Most Service Agreements are quite one-sided when it comes to termination. The Client generally wants a good deal of flexibility in how they can terminate the agreement. The Agency of course wants things locked in.
While some one-sidedness is acceptable, there are a few things you’ll want to watch out for.
The term of a Service Agreement is the duration during which its terms apply. Remember that if your agreement does not contain an express term, then its provisions apply to any SOWs that you sign with the Client, whenever those are signed. If an agreement has a stated term, it only applies to SOWs signed within that term. If an agreement has a specific term, keep the following in mind:
- When A Longer Term Can Be Better. As a general matter, if the agreement contains terms that are favorable to you, you would prefer a longer term. An Agency might look for a longer term after you negotiate a favorable rate card or payment terms with a long-term Client.
- When A Shorter Term Can Be Better If the agreement contains unfavorable provisions, you’ll prefer a shorter term. Similarly, when you are dealing with a new client, a risky type of project, or difficult business environment, you’ll generally prefer a shorter term.
Generally, I prefer agreements without a stated term. I think this better sets the stage for negotiation of terms on an SOW by SOW basis.
Bigger than the issue of term is termination. These paragraphs describe when the Agency or the Client can exit a relationship. There are three categories of termination provision you’ll see: termination for convenience, termination following bankruptcy, and termination for breach.
Client prepared Service Agreements often contain a clause allowing the Client to terminate at any time. A typical clause reads like this:
Keep the following in mind when facing a clause like this:
- Require Advance Notice. Be sure the client is obligated to provide 10 to 30 days advance notice before terminating for convenience.
- Notice + Stop Work. Even when an agreement requires advance notice before termination, sometimes the Client will give you notice that it plans to terminate along with instructions to stop work pending the termination. This effectively makes the termination immediate. Language like the following may help to ensure the notice period is respected:
Notwithstanding any contract language, once termination is on the table, an Agency’s ability to collect on outstanding invoices and additional work is in jeopardy. Agency’s focus should be on minimizing additional receivables and collecting existing receivables.
- Be Aware of Project Type. If you work on an hourly basis, a Client being able to terminate for convenience doesn’t present you much risk. For retained work or project-based work, termination for convenience can be very disruptive. If you are operating under a retainer or fixed fee, ask to strike the clause allowing the Client to terminate for convenience. If you are unsuccessful, an Agency may need to increase its fee to compensate for the additional risk it faces in a contract that can be terminated at any time (The Negotiation Equation). Better yet, work to structure your payments in a way that minimizes receivables as discussed in Payment Terms. An Agency may also consider adding a termination fee as discussed in this book’s section about Kill Fees.
Termination for Bankruptcy
There is commonly a clause stating that Client can terminate if the Agency goes bankrupt. The provision is much longer than that, referring to all the different types of types of bankruptcy-type problems, but the details are generally the same. A few quick thoughts:
- Make Mutual. While this is a reasonable provision for the Client to include, it is also reasonable to ask that such a clause permit Agency to fire the Client if the Client goes bankrupt. An Agency can be practical in this request based on the nature of the Client: (Nike, no. Unfunded startup, yes).
- May Be Unenforceable. Despite the ubiquity of these provisions, the fact is that they can become unenforceable. When a bankruptcy is actually filed, provisions of bankruptcy law kick in specifying what contracts can and cannot be terminated. The law overrides most contract provisions. If the clause you are facing permits termination prior to filing of an actual bankruptcy case (not unenforceable), and later a bankruptcy case is in fact filed, then the bankruptcy law will still apply and override the earlier termination.
- Manage Risk Through Business Terms. Given the legal issues with provisions allowing termination on bankruptcy, an Agency may be better off using business terms to manage risks in this area. An Agency doing work with unfunded startups or a Client facing difficult economic conditions should get paid in advance.
Termination for Breach
This is the most important termination provision. The Service Agreement will include a provision allowing Client to terminate following a breach by Agency. Use the tips below to ensure this clause protects the Agency as well:
- Make Mutual. It is fair that the Client can terminate a contract if the Agency breaches. It is also fair for the Agency to be able to terminate if the Client breaches.
- Focus on Material Breaches. The power to terminate (by either Client or Agency) should be limited breach of a material term of the agreement. This ensures that technical breaches aren’t used as a way of gaining leverage. A material breach clause might read like this:
- Allow for Cure. The power to terminate for a material breach should only exist after notice is given describing the breach and giving an opportunity to fix the problem, 30 days is typical. The above clause contains an example of this type of language.
Let’s look at termination as applied to common situations for both Client and Agency.
- Termination by Client. Suppose an Agency delivers a website and it is missing a material piece of functionality specified in the SOW. The Client would give Agency notice of the breach and the Agency would have 30 days to fix the problem. Assuming Agency cured the breach, Client would have no further complaint and Agency would bill as normal. If Agency failed to cure the breach, Client could terminate the SOW and find another developer to finish the website. If it costs the Client more to complete the website with a new developer, or if Client paid Agency money for the work that was noncompliant, Client could sue Agency for those damages.
- Termination by Agency. The material breach of most concern to Agencies is payment. Almost without exception, any failure to pay is a material breach. Collection risk increases with time, so when a Client misses a payment deadline, an Agency should immediately consider its options. An Agency’s goals are to (i) collect on outstanding receivables and (ii) prevent additional receivables from being incurred. So, any late payment not easily (and convincingly) explained should be addressed promptly. Sometime like this might be a good place to start:
If Client pays within the 30 days, there are no grounds for breach. If the Client fails to pay within the 30 days, Agency must make the business call whether terminating the contract is the appropriate next step. That’s a good conversation to have with your lawyer.
- Restate Payment Obligation on Termination. One point generally applicable to all types of termination clauses: the contract should make clear that the Client must pay for all services provided through the termination date:
Termination is the Agency’s escape hatch when a project goes off the rails, but also a source of risk if a Client exits a project unexpectedly. Keep the above provisions in mind to help make sure your Agency doesn’t get stuck in a project going from bad to worse.
Most Service Agreements do not contain a provision allowing the Agency to suspend work when a Client is slow to pay or otherwise not fulfilling its responsibilities. What you want is a provision that expressly grants the Agency the right to stop work if the Client fails to make a payment when due or otherwise breaches a material term of the contract. Something like this would be a great add for an Agency:
A few points of note about clauses like this:
- Limit to Material Breach. In the first sentence, the Client might ask that this only be triggered on breach of a material term of the agreement rather than any breach. This is a fair request.
- Timing. Note the difference between the above clause and the termination clauses discussed above. In the stop work clause, the Agency can stop right when the breach occurs. On the termination clause, the Agency must give notice before acting. This helps the Agency building up receivables when the Client is already in breach.
- Dealing with Pushback. I’ve certainly had more than one Client resist addition of this clause. If you face similar resistance, ask your Client to explain why Agency should have to continue working when the Client is in breach. Also, be sure to pay extra attention to the termination clause to ensure it allows you to terminate following a material breach by the Client. A Client that expects an Agency to continue working despite having broken the contract is not a Client you want to work with.
- Conditions are Important. The suggested clause is powerful because it allows the Agency to insist on an updated contract as a condition to Client fixing the problem. Use this as a method to fix the contract to reflect what you have learned about the Client. For example, if a Client is consistently late on payment, use this clause to require an updated SOW where Client pays in advance.
- Be Practical. Don’t panic if you don’t have this clause in your contract. While an express provision is best, I many instances an Agency can still stop work if the Client hasn’t made a payment when due.
- Don’t Wait. The power in this clause comes from using it early in a relationship. Stopping work at the first sign of trouble is an excellent way to communicate the importance of timely payments and the Client fulfilling its other obligations. Most problems I see stem from an Agency “being nice” with its client and letting a small problem become a big problem.
Stopping work is a powerful and effective tool for holding a Client accountable to its promises. Make sure your project managers and account managers know how and when to use this clause.
A kill fee (or termination fee) is a provision that compensates the Agency if the Client bails on the project. These are tough to get added to a Service Agreement but can be valuable motivators to keeping a Client honest and engaged on the project.
A typical kill fee clause an Agency would like to add might read something like this:
This clause says that if the Client bails on the project other than due to a material breach by the Agency, that the Agency can collect a kill fee equal to a percentage of the killed portion of the project budget. A few recommendations when negotiating kill fee provisions.
- When to Use. A kill fee generally only makes sense in fixed fee and retainer projects. It doesn’t apply as well to hourly projects. Though if you must take on additional or special staff for an hourly project, a kill fee may still be worth considering. But instead of calculating based on a percentage of the killed portion of the project, you may instead specify a fixed amount or a percentage of the total estimated budget.
- Balance with Termination. As we discussed in the section about Termination For Convenience, this is an important add if the Client insists on the ability to terminate simply for its convenience. Your response on the business issue is that they need to pay for that flexibility. You can also remind them that the kill fee does not apply if they terminate because the Agency is in breach. That’s the side of the equation that keeps the Agency honest. If your Client still resists, then consider The Negotiation Equation: your price might need to be increased to compensate for the risk that Client bails for no reason.
- Don’t be Greedy. Be reasonable when specifying the kill fee percentage, 20% to 50% is typical. Overly aggressive kill fees can be held to be unenforceable. Pigs get fed. Hogs get slaughtered.
- Works Both Ways. In the ideal case, you’d also have the kill fee triggered if the Agency terminates due to a material breach by the Client.
A practical note: unless you have Client deposit funds on hand, kill fees are difficult to collect short of litigation. That doesn’t mean you shouldn’t negotiation strongly for them. Quite the opposite. Asking for a kill fee communicates that you are taking your contract obligations seriously and you expect the Client to do the same. While it won’t prevent an unscrupulous Client from bailing on you, it will keep honest people honest (and hopefully you’re weeding out the unscrupulous ones as part of your intake anyway).
Clauses regarding, termination, suspension of work, and kill fees are important provisions in a Service Agreement. They can help you get a troubled project back on track or to get out of a project that has gone off the rails.
But these clauses don’t operate on their own. They need strong project managers and account people that are unafraid to have a direct conversation with the Client at the first sign of trouble. Don’t wait until the Client is 90 days overdue to start gently probing about payment. I know it is hard! But it gets easier each time you do it. Your willingness to have a frank conversation with your Client at the first sign of trouble is a key tool to having successful projects.