experience, the specific fact patterns described herein are composites. In addition, certain details have been omitted, obscured or changed to protect the parties. No fact pattern should be understood to describe any particular case.

2. Nat’l Equipment Rental, Ltd. v. Szukhent, 375 U.S. 311, 316 (1964).