The services sector—businesses that offer knowledge or skills to provide maintenance services or improve performance—is the largest component of the U.S. gross domestic product and is the fastest growing component of the nation’s economy. Accordingly, many corporate attorneys draft and negotiate service agreements, and many trial attorneys find themselves litigating conflicts relating to these same agreements. The following is a crash course in drafting effective service agreements.
The first step to drafting an effective service agreement is to understand the business transaction. This knowledge enables the attorney to prepare an agreement that accurately describes the scope of services to be provided and the agreed obligations and rights of the parties. Almost every aspect of a service contract can be negotiated. Some key legal terms that are usually subject to considerable negotiation include warranty, indemnity, and liability provisions.
Warranty. The purchaser typically demands some type of protection that the services provided will be free from defects. The warranty provision should define the types of defects covered by the warranty (e.g., workmanship and material) and the duration of the warranty (i.e., when the warranty commences and ends).
The contract also should specify the warranty’s conditions and limitations. The provision may describe any requirements for exercising the warranty, such as prompt notification of a claim or return of the deficient serviced product, as well as any exceptions to the warranty, such as improper use by the purchaser or normal wear and tear.
In addition, the warranty clause should delineate the applicable corrective action for failure to meet the warranty and stipulate both the remedies and cost allocations.
Finally, the service provider may include exclusive remedy and warranty provisions, excluding the application of any other remedies and warranties (e.g., implied or statutory warranties and warranties of merchantability or fitness for a particular purpose).
Indemnity. Most purchasers ask for indemnities to supplement warranty coverage. A standard indemnity obligates the service provider to hold harmless the purchaser when the seller’s action results in harm to a third party who makes a claim against the purchaser.
The service provider typically desires to limit such indemnity coverage only to harm caused to third parties and not encompass harm directly suffered by the purchaser, who can seek redress under the warranty. For example, the indemnity may be limited to personal injury or death and third-party physical property damage.
The service provider may confine its exposure by ensuring the indemnification provision triggers liability only to the extent the damages are caused directly and solely by the service provider, requiring a threshold level of legal fault and/or preserving the option for the service provider to defend (or settle) the third-party claim.
Liability. The service provider nearly always desires to limit the type and amount of damages it could be responsible for under the contract. The limitation of liability provision should include an overall cap on the service provider’s liability, as well as an express disclaimer for certain types of damages, such as consequential, indirect, incidental, and punitive damages.
The limitation of liability clause should enumerate the circumstances from which liability could arise (e.g., use or sale). It should specify any carve outs to the cap for third-party liability or claims that arise from the willful misconduct (or other legal fault level) of the service provider.
Similar to the warranty provision, the limitation of liability provision should include a restatement that the language in the contract contains the sole remedies for the purchaser and the exclusive liabilities for the service provider.
In summary, drafting an effective service agreement requires consideration of all the terms and conditions of the underlying business arrangement. Carefully drafted warranty, indemnity, and liability provisions help clarify the obligations and liabilities of the parties and minimize risks associated with disputes.