Service Credits in the Cloud

Service providers need incentives to continue providing top-notch service.
That is what most customers believe. Whether a customer engages a vendor for cloud computing, software offered as a service (“SaaS”), outsourcing, or simply the maintenance aspect of a traditional software licensing agreement, if an element of the deal is for the vendor to provide ongoing services, the customer will always seek a financial lever to provide the vendor with an incentive to perform.

Consider the following example of a services-based agreement governing multiple service features with a five-year term.

The agreement subjects Vendor Co. to a number of individual performance service levels. The agreement provides for service level credits, as well as termination rights for material breach, abandonment of the agreement and “chronic service failure” (i.e., failure to meet service levels a certain number of times over a long period of time, say six months to one year). Over the first three years of the term of the agreement, Vendor Co. misses a few service levels each year and pays a few service level credits, but performance is generally acceptable. Vendor Co.'s performance then drops significantly, triggering Customer Co.'s right to terminate for chronic service failure. Although Customer Co. elects to terminate, it also determines it has a strong factual case for damages due to Vendor Co.'s performance failures. Vendor Co., seeking to avoid a public litigation, argues that Customer Co.'s damages claim is barred because Customer Co. accepted service level credits as liquidated damages. Customer Co.'s general counsel frantically reviews the agreement, tries to recall first year contracts law, and calls external counsel. Is Customer Co.'s damages claim lost because it accepted a few service level credits in the first three years of the contract?

Service levels and service level credits are routinely the source of heated negotiation in various types of commercial agreements with technology and services vendors, including rigorous debate about the very purpose of such credits. From the customer's perspective, although a decrease in payment liability likely does not fully compensate the customer for the particular harm suffered due to a vendor's service level failure, the credits create an incentive for the vendor to perform at the agreed-upon levels. That incentive is the customer's primary objective for service credits. Vendors may also have a stake in the service credit model, preferring a set of fixed and achievable performance expectations and consequences instead of an amorphous and subjective standard for service performance.

While service level credits are commonplace in service-based agreements, a customer's ability to recover actual damages in the event of a chronic service failure in addition to service credits is somewhat unclear. The question is far from esoteric: It is easy to imagine a vendor relationship similar to the example above, where Customer Co. accepts a handful of service credits before Vendor Co.'s performance deteriorates to the point of permitting Customer Co. to terminate the agreement for Vendor Co.'s material breach. At that point, Customer Co. attempts to recover the costs it has incurred as a result of such material breach. Vendor Co. resists the collection attempt, arguing that service credits are liquidated damages and, accordingly, preclude any additional relief. Courts have not addressed this question ' a fact that is likely due to the nature of services agreements, in which vendors prefer a negotiated settlement of differences, as opposed to what could become litigation with consequent negative publicity.

Liquidated Damages or Penalties?

How courts might determine the availability of actual damages in addition to service credits likely depends on whether courts find service credits to be liquidated damages. There are at least three possible outcomes at litigation: 1) a finding that service credits are liquidated damages; 2) a finding that service credits are not liquidated damages; or 3) a finding that service credits are a penalty, an invalid contractual term that the courts reject. See, 3 Farnsworth on Contracts '12.18 (3d Ed. 2004).

If a court finds a service level credit clause to be a valid liquidated damages clause, the court might find that a customer's recovery is limited to that liquidated sum. See, Commercial Damages: Remedies in Business Litigation, 9A.02 (Matthew Bender & Co., Inc. 2007). Such an outcome would, obviously, be disastrous for all the Customer Co.'s out there. If, instead, a court finds a service level credit clause to be a penalty, a customer could still recover its actual loss, but the service credit clause will be deemed an unenforceable penalty clause and the customer may have to refund the creditor for any credits paid or deduct any credits paid from any damages award. (The fate of credits paid under a clause that a court finds ultimately to be a penalty is unclear, as most case law regarding liquidated damages involves challenges to such provisions before any amounts have been paid thereunder. However, it is likely that if a clause is found by a court to be an invalid penalty, any payments already made under such invalidated provision would have to be returned.) If courts invalidate service level credit clauses as penalties, the resulting case law would have a potentially tumultuous effect on customers' ability to provide proper incentives for service provider performance in the thousands and thousands of agreements containing service level credit provisions. The best outcome for customers is a service level credit clause that allows customers to accept service credits for vendors' failures to meet certain service levels, while also retaining the right to recover actual damages in the event of breaches that rise to a level of material breach of the contract.

Enforcing Liquidated Damages

A liquidated damages clause provides for a specific sum expressly stipulated by the parties as the amount of damages to be recovered for a party's breach of the agreement. See, Massachusetts Indemnity & Life Co. v. Dresser, 269 Md. 364, 368 (1973) (citing Black's Law Dictionary (Rev. Fourth Ed. 1968)). When considering whether a stipulated amount is enforceable, courts consider: 1) the intent of the parties; 2) whether, at the time of contract, damages caused by a future breach are likely to be uncertain or difficult to quantify; and 3) whether the agreed amount is a reasonable forecast of the probable damages. See, 11-58 Corbin on Contracts, '58.5. Generally, where a contract includes a valid liquidated damages clause, “the measure of damages for a breach will be the sum in the clause, no more, no less.” JMD Holding Corp. v. Cong. Fin. Corp., 828 N.E.2d 604, 609 (N.Y. Ct. App. 2005).

Intent

With respect to the first factor ' the parties' intent ' the parties are likely not of one mind as to their intent regarding service level credits. As stated above, customers generally intend for the service credits to create an incentive for the vendor to perform at a high level, while also providing token relief for the customer. Customers will argue that even the sum of multiple service level credits is not intended to provide sufficient compensation in the event that service provider failures amount to an overall breach of the contract. Customer will point out that service credits are expressly tied to the vendor's failure to meet specific service level requirements, not an overall contract breach. Vendor, on the other hand, will argue that service level credits represent an agreed-upon liquidated damages amount intended to fully compensate customer for all liability associated with vendor's failure to meet the service levels. However, because many service credit provisions permit the vendor to “earn back” credits for exceptional performance, vendor will have an uphill battle, since such bilateral “provisions may even tend to show that the parties have not tried to liquidate damages at all, but have merely fixed a sliding scale for determining the price to be paid for an agreed performance.” 11-58 Corbin on Contracts, '58.21. Therefore, although somewhat counter-intuitive, it may be in the customer's interest to permit the vendor to “earn back” credits for exceptional performance, because such a bilateral credit scheme corroborates the notion that service credits are not liquidated damages, and merely represent price adjustments to reflect actual services rendered.

Difficulty in Quantifying Damages

With regard to the second factor ' the uncertainty or difficulty, at the time of contract, in quantifying damages resulting from a future breach ' again, the parties are likely to disagree. Customers are in a difficult spot here: A customer would instinctively argue that actual damages under a vendor agreement are unquantifiable at the time of contract; however such an argument could help cement a finding of service credits as liquidated damages. And that dilemma for customers foreshadows the outcome analyzed here ' that whether or not determined to be liquidated damages, receipt of service credits should not foreclose a claim for actual damages.

Reasonableness

In terms of the third factor ' the reasonableness of the service level credit as a forecast of damages ' customers will similarly argue that even when damages are more easily quantified, the service level credit amount still does not cover such predictable damages. Although ultimately a point for the customer to argue, the parties are not likely to agree as to whether credits sufficiently compensate the customer for damages. (Although a liquidated damages clause is enforceable only if it represents a reasonable and proportionate estimate of damages, a clause that underestimates damages may still be enforceable. See, Oscar De La Renta, Ltd. v. Mulberry Thai Silks, Inc., 2009 U.S. Dist. Lexis 33221, at 18-19 (S.D.N.Y. Apr. 20, 2009) (noting that where liquidated damages “represent the minimum amount [the plaintiff] stood to gain from the performance of the remainder of the contract ' [the liquidated damages clause was] hardly an unreasonable or disproportionate estimate of the probable loss caused by a breach of the License Agreement.”))

Based on the above analysis, there is a colorable argument both for and against a finding that service level credits are liquidated damages. Note that in at least some jurisdictions, even a valid liquidated damages clause does not exclude other legally recognized remedies ' such as equitable remedies. See, Massachusetts Indemnity & Life Ins. Co. v. Dresser, 269 Md. 364, 369-70 (Md. Ct. App. 1973) (citing 17 Am. Jur. 2d Contracts '445, at 906 (1964)). As discussed above, if a court found service level credits were not liquidated damages, customers would enjoy their best outcome ' both retaining the right to accrue service credits while retaining the right to bring an actual damages claim. If a court found service level credits were liquidated damages, vendors would argue that such a finding bars customer's right to an actual damages claim. However, the sample
contractual language included in the next section is aimed at preserving a customer's actual damages claim in such a scenario.

If, as a third alternative, a court were to reject a service credits clause altogether, finding it to be an invalid contractual penalty, the customer could seek actual damages flowing from vendor's breach, but may have to return or offset service credits against the recovery. See, Id. (“If a provision is condemned as a penalty, it is unenforceable. But the rest of the agreement stands, and the injured party is remitted to the conventional damages remedy for breach of that agreement, just as if the provision had not been included.”) If a court has invalidated service credits as a penalty, customers would be forced to decide between accepting performance that does not comply with the vendor's contractual obligations, and suing the vendor for material breach. Such extreme options beg for a middle ground, and service credits are the well-accepted method to ensure predictability and encourage satisfactory performance. The widespread reliance on service credit clauses means that if a court were to prohibit a customer that has collected service credits from also recovering damages in the case of material breach, the intent of many parties, at least many customers, will be frustrated.

Structuring a Damages Clause

What follows is a customer-oriented provision intended to preserve a customer's right to sue for damages in the event of breach, despite the customer having received (or simply having been eligible for) service level credits prior to the breach claim. The provision can be seen as an extension of a cumulative remedies clause that is found in the boilerplate of many services and vendor agreements.

It is specifically acknowledged and agreed that service credits are a price adjustment for the relevant period to reflect the reduced level of, and value of, the services provided, and are not an estimate of the loss or damage that may be suffered by Customer as a result of a failure to meet a service level. Accordingly, the issuance or payment by Vendor of a service level credit for a service level default shall be without prejudice to, and shall not limit, any right Customer may have to: a) damages or non-monetary remedies at law or in equity resulting from, or otherwise arising in respect of, a service level default; or b) terminate this agreement for cause, as expressly provided for by this agreement, and recover damages.

As this language suggests, it is important that service credit provisions correlate directly to specific service level failures. Additionally, customers should ensure that the damages provision expressly describes service credits as tied only to particular service level defaults. If possible, this means including language explicitly disclaiming any intention for service credits to compensate for harm suffered as a result of cumulative defaults or full contract breach. Importantly, the provision should clearly define service credits as a price adjustment intended to reflect the price of services actually performed.

Using “price adjustment” language similar to the example above accurately portrays service credits for what they are ' a tool that creates an incentive to the vendor to provide quality service. And remember that a reasonably evenhanded “earn back” provision may be an advantage for customer in a later dispute. While the specific descriptive terms chosen by the parties may not be determinative, courts do give some weight to such language in interpreting the intent of the parties. See, 11-58 Corbin on Contracts, '58.5; Jameson Realty Group v. Kostiner, 813 N.E.2d 1124 (Ill. App. 2004).

While a customer could simply agree to language that bars receipt of actual damages to ensure that service level credits are enforceable, the customer need not unnecessarily concede defeat on the issue of actual damages. It would be better to hold a more aggressive position, even if there is a chance it does not prevail in the event this point is ever litigated, rather than win a nonexistent battle, but lose the looming war.

Vendors: Credits Bar Actual Damages

A vendor's strongest argument supporting the notion that service credits, as liquidated damages, bar the right to seek actual damages, states that a claim of actual damages will be based on the very same type of breach that the service credits accommodate, just more of such breaches than a single service default. Tripping a few service level agreements each year is common, and the service credits function to give vendor an incentive to return to compliant performance. If Vendor Co., in the example above, trips every service level agreement multiple times in a single month, or trips a number of service level agreements every month for several months running (i.e., enters a chronic service default scenario), and Client Co. claims material breach and asks for damages, Vendor Co. may craftily argue that if service credits are sufficient for the occasional service default, they should also be sufficient for material breach made up of a slew of service defaults. Client Co.'s task will be to convince Vendor Co., and a court if litigation ensues, that material breach due to service failure or chronic service default is a different breach from those intended to be covered by the service level credits ' possibly a tough sell, but certainly a healthy challenge for enterprising litigators.

In the event of such litigation, absent the sample language, the vendor's argument will be stronger, and the vendor may take the position that: 1) service credits are liquidated damages; and 2) accordingly, no other damages are available. The sample language might very well short-circuit that argument by allowing the customer to distinguish the harm caused by the vendor's failure to adhere to service levels from the separate and qualitatively different harm caused by the vendor's material breach or chronic failures.

By including a service credit clause like the sample language, cloud customers and customers of other service-based offerings can try to preserve their rights to actual damages in the event that they suffer a material contractual breach.

Service providers need incentives to continue providing top-notch service.
That is what most customers believe. Whether a customer engages a vendor for cloud computing, software offered as a service (“SaaS”), outsourcing, or simply the maintenance aspect of a traditional software licensing agreement, if an element of the deal is for the vendor to provide ongoing services, the customer will always seek a financial lever to provide the vendor with an incentive to perform.

Consider the following example of a services-based agreement governing multiple service features with a five-year term.

The agreement subjects Vendor Co. to a number of individual performance service levels. The agreement provides for service level credits, as well as termination rights for material breach, abandonment of the agreement and “chronic service failure” (i.e., failure to meet service levels a certain number of times over a long period of time, say six months to one year). Over the first three years of the term of the agreement, Vendor Co. misses a few service levels each year and pays a few service level credits, but performance is generally acceptable. Vendor Co.'s performance then drops significantly, triggering Customer Co.'s right to terminate for chronic service failure. Although Customer Co. elects to terminate, it also determines it has a strong factual case for damages due to Vendor Co.'s performance failures. Vendor Co., seeking to avoid a public litigation, argues that Customer Co.'s damages claim is barred because Customer Co. accepted service level credits as liquidated damages. Customer Co.'s general counsel frantically reviews the agreement, tries to recall first year contracts law, and calls external counsel. Is Customer Co.'s damages claim lost because it accepted a few service level credits in the first three years of the contract?

Service levels and service level credits are routinely the source of heated negotiation in various types of commercial agreements with technology and services vendors, including rigorous debate about the very purpose of such credits. From the customer's perspective, although a decrease in payment liability likely does not fully compensate the customer for the particular harm suffered due to a vendor's service level failure, the credits create an incentive for the vendor to perform at the agreed-upon levels. That incentive is the customer's primary objective for service credits. Vendors may also have a stake in the service credit model, preferring a set of fixed and achievable performance expectations and consequences instead of an amorphous and subjective standard for service performance.

While service level credits are commonplace in service-based agreements, a customer's ability to recover actual damages in the event of a chronic service failure in addition to service credits is somewhat unclear. The question is far from esoteric: It is easy to imagine a vendor relationship similar to the example above, where Customer Co. accepts a handful of service credits before Vendor Co.'s performance deteriorates to the point of permitting Customer Co. to terminate the agreement for Vendor Co.'s material breach. At that point, Customer Co. attempts to recover the costs it has incurred as a result of such material breach. Vendor Co. resists the collection attempt, arguing that service credits are liquidated damages and, accordingly, preclude any additional relief. Courts have not addressed this question ' a fact that is likely due to the nature of services agreements, in which vendors prefer a negotiated settlement of differences, as opposed to what could become litigation with consequent negative publicity.

Liquidated Damages or Penalties?

How courts might determine the availability of actual damages in addition to service credits likely depends on whether courts find service credits to be liquidated damages. There are at least three possible outcomes at litigation: 1) a finding that service credits are liquidated damages; 2) a finding that service credits are not liquidated damages; or 3) a finding that service credits are a penalty, an invalid contractual term that the courts reject. See, 3 Farnsworth on Contracts '12.18 (3d Ed. 2004).

If a court finds a service level credit clause to be a valid liquidated damages clause, the court might find that a customer's recovery is limited to that liquidated sum. See, Commercial Damages: Remedies in Business Litigation, 9A.02 (Matthew Bender & Co., Inc. 2007). Such an outcome would, obviously, be disastrous for all the Customer Co.'s out there. If, instead, a court finds a service level credit clause to be a penalty, a customer could still recover its actual loss, but the service credit clause will be deemed an unenforceable penalty clause and the customer may have to refund the creditor for any credits paid or deduct any credits paid from any damages award. (The fate of credits paid under a clause that a court finds ultimately to be a penalty is unclear, as most case law regarding liquidated damages involves challenges to such provisions before any amounts have been paid thereunder. However, it is likely that if a clause is found by a court to be an invalid penalty, any payments already made under such invalidated provision would have to be returned.) If courts invalidate service level credit clauses as penalties, the resulting case law would have a potentially tumultuous effect on customers' ability to provide proper incentives for service provider performance in the thousands and thousands of agreements containing service level credit provisions. The best outcome for customers is a service level credit clause that allows customers to accept service credits for vendors' failures to meet certain service levels, while also retaining the right to recover actual damages in the event of breaches that rise to a level of material breach of the contract.

Enforcing Liquidated Damages

A liquidated damages clause provides for a specific sum expressly stipulated by the parties as the amount of damages to be recovered for a party's breach of the agreement. See , Massachusetts Indemnity & Life Co. v. Dresser , 269 Md. 364, 368 (1973) (citing Black's Law Dictionary (Rev. Fourth Ed. 1968)). When considering whether a stipulated amount is enforceable, courts consider: 1) the intent of the parties; 2) whether, at the time of contract, damages caused by a future breach are likely to be uncertain or difficult to quantify; and 3) whether the agreed amount is a reasonable forecast of the probable damages. See, 11-58 Corbin on Contracts, '58.5. Generally, where a contract includes a valid liquidated damages clause, “the measure of damages for a breach will be the sum in the clause, no more, no less.” JMD Holding Corp. v. Cong. Fin. Corp. , 828 N.E.2d 604, 609 (N.Y. Ct. App. 2005).

Intent

With respect to the first factor ' the parties' intent ' the parties are likely not of one mind as to their intent regarding service level credits. As stated above, customers generally intend for the service credits to create an incentive for the vendor to perform at a high level, while also providing token relief for the customer. Customers will argue that even the sum of multiple service level credits is not intended to provide sufficient compensation in the event that service provider failures amount to an overall breach of the contract. Customer will point out that service credits are expressly tied to the vendor's failure to meet specific service level requirements, not an overall contract breach. Vendor, on the other hand, will argue that service level credits represent an agreed-upon liquidated damages amount intended to fully compensate customer for all liability associated with vendor's failure to meet the service levels. However, because many service credit provisions permit the vendor to “earn back” credits for exceptional performance, vendor will have an uphill battle, since such bilateral “provisions may even tend to show that the parties have not tried to liquidate damages at all, but have merely fixed a sliding scale for determining the price to be paid for an agreed performance.” 11-58 Corbin on Contracts, '58.21. Therefore, although somewhat counter-intuitive, it may be in the customer's interest to permit the vendor to “earn back” credits for exceptional performance, because such a bilateral credit scheme corroborates the notion that service credits are not liquidated damages, and merely represent price adjustments to reflect actual services rendered.

Difficulty in Quantifying Damages

With regard to the second factor ' the uncertainty or difficulty, at the time of contract, in quantifying damages resulting from a future breach ' again, the parties are likely to disagree. Customers are in a difficult spot here: A customer would instinctively argue that actual damages under a vendor agreement are unquantifiable at the time of contract; however such an argument could help cement a finding of service credits as liquidated damages. And that dilemma for customers foreshadows the outcome analyzed here ' that whether or not determined to be liquidated damages, receipt of service credits should not foreclose a claim for actual damages.

Reasonableness

In terms of the third factor ' the reasonableness of the service level credit as a forecast of damages ' customers will similarly argue that even when damages are more easily quantified, the service level credit amount still does not cover such predictable damages. Although ultimately a point for the customer to argue, the parties are not likely to agree as to whether credits sufficiently compensate the customer for damages. (Although a liquidated damages clause is enforceable only if it represents a reasonable and proportionate estimate of damages, a clause that underestimates damages may still be enforceable. See, Oscar De La Renta, Ltd. v. Mulberry Thai Silks, Inc., 2009 U.S. Dist. Lexis 33221, at 18-19 (S.D.N.Y. Apr. 20, 2009) (noting that where liquidated damages “represent the minimum amount [the plaintiff] stood to gain from the performance of the remainder of the contract ' [the liquidated damages clause was] hardly an unreasonable or disproportionate estimate of the probable loss caused by a breach of the License Agreement.”))

Based on the above analysis, there is a colorable argument both for and against a finding that service level credits are liquidated damages. Note that in at least some jurisdictions, even a valid liquidated damages clause does not exclude other legally recognized remedies ' such as equitable remedies. See , Massachusetts Indemnity & Life Ins. Co. v. Dresser , 269 Md. 364, 369-70 (Md. Ct. App. 1973) (citing 17 Am. Jur. 2d Contracts '445, at 906 (1964)). As discussed above, if a court found service level credits were not liquidated damages, customers would enjoy their best outcome ' both retaining the right to accrue service credits while retaining the right to bring an actual damages claim. If a court found service level credits were liquidated damages, vendors would argue that such a finding bars customer's right to an actual damages claim. However, the sample
contractual language included in the next section is aimed at preserving a customer's actual damages claim in such a scenario.

If, as a third alternative, a court were to reject a service credits clause altogether, finding it to be an invalid contractual penalty, the customer could seek actual damages flowing from vendor's breach, but may have to return or offset service credits against the recovery. See, Id. (“If a provision is condemned as a penalty, it is unenforceable. But the rest of the agreement stands, and the injured party is remitted to the conventional damages remedy for breach of that agreement, just as if the provision had not been included.”) If a court has invalidated service credits as a penalty, customers would be forced to decide between accepting performance that does not comply with the vendor's contractual obligations, and suing the vendor for material breach. Such extreme options beg for a middle ground, and service credits are the well-accepted method to ensure predictability and encourage satisfactory performance. The widespread reliance on service credit clauses means that if a court were to prohibit a customer that has collected service credits from also recovering damages in the case of material breach, the intent of many parties, at least many customers, will be frustrated.

Structuring a Damages Clause

What follows is a customer-oriented provision intended to preserve a customer's right to sue for damages in the event of breach, despite the customer having received (or simply having been eligible for) service level credits prior to the breach claim. The provision can be seen as an extension of a cumulative remedies clause that is found in the boilerplate of many services and vendor agreements.

It is specifically acknowledged and agreed that service credits are a price adjustment for the relevant period to reflect the reduced level of, and value of, the services provided, and are not an estimate of the loss or damage that may be suffered by Customer as a result of a failure to meet a service level. Accordingly, the issuance or payment by Vendor of a service level credit for a service level default shall be without prejudice to, and shall not limit, any right Customer may have to: a) damages or non-monetary remedies at law or in equity resulting from, or otherwise arising in respect of, a service level default; or b) terminate this agreement for cause, as expressly provided for by this agreement, and recover damages.

As this language suggests, it is important that service credit provisions correlate directly to specific service level failures. Additionally, customers should ensure that the damages provision expressly describes service credits as tied only to particular service level defaults. If possible, this means including language explicitly disclaiming any intention for service credits to compensate for harm suffered as a result of cumulative defaults or full contract breach. Importantly, the provision should clearly define service credits as a price adjustment intended to reflect the price of services actually performed.

Using “price adjustment” language similar to the example above accurately portrays service credits for what they are ' a tool that creates an incentive to the vendor to provide quality service. And remember that a reasonably evenhanded “earn back” provision may be an advantage for customer in a later dispute. While the specific descriptive terms chosen by the parties may not be determinative, courts do give some weight to such language in interpreting the intent of the parties. See, 11-58 Corbin on Contracts, '58.5; Jameson Realty Group v. Kostiner , 813 N.E.2d 1124 (Ill. App. 2004).

While a customer could simply agree to language that bars receipt of actual damages to ensure that service level credits are enforceable, the customer need not unnecessarily concede defeat on the issue of actual damages. It would be better to hold a more aggressive position, even if there is a chance it does not prevail in the event this point is ever litigated, rather than win a nonexistent battle, but lose the looming war.

Vendors: Credits Bar Actual Damages

A vendor's strongest argument supporting the notion that service credits, as liquidated damages, bar the right to seek actual damages, states that a claim of actual damages will be based on the very same type of breach that the service credits accommodate, just more of such breaches than a single service default. Tripping a few service level agreements each year is common, and the service credits function to give vendor an incentive to return to compliant performance. If Vendor Co., in the example above, trips every service level agreement multiple times in a single month, or trips a number of service level agreements every month for several months running (i.e., enters a chronic service default scenario), and Client Co. claims material breach and asks for damages, Vendor Co. may craftily argue that if service credits are sufficient for the occasional service default, they should also be sufficient for material breach made up of a slew of service defaults. Client Co.'s task will be to convince Vendor Co., and a court if litigation ensues, that material breach due to service failure or chronic service default is a different breach from those intended to be covered by the service level credits ' possibly a tough sell, but certainly a healthy challenge for enterprising litigators.

In the event of such litigation, absent the sample language, the vendor's argument will be stronger, and the vendor may take the position that: 1) service credits are liquidated damages; and 2) accordingly, no other damages are available. The sample language might very well short-circuit that argument by allowing the customer to distinguish the harm caused by the vendor's failure to adhere to service levels from the separate and qualitatively different harm caused by the vendor's material breach or chronic failures.

By including a service credit clause like the sample language, cloud customers and customers of other service-based offerings can try to preserve their rights to actual damages in the event that they suffer a material contractual breach.