Defined Terms in SaaS Agreements

Edited for Contract Nerds from Foster’s Newsletter, “Mastering Commercial Contracts.”

KEY TAKEAWAYS:

• Defined Terms are crucial to get right in any commercial agreement and SaaS agreements are no exception.
• Defined Terms must be capitalized, have a clear and consistent definition, and not contain operating language.
• To be clear, consider defining the term with sufficient detail, carving out exceptions from the definition, and taking care when cross-referencing other Defined Terms.

Words in a contract will be given their ordinary meaning unless you specifically define them in the agreement. If you have a precise meaning you want to attach to a particular term, then you’ll need to explicitly define the term within your contract—like this—(the “Defined Term”).

Defined Terms can be one of the most negotiated and time-consuming aspects of a commercial contract negotiation. In particular, software-as-a-service (“SaaS”) agreements usually contain quite a few Defined Terms given the complexity of the deal. This article outlines some best practices when it comes to drafting and negotiating Defined Terms in SaaS agreements.

How to Draft Defined Terms

Defined Terms must be capitalized, have a clear and consistent definition, and not contain operating language. They are usually bolded or underlined the first time they are defined in order to help the reader find the definition when needed.

Capitalization

Defined Terms should have the first letter of the word capitalized. If it consists of more than one word, the first letter of each word should be capitalized, except for its conjunctions and prepositions.

There is a reason that contractual language is often panned for its lack of style–there are legal implications. Capitalizing a term for purely stylistic reasons is a “no-no” in contracts. If a term in the agreement is capitalized, then it must have a definition. If it does not need to be a defined term, then the term must appear in lowercase.

There are a couple of exceptions to this rule of thumb. Words with an ordinary meaning that are grammatically required to be capitalized, such as months or names, do not need to be defined.  While you may choose to make a term used once a Defined Term for the sake of clarity, typically you should only define terms that are used more than once in the agreement.

Definitions

The definition of the Defined Term must be clear. To be clear, consider defining the term with sufficient detail, carving out exceptions from the definition, and taking care when cross-referencing other Defined Terms. A vague or ambiguous term is contrary to the purpose of making it a Defined Term. You and your counterparty should resolve any disagreements over the meaning of a Defined Term before the contract is executed. While this can be time-consuming it is critically important to resolve and ideally avoid disputes in the future.

Also, the definition must be consistent with how the term is used throughout the SaaS agreement and any collateral agreements. During the contract review, be sure to use the “ctrl + f” function (when drafting in Microsoft Word) and search for all instances of a Defined Term to ensure that the definition makes sense in each case. Do the same search in any related contracts, like the SLA, Order, or Statement of Work.

A Defined Term may include another Defined Term in its definition. I call these “Russian Doll Definitions” because you must unpack each definition to ensure the appropriateness for the Defined Term you’re reviewing at the top level. While this approach can save time in drafting, if it doesn’t quite make sense to reference a particular Defined Term in the definition it’s better to remove it. Always take the time to get the meaning correct.

No Operating Language

A Defined Term must not contain operating language in its definition, such as conditions or obligations. The definition should only provide the meaning of the term and should not address how that term should be operated against in the context of the commercial relationship. For example, “Payment Terms” can be defined to mean, “the number of days from receipt of an invoice that Customer has to make payment.” However, it would be problematic to state that “Payment Terms” mean “Customer shall pay undisputed invoices within net 30 days of its receipt to the address on the invoice or through an ACH payment.” Keeping definitions restricted to meaning makes the overall negotiation less complicated.

How and Where to Place Defined Terms

There are two general schools of thought on how and where to place the definitions of Defined Terms: 1) you can define as you go when the term is first used in the agreement, or 2) you can put Defined Terms in a Definitions Section. Neither approach is right or wrong, and which to use depends on the nature of your agreement.

Define as You Go

Defining as you go facilitates quick understanding as the Defined Term is encountered in context. If most Defined Terms have meanings that are not overly complex and are fewer than ten or in an agreement fewer than five pages, then defining as you go may be the best approach. Generally, this approach should be disfavored when there are many Defined Terms in your SaaS Agreement, and a dedicated section would make the contract review more efficient.

Definitions Section

With a Definitions Section, you have one place to go to find all the definitions for the Defined Terms in an agreement. The Definitions Section can be placed at the beginning of a SaaS Agreement but does not have to be. Having the Definitions Section at the end of the SaaS Agreement can discourage negotiating them by de-emphasizing them. A variation of a Definitions Section is to have them in an appendix to the agreement.

Mixed Approach

A mixed approach is where you have a Definitions Section for some terms but will define others in context as you go. This should generally be avoided but is a judgment call for drafters.

If you are using a Defined Term exactly once in the SaaS Agreement, then defining it in the only place it is used is excusable when there is also a Definitions Section. Otherwise, having a Definitions Section and defining as you go will make negotiations less efficient as the counterparty will likely have difficulty locating some definitions. It can also open you up to defining a term twice and inconsistently.

However, it’s generally acceptable to use a define-as-you-go approach in the preamble of a SaaS Agreement as to the parties, in terms of defining the “Vendor,” “Customer,” and “Party” or “Parties” even if you intend to also have a Definitions Section addressing the Defined Terms used in the SaaS Agreement.

Key Defined Terms in SaaS Agreements

Here are three common Defined Terms in SaaS agreements and some tips on how to draft and review them.

Defining “Documentation”

Documentation is a central definition in a SaaS Agreement and typically should be defined to include the source material describing the operation of the software provided as a service.

The definition should reference the full body of relevant technical and system information. For example, “Documentation” means manuals, end-user documentation, technical and system documentation, and other written material provided to the Customer by the Company (both online and in hard copy), including any updates, upgrades, revisions, or new releases thereto, that describe the business functionality or technical specifications of the Solution].

Of course, be sure to review each of the Defined Terms within the definition of Documentation, such as Customer, Company, and Solution.

Defining “License Metric”

How you charge for your SaaS product can vary and some companies may have more than one product they offer as SaaS. That’s why it’s a good idea to have a definition for License Metric so that it’s clear what drives the price of the SaaS product.

Define “License Metric” to mean the basis for pricing as specified in the applicable “Order” (however defined). Provide examples, like users, storage, transactions, etc.

Defining “User”

The definition of “User” is critical in most SaaS agreements. The per-user or per-seat model is the prevailing one in many types of SaaS. When it comes to enforcing the license to the SaaS, it often concerns compliance with the number of “Users” that the customer is contracted to have. As such, defining “User” to make it clear who constitutes an authorized user is important.

When defining “User” it may make sense to describe the types of individuals that can be users. This allows customers to not only comply with the agreement but also utilize it fully with their contractors and service providers where such would be appropriate and acceptable to the SaaS provider.

Defined Terms are crucial to get right in any commercial agreement and SaaS agreements are no exception. Following these best practices and taking the right approach for your business will put you on track to success.

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