Service contracts are often split into two parts for faster and more flexible deals. First, there is a “Master Service Agreement” (MSA). This is the longer document that contains the legal terms. Then there is a shorter “Work Order” or “Statement of Work” (SOW) that sets out the business terms of a particular project. Once the detailed terms of the MSA are in place, the business and technical people can re-use the MSA for each future SOW without bringing the lawyers back in.
This post explains some of the critical deal terms and offers some tips for negotiating a master service agreement from both the buyer’s side and the service provider’s side. It also discusses several common issues to help you think through the process and avoid possible pitfalls.
Our team focuses on deals for technology and consumer products clients, so that is where this post will be most useful. The goal here is to educate you on the basic deal terms and will help you work with your lawyer more efficiently.
Master Service Agreement
A good master service agreement is broken up into numbered headings that make it easy to follow and negotiate. The major headings usually include the payment terms, intellectual property ownership, allocation of risk (including reps and warranties, indemnification, limitation of liability, and disclaimer of warranty), confidential information, non-solicitation, and then general contract boilerplate.
The payment amount is usually included in the SOW, while the payment mechanics tend to live in the MSA.
Payment Deadline. The MSA will set out the customer’s payment deadline. Standard terms are usually 30 days after they receive the invoice. Customers (usually big companies) may try to delay this payment deadline to manage their cash flow. 60 or 90 days is not unheard of.
Late Payments. The MSA may set out consequences for late payment. Will late payments accrue interest? Be sure the interest doesn’t violate applicable “usury” laws (rules against unreasonably high interest).
Collection Fees. If the service provider needs to hire a lawyer to collect late payments, is the customer also responsible for paying for the collection costs and legal fees? Collection costs can be expensive. If they are not included, the service provider may not bother trying to collect smaller invoices, and customers may have less incentive to pay on time.
Stopping or Pausing Work. Service providers may ask for a clause stating that if payments are late, the service provider can suspend work. Without such a clause, the service provider’s right to suspend work for non-payment is not automatic. See, e.g., Restatement of Contracts §237.
Conditioning Payment. Customers may want to condition payments upon receipt of deliverables in a condition that meets certain specifications.
- Customers may ask to condition payment upon receipt of deliverables “in a form satisfactory to customer.” This language gives the customer a lot of leeway.
- Service providers may prefer that payment be due when the deliverables conform to certain objective specifications rather than the customer’s subjective opinion.
Intellectual Property Ownership
IP is critical. Take some time to define what IP will stay with the service provider and what IP will be assigned to the customer.
Custom Work. When the deliverables are custom work, then the customer will often want to own any related intellectual property (patents, copyrights, trade secrets, trademarks, etc.). However, the service provider must be careful not to assign away any intellectual property rights it may need to do work for other clients.
Pre-Existing Work. If the deliverables include any pre-existing work, then the service provider will generally want to maintain IP ownership of that pre-existing work. Likewise, where the deliverables are not custom work or include proprietary tools or software, the service provider will want to own the related IP so that it can be re-used for future customers.
License. For IP that will stay with the service provider, the customer should receive a non-exclusive, royalty-free license. This will allow the customer to use the IP, but not own it. The license may also specify that the customer can only use the IP for its original intended purpose; that it can’t be re-used or transformed for other purposes.
When negotiating the IP ownership terms, a service provider can argue that the scope of the IP assignment affects the deal price:
“We were able to offer an affordable price because we are building our background knowledge and existing tools, and therefore we need to maintain access to this knowledge and IP. If you want to be the sole owner, I have to go back to my sales guys and review the pricing on this deal.”
Service providers may want to make the IP assignment contingent upon the customer’s full payment. If the customer doesn’t pay, then the service provider would retain ownership of the IP rights. This will set up the service provider to bring an IP infringement claim as well as a breach of contract claim against a delinquent customer.
“Hereby Assigns”. Contracts assigning IP should use the phrase “hereby assigns” rather than just “assigns”. The reason is not intuitively obvious. “Hereby assigns” creates a present assignment of IP rights. “Assigns” may be interpreted as a mere “agreement to assign” IP rights at some point in the future. Stanford v. Roche, 2011.
Assignments and Recording Assignments
Formal IP applications and registrations (like patent applications) require formal government filings at the USPTO to properly assign ownership. These filings are quick, and usually just involves an hour or two of legal time and a few hundred dollars in filing fees. That said, it is still helpful to:
- confirm that the inventor or author of the IP will cooperate with the assignment and sign the necessary paperwork,
- identify who will pay the legal and filing fees.
Confirm All Employees and Subcontractors Have Assigned IP
Before the service provider can assign IP to the customer, the service provider must actually own the IP. Customers may want to see a representation that all of the service provider’s employees and contractors have signed appropriate documents to confirm that the service provider actually owns the IP they are purporting to assign to the customer. If the service provider doesn’t own the IP, they can’t assign the IP.
Allocation of Risk
Representations and Warranties
A party may represent to the other party that a certain fact is true or will be true. This representation is usually connected to an “indemnification” provision. If the representation is not true, then the party making the rep will need to pay up.
The most important rep in a technology or consumer goods contract is generally the IP rep. The service provider will be asked to represent that the deliverables will not infringe any intellectual property of any third party. Since it is difficult to know about every possible IP infringement claim in advance, this is a dangerous rep to make.
A service provider may want to limit this IP rep with a “knowledge qualifier”. Instead of representing that there is no IP infringement at all, the rep would just say there is no IP infringement that the service provider actually knows about.
A customer may agree to the “knowledge qualifier” but further require “reasonable inquiry”. That is, the service provider represents that it is not aware of any IP infringement after a reasonable inquiry into the facts. The service provider can’t just bury his head in the sand, he needs to do some research before making the rep.
If the customer insists that this IP rep is not limited by an knowledge qualifier, then the service provider may want to commission an IP clearance search from a reputable IP attorney. This may cost tens of thousands of dollars, depending on the complexity of the technology involved.
Indemnification addresses the issue of “what happens when you’re sued for for a problem that’s really someone else’s fault?” Let’s say you hire a consultant to build an app, you sell the app, and then Google sues you claiming that the app infringes their patents. Even through you didn’t build the app yourself, you’re on the hook for the infringement claim. An indemnification clause doesn’t stop Google from suing you, it just says that the consultant will need to step up to pay your losses in the suit and possible pay for the legal defense as well.
Customers frequently ask for broad IP indemnification provisions. Their theory is that the service provider knows the technology better, and is in a better position to identify (and avoid) patent infringement and related risks.
Service Providers generally ask for exceptions to the indemnification provisions. For example, if the customer misuses the technology, then the service provider does not need to pay to indemnify.
The indemnifying party (who will end up paying any settlement) may want to control the defense. They may have more skin in the game, and therefore way want to pick out the defense counsel and control the defense strategy. However, the protected party may negotiate for a clause that says the defense team and defense strategy may be subject to the protected party’s reasonable approval.
The indemnifying party may also want the MSA to state that the protected party will cooperate in the litigation process.
Will the indemnitee be allowed to step in and be involved in the defense at it’s own costs? Something to consider.
In general, the indemnification clause should be about third party claims, not all claims. If the indemnification clause will cover direct claims as well as third party claims, then the language must be clearly stated. Hooper Assocs. v. AGS Computers, 74 NY.2d 487 (NY 1989)).
Will the indemnification provision be mutual? Will the customer ever need to indemnify the service provider? This is not very likely, but it is possible. If it’s a concern, then the service provider can ask for a mutual indemnification clause.
Remember that mutual does not necessarily mean fair. If the parties are not doing the same things, then they don’t necessarily need equivalent terms.
What will the indemnification cover? Is it just protection for a breach of the reps and warranties? Or for breach of any term? Or just protection for damages caused by negligence? Or protection for any “acts or omissions”?
Limitation of Liability
By default, a party breaching a contract may be liable for direct and indirect (e.g., consequential, punitive, etc.) damages. These damages can be quite high, even when the value of the contract itself is small. This is why parties generally want to set out an upper limit to their liability.
A limitation of liability clause may eliminate damages for a specific type of claim. For example, it may exclude indirect damages (no punitive damages, no lost profits, etc.) while allowing claims for direct damages.
A limitation of liability may also cap damages to a certain dollar amount, or to a certain multiple of the contract value.
Statute of Limitations. The limitation of liability may put a deadline on filing any claims. The statute of limitations for a breach of contract is generally 4 to 6 years (it’s 6 years in Washington State, 6 in New York, 4 in California, and 4 in Texas). Parties to a contract can agree to shorten that period.
Disclaimer of Warranty
The laws of most states provide for various implied warranties. For example, Washington State law provides for an implied warranty that goods sold shall be merchantable and fit for their ordinary purposes. RCW 62A.2-314. Rather than rely on these statutory warranties that can be unclear, a MSA may set out its own warranty, and then disclaim all other warranties. This way, the parties know exactly what warranties apply to their deal, without having to research any outside statutes.
When negotiating a MSA, the customer may push back on a broad disclaimer. Try asking “if there are specific warranties that you think are missing, then let us know and we can add them back in.” This can help get to the heart of the real issue, without the need for overbroad warranties.
If the language disclaims “express, implied, or statutory warranties”, then the service provider should press to remove “express” from the list. The disclaimer should not be able to disclaim what is expressly guaranteed under the contract.
Disclaimers need to be clear and conspicuous. They ban be set in ALL CAPS or bold or otherwise highlighted. They can’t be in a small font or a footnote or otherwise hidden away.
Customers may insist that a service provider carry a standard amount of insurance. If there are indemnity obligations (protection from third party claims), then the customer may want an insurance policy to confirm that the service provider can actually pay, especially when the service provider is a small company.
The Master Service Agreement should set out a procedure for the customer to review and accept the deliverables. Service providers should insist on a reasonable time-frame for review and feedback. E.g., the customer must review the deliverables and reject them within 14 days, or else they are “deemed” accepted. If the customer rejects the deliverables, they must identify the deficiencies with reasonable specificity (to allow the service provider to fix things).
Setting out objective metrics for deliverables is helpful, whenever that is possible.
Deadlines and Delivery
If deadlines for deliverables are critical, the Master Service Agreement or Statement of Work should say so.
In addition to stating who will own the IP, there are a number of other IP considerations.
Unilateral or Mutual. Will either party be providing access to confidential information? Where both parties are providing confidential info, then the confidentiality clause should be mutual. If just one party is providing confidential info, then a “unilateral” confidentiality provision may be appropriate. If the customer does not anticipate receiving any confidential information from the service provider, then they may refuse to agree to a mutual confidentiality clause.
Degree of Care. Confidentiality provisions should define the appropriate degree of care to be used in keeping the info secret. For example:
Recipient shall protect and safeguard the confidentiality of all such Confidential Information with at least the same degree of care as the Recipient would use to protect its own Confidential Information, but in no event with less than a commercially reasonable degree of care
Recipient shall use its best efforts to protect and safeguard the confidentiality of all such Confidential Information.
Carveouts. Confidentiality provisions should include standard carveouts.
The term “Confidential Information” shall not include information that: (a) is or becomes generally available to and known by the public other than as a result of any breach of this Agreement; (b) is or becomes, available to the Recipient on a non-confidential basis from a third-party; (c) was known by or in the possession of the Recipient, as established by documentary evidence, prior to being disclosed by the Disclosing Party pursuant to this Agreement; or (d) was or is independently developed by the Recipient, as established by documentary evidence, without reference to or use of any of the Confidential Information.
Removal from Premises. Many older contract templates will require that confidential information not be removed from the premises. If you anticipate storing confidential information in the cloud, be sure to strike or amend this clause.
Non-Solicit of Employees
A non-solicit provision limits the customer’s ability to hire away employees from the service provider. Large clients may try to hire away the service provider’s key employees to “cut out the middle man.” To prevent this, service providers should consider including appropriate non-solicit language.
The language should prohibit solicitation of an employee during the term of the agreement and for a reasonable time period afterwards. Twelve months after termination is common.
The language should prohibit soliciting employees, and also provide for some appropriate payment if an employee does jump ship. For example, payment of 1 year’s salary:
If either party breaches the non-solicit agreement in this section, the breaching party shall, on demand, pay to the non-breaching party a sum equal to one year of the relevant employee’s salary [plus the recruitment costs incurred by the non-breaching party to replace such employee].
Check whether the claims is a “non-solicit” or a “non-hire”. A non-solicit just prevents actively soliciting employees, but would allow an employee to respond to a public job post. A “non-hire” would prevent any hiring of the service provider’s employees.
The customer should know and understand what open source technologies are being incorporated into the work.
Customers may want to prohibit GPL type open source products. GPL products are not only open source, but also require that any tech built on top of them be open source. If customers want to build proprietary technology, they should require a representation from the service provider that no GPL or similarly licensed tech is included in any deliverables.
Service providers like to advertise their big name customers. Customers however, may see their vendors as a strategic advantage, and may want to keep the relationship secret.
Will the service provider be allowed to use subcontractors? Subcontractors are generally allowed and non-controversial, unless the customer is providing access to extremely sensitive confidential information. If extremely sensitive information is being shared, it may be appropriate to prohibit subcontractors, and limit the work to the service provider’s trusted employees.
The MSA will often state that the parties are independent contractors. Note that this independent contractor language by itself does not make someone an independent contractor. The IRS and state labor agencies will look to the actual relationship to figure out whether someone is an independent contractor or employee. This issue is often called “employee misclassification”.
Customers will often want the work performed by the service provider they hired, and not allow the contract to be assigned to a new provider. Service providers may ask for an exception to this, which would allow them to assign the contract if their entire company is purchased by a third party (e.g., in an M&A deal).
Customer might argue that they are buying a very personal service: “I’m hiring you specifically for your expertise, and don’t trust anyone else to step in to your place.” This about whether the master service agreement should prohibit assignment.
The Master Service Agreement should set some guidelines for setting disputes.
Location. A master service agreement will generally identify the city or state where any disputes will be settled, and whether the disputes will be settled in arbitration or in court.
Escalation of dispute resolution An MSA may require a specific dispute escalation process. For example, the project managers may need to first talk it out for 30 days, then the CEO’s need to talk it out for 30 days, and then the dispute can go to the legal department and to court.
There is often an exception for injunctions, which are time sensitive. The MSA may state that if an injunction is needed, then the dispute go straight to court.
Mediation. An MSA may require mediation. Mediation is a non-binding dispute resolution process. Some people prefer optional mediation to mandatory mediation. Mediation adds time and expense, and the dispute may end up in court afterwards anyway.
Arbitration. An MSA may require arbitration. Arbitration is a binding legal process, but disputes are decided by a private party, not a judge. It’s generally quicker, and sometimes cheaper. Arbitration is also confidential, where courts are generally public.
Jury Waiver. If the MSA states that disputes will not go to a jury, then this jury waiver must be conspicuous. Set it in bold or all caps. Smaller companies tend to do better in front of a jury. They are the more sympathetic party.
Attorneys Fees. The MSA may state that the losing party to a dispute must pay the attorneys fees for the prevailing party. This may help deter meritless lawsuits, and also allows smaller players to bring legitimate claims.
Force Majeure / Act of God
The parties may agree that no remedies are appropriate if there is a breach of the contract caused by something totally outside of the parties’ control. The service provider may want to carve out the customer’s payment obligations from the Force Majeure provision.
If the deal isn’t working out, you should have an exit strategy.
The termination section of a master service agreement should set out the amount of notice needed for termination. It is generally split up into termination for cause, and termination without cause.
Termination Without Cause. Many contracts allow for termination without cause, upon advance written notice. This can range from immediate notice to several weeks notice required to terminate.
How does the termination for convenience affect the deal? If I’m committing to a huge project, I may be hiring new people or setting aside a big part of my team for this deal. How does termination on 10 days notice affect that? Do I need to turn away other potential projects to get this deal done? What about the service provider? How difficult will it be for them to find a replacement service provider?
Termination For Cause. This subsection generally allows for termination on shorter notice, if there is a breach of the agreement. Usually there will be a “Cure” period, where the breaching party has 15 days or so to fix it. Should it be limited to a “material” breach, or allow termination for any breach?
If there is a termination, does the service provider need to complete the SOW or next milestone, or package up the project in a condition to be easily handed off to a new service provider?
Is there a termination fee? payment for work being done, and additional payment for early termination.
The more difficult it is to terminate the MSA, the more detail you need in the SOW. However, more detail in the contract requires more lawyer time. Sometimes it’s better to have a more ambiguous contract and an easy termination clause.
The “Work Order” or “Statement of Work”
After the master service agreement sets out the general terms, a Statement of Work or (Work Order) will spell out the business terms for a particular project.
Service providers being paid a fixed project fee should define the scope of services in detail. It should be very clear to both parties when a change request goes out of scope, and the fixed fee should be adjusted.
The SOW Designate project managers on each side, so everyone knows who the decision makers are.
Interplay between Work Order and Statement of Work
If there is a conflict between the terms in the Work Order and the Statement of Work, which term controls? The general rule of contract interpretation is that the more specific terms of the work order would control.
However, this is not always the desired result, as companies tend to involve lawyers in drafting the MSA, but not the SOW. Therefore, it may be helpful to include a clause in the MSA stating that the MSA controls any conflict, unless the SOW specifically states that it is overriding a term in the MSA.
Define the services
What are the specific deliverables? What are the deadlines? Will any third parties be working on the deliverables? Will the deliverables incorporate any third party software? What are the project milestones and intermediate deliverables? Define the specifications for success. What are the key performance indicators?
Time and Materials vs. Fixed Price
Will the customer be paying by the hour, or paying a flat fee for the deliverables?
General payment terms may be set out in the Master Service Agreement, while project-specific payment terms are set out in the Statement of Work.
This section of the work order will set out the price and when it is paid. For example, is there an initial deposit? Will invoices go out monthly or at milestones?
This section of the Statement of Work should also cover project expenses. It should define who pays for the expenses, whether the service provider will charge a markup, and whether the service provider needs advance permission to incur expenses over a certain amount.
There are many payment options to consider. Revenue Share? Any payment in advances? Implementation fees? Payment of Expenses?
If you need help negotiating a master service agreement, feel free to reach out.
What every Product Manager Ought to Know about Contract Negotiations. Daniel Elizalde, 2015. A good summary of the Master Service Agreement and Statement of Work from a product manager’s perspective.
Top ten tips in negotiating service agreements. Ted Maduri, 2013.