How to Enforce Business Boundaries and Navigate Breakups Using Contracts
Hi. I'm Max Clark. I'm gonna talk about some things I see when negotiating contracts and mistakes that people make. So the first thing to talk about is why contracts matter. Contracts matter when the relationship is ending.
Speaker 1:Well, it matters when the relationship's ending or when one side wants to enforce a boundary. And that's when the contracts come into play. When the when when you're in a honeymoon phase with a with a provider and everything's lovey dovey or the provider is trying to get more out of you and the relationship, everything is fantastic, everything's going great, there's no problems it's all just sunshine and roses. Now when you get to a point where a support where a boundary is trying to be enforced or worse where the relationship is is ending this is when the contracts come into play. Now when you are negotiating a contract there's a bunch of things that really matter and there's a bunch of things that are gonna matter to your lawyers reps and warranties limitations liability venue jurisdiction mechanics of how it gets enforced things along those lines When we look at contracts for our clients what we're looking for comes into how we manage risk for them and what I mean by that is what terms govern financial implications or service implications within that contract.
Speaker 1:So the most common things and these are the things that are on our checklist that we start with before we even look at anything else. Does the contract auto renewal? How does the contract on auto renew how do you prevent the contract from auto renewing is that defined in the agreement is it not defined in the agreement so that's important if you want to terminate that contract early if you're in term what happens? How do you terminate early? What is the penalty for terminating early?
Speaker 1:You're gonna see this defined as either an early termination liability or early termination fee ETFs and etls are there? What's the actual reality of that termination? So for instance, I've seen a lot of agreements that have a 100% ETF language built into it and I will tell you from experience in this in court judges don't like enforcing 100% ETF language So you know hint for providers out there a 100% ETF doesn't work also hint for on the client side. If you see somebody trying to enforce a 100% ETF chances are they haven't litigated that agreement yet because it's not enforceable. We look for how do you what's your rights to terminate without penalty?
Speaker 1:So commonly within within contracts for IT services, you're gonna have a service level agreement and there's going to be phrasing within the actual contract usually the master services agreement that's gonna say that the sole remedy under non performance for the provider is defined in the SLA. And then you go and you find the SLA document and the SLA documents gonna start defining all these crazy things for service credits. And it's gonna say if we have an outage for 5 minutes and 24 seconds with or latency over 60 62 milliseconds or jitter beyond this point or something else and it's it's always usually extremely technical. These things happen and usually after a threshold what happens is some sort of credit gets issued. Now this is not a penalty or payment back to you as a customer in this situation.
Speaker 1:It is a credit on a future invoice and oh by the way pay really close attention to this what is the SLA enforcement mechanism and how do you actually request an SLA credit in the 1st place? Usually it requires the provider to acknowledge the outage and it requires you to request it via a ticket within a set amount of time from the actual outage itself. So if you don't do that, you're not getting the credit anyways. Now credits are really I mean, they're good but they're but they're a really weak mechanism for you as a client within a contract with a provider because the the penalty is relatively weak for that provider especially if you're dealing with a high margin service if you're dealing with something like, a voice over IP or UCaaS platform, you're you're it's more than 90% margin. So it's not really that significant of a penalty for the provider.
Speaker 1:So we like to do is we like to make sure that we define exits and and the right for the client to terminate the contract under SLA breaches. Now, again, you're gonna tell a lot about the provider by how they negotiate this with you and what they're looking for. But really what we're looking for is we're looking for a breakup provision or a right to terminate the contract without penalties for our clients based on non performance and SLA violations. So if the provider is violating their own SLA that they write at some threshold, the client has the right to say this isn't working for us and we're gonna move on. Now there's other things that you want to have in these agreements understanding what your force majeure rights are are very important.
Speaker 1:So force majeure what have we seen? Major fires in California, a pandemic of course into 2020, supply chain issues a result of that. So there was just an earthquake in Japan. Previously, you see hard drive supplier shortages with the tsunami in Thailand. These sorts of things actually do impact and apply to you and how that language is written becomes more and more important.
Speaker 1:Now what we're looking for within these things becomes managed risk risk and measured risk. So if this relationship sours, what happens and what do you do about it? If the provider is not performing, what can you do about it? What do you do about it? How do you get away from a provider that's not performing and damaging your business and being able to replace that provider with another solution another provider that actually can meet your needs and help help you stay in business and grow so I've seen a lot of time spent in contract negotiations where lawyers are focused on arguing what word is used and what section what semicolon or comma exist where and these become important measures if you start talking about the technical implications of enforcing that contract and how that contract is supposed to read there's a pretty famous case with I believe it was a dairy farm and How they were classifying their drivers and do they qualify for overtime or not?
Speaker 1:And and this came down I mean the judgment came down to a common where the common was placed so very important Yes, the way I look at it and think about it is is you do not want to get to a point where you're fighting over where a comma is in your contract if you're litigating that contract you just want the right to say thank you very much this didn't work out and move on with your life either you want to know that this is only gonna cost you a certain amount of money and you're gonna move on with your life or you're, you know, gonna be able to execute an SLA provision and walk away with some notice and move on with your life. These things are these things are our top priorities when we're doing contract reviews with our clients. Now I'll talk a little bit about ETF language. So so again, most commonly you're going to see an agreement that's going to say that the ETF is 100% of the remaining term. Now, if you go to that provider and you say we're not going to sign a contract that has 100% ETF, that provider should do one of a couple of things 1 or 2 things really for you.
Speaker 1:The first thing that provider should do is they should offer you, a price list and a pricing service schedule for a shorter term. And this is probably the sanest way for most providers to deal with this stuff. Here's your here's a price for 36 months. We don't want to sign a 30 minute 6 month contract. Okay.
Speaker 1:No problem. Here's a price for 12 months. It still has a 100% ETF in that but this is the price for 12 months. Now you can you can use a strategy with this of of signing for 12 months and then pushing for a renewal at less rate at the end of those 12 months, which isn't guaranteed but you can get into that kind of game mainly because that provider is already established and they know that the cost of churn is higher than the cost of just giving you a better price especially if there's a competitive bid coming in you can usually leverage that and take advantage of that. Now the negative that, of course, becomes the price goes up.
Speaker 1:What was probably pretty cheap at 36 months becomes much, much more expensive at 12 months. On the other end of this, we have a lot of providers in our portfolio that have standard language of 50% ETF. So if you sign a 36 month contract and on month 6 you decide to cancel it's 50% of 30 months remaining you're writing a check for 15 months worth of service and that's a very I think reasonably appropriate ETF language for both the provider and the the provider and you as the customer. Now okay. So third one third one that's pretty common is we'll see a 100% ETF for the 1st year and then you'll see step down for additional periods within that term.
Speaker 1:So maybe it's a 100% year 1 and then 80% year 2 and then 60% year 3 and so on and so forth. And also depending on how that language is actually written pretty reasonable. So what the provider is trying to deal with is covering their costs and their outlay under their under that agreement in their contract with their providing service to you. Right? So what their risk is is really is recouping what their cost is plus whatever margin they need in order for it to make sense.
Speaker 1:So understanding what the provider's actual cost structure is becomes of very it becomes very critical for you if you wanna start negotiating these ETFs. So if you're dealing with a an aggregator or reseller, somebody that's reselling a service, what are they reselling and what are their terms with their service provider? Right? So if you're dealing with somebody who's reselling one of the one of the ILECs. Right?
Speaker 1:So what are their what's their term? What's their language with the ILEC? If they have a 50% ETF language with that ILEC and most likely if they have a same contract, they also have the right to move service within a certain period of time. So now this that your maximum ETF to that reseller should only be 50% and you should also have language in there that says if they're successfully able to relocate that service with the next period of time that your TF should probably not even be 50%. Right now you have to pay it'd be reasonable for you to pay a fee for the inconvenience that they have to go through and whatever costs they have to bear in that process.
Speaker 1:But is it really is it really costing them a 100% to terminate no of course not so knowing what those numbers are and knowing what that structure is will help you as you're negotiating your own contract language now let's see what else should we talk about here so ETFs also commonly you'll see provisions where your rates are protected inside of the term but once the contract goes month a month then the rate go to market this becomes a really interesting one some providers will go month to month and then they'll immediately double the cost once you hit month to month to try to reinforce a new contract term understanding what that looks like whether or not you can or cannot negotiate that in the first place is is good to know and as a strategy in a lot of cases we'll advise our clients as part of their, initial order when they're signing and executing the first contract to immediately submit a termination notice. So if we were not able to negotiate a month to month renewal extension of after the initial term and the provider really dug their heels in and and was forcing some sort of annual renewal terms, just some notice immediately.
Speaker 1:Give them give them termination notice. There's nothing that says termination language says that you have to provide notice before some date. By default, it's usually 90 days. Doesn't say that you can't, that it has to be within a certain range. So you sign a 36 month contract.
Speaker 1:Your termination notice has to be sent before month 3 90 days beforehand. Why not send it month 36? Hey, we're just giving this there upfront so that way we don't have this issue down the road and we will look forward to working together and making sure that we renew I mean, it's it's it's not it's not even costal to do it that way. It's great. Absolutely do that.
Speaker 1:Just remember that your contract is terminated terminating out. Now this becomes really interesting. So so paying attention to what your renewal terms are and when your contracts come up by the way, I've only seen this with 1 provider and it was the most amazingly hostile activity from a provider that we've seen where this company was was was looking at evaluating whether or not they were gonna continue to renew the service. They asked the provider to terminate their auto renewal and go month to month with them and the provider came back and said no if you terminate with us the service is over on this date and we're shutting you down and the company did not give themselves enough time to deal and look at an alternate alternate which that incumbent provider knew and they were forced into an auto renew for another year that provider maintained that customer for another year and that e customer then of course was spent that next year to make sure that they were ready to migrate off and terminate that contract and we'll never use that provider ever again for the rest of eternity. So, short term wins for for long term losses.
Speaker 1:Right? It was one of those when when the battle but lose the worst kind of things. Now there's reasonable. So then we so going back to this earlier statement I made about risk and financial risk. Right?
Speaker 1:If you are negotiating a contract that has a monthly service cost of $500 and it's a 36 month contract and so you're dealing with a $6,000 a year expense with us $18,000 total liability under that contract. Do not spend $25,000 negotiating terms in that contract. Right? Like there, if I had a dollar for every time I've seen this, I would it is just there's a certain point where what you're negotiating just isn't worth it anymore. Now if you're if you're negotiating a master services agreement and you intend to grow that service from $5,000 to $50,000 or $500,000 then it makes sense to negotiate that and by the way you can always negotiate that later but I've seen a lot of contracting cycles get completely derailed because council gets involved and wants to just go absolutely crazy with their red with a red pen on an agreement.
Speaker 1:And and you get this contract back and and you look at it and you're like, this thing is this contract is worth $10,000 right? Like there's there's like you're gonna really argue every paragraph of a 6 page MSA because that's just what you feel like are you bored and usually in those cases the providers will just say no and again a lot of providers will not negotiate contracts under certain dollar values because it's not worth it to them especially if they have reasonable mutual language in their agreement and they know it and this is when you get again you go back to what is really important to you and what do you care about in that agreement to protect yourself and and what does that really look like almost every provider is going to have the same limitations of liability right their liability is limited to the total dollar amount that you've paid them in some period of time are you gonna be able to change that probably not by the way providers cannot contract you can't protect yourself against negligence and intentional acts in a contract right so like seeing people waste a lot of time trying to change language related to that.
Speaker 1:It doesn't matter. You walk into court because of of of intention of negligence or an intentional act by an employee, the provider and all bets are off. My other favorite one I see all the time is related to bankruptcies. Of course, you get all this language inserted about in the case of bankruptcy this contract is null and void and blah blah blah this and that the next thing and and guess what? The minute of the bankruptcy happens a t r o goes into place and everything is controlled by a federal judge and I what?
Speaker 1:You are not you are you are not going to that judge and saying, your honor, my contract says that the contract is null and void because of bankruptcy and that judge is gonna look at you and just just be like, no it's not. I'm in control here. Deal with it basically. So don't don't waste a lot of time trying to negotiate bankruptcy provisions in these agreements because they don't it doesn't matter. If you haven't been through a bankruptcy with a service provider or or if you haven't if you're a service provider and you haven't been through a bankruptcy with a with one of your customers as an unsecured creditor in that line.
Speaker 1:It's an eye opening experience because what you think matters actually doesn't matter anymore. Anyways, I'm Max Clark. Hope this helps you. If you have any questions let me know in the comments below and I will answer them as best as I can. Have a great
