Edited for Contract Nerds from Foster’s Newsletter, “Mastering Commercial Contracts.”
KEY TAKEAWAYS:
- Payment terms in SaaS agreements define how fees are agreed upon, invoiced, and handled, requiring harmonization between the main agreement and any accompanying orders.
- Clear payment terms are crucial for minimizing disputes and ensuring transparency in SaaS agreements.
- To promote long-term relationships, use suspension procedures rather than termination triggers for payment issues.
Terms and conditions on payment terms (“Payment Terms”) are going to be part of every SaaS Agreement, as these terms establish how the SaaS provider and SaaS customer agree to fees, and how invoices will be issued and become due, and how to handle payment issues.
In addition, the Payment Terms section may also contemplate the order document (“Order”) being the location for terms like price increase, billing frequency, and when payments are due. In those cases, it’s important to ensure the terms of the SaaS Agreement and the Order are harmonized.
The Payment Terms section is generally drafted to be more favorable to the SaaS provider as this is one of the few performance obligations in the contract that is owned by the SaaS customer. For this reason, the discussion of this topic will feature more best practices for a SaaS provider than for a SaaS customer.
In this article, I’ll review key concepts, offer some example clauses, and provide guidance on best practices to keep in mind when drafting, reviewing, and negotiating Payment Terms in your SaaS Agreements.
Introduction to Payment Terms
In this example, “Payment Terms” is the heading used, but these section headings tend to vary. Although most permutations include a combination of words like payment, billing, invoices, taxes, charges, or fees. If those words are not in the section heading then they’ll often be found in a subheading.
Typically, the payment amounts subject to the Payment Terms are going to be a defined term (e.g., “Fees”). So, start any review of Payment Terms by ensuring that the definition of Fees is understood and correct. For that reason, the example Payment Terms below will follow the Fees definition applicable to the example.
Example Payment Terms
“Fees” means collectively (i) Subscriptions to Company Solutions, Equipment, and Professional Services fees and any amounts payable as set forth on the Order, (ii) reasonable travel expenses, and (iii) project-related expenses incurred while performing Professional Services.
X. Payment Terms.
X.1 Fees. Unless stated otherwise, all Fees stated on the Order are in United States dollars and are exclusive of applicable taxes and expenses. Fees are only applicable to the specific Company Solutions and License Metric set forth on the Order for the Term; changes or additions may be subject to the then-current market rates and require execution of a new Order. Customer agrees that the Initial Term commitment is partial consideration for the Agreement and to be responsible for the Fees for the Term.
X.2 Changes to Fees. Except as may be specifically set forth in an Order, Company may change the Fees for Company Solutions upon sixty (60) days’ notice to Customer no more than once per year. Company may change the Fees if Customer’s mergers, acquisitions, or divestitures give additional access to the Company Solutions. Company may review Customer’s usage at any time and if the actual usage exceeds the quantity and License Metric purchased on the applicable Order(s), may modify the Fees.
X.3 Invoices and Payment. Invoicing commences on the Order Effective Date. Unless otherwise specified on the applicable Order, undisputed Fees shall be due and payable by Customer (i) within thirty (30) days of the date of Company’s invoice, or (ii) on a schedule as specified in the Order and commencing on the Order Effective Date or date specified in the Order. Customer shall pay the applicable Fees in accordance with any payment terms and schedules for payment set forth in each applicable Order. Disputes to Fees must be brought before the invoice or Fees become due or they will be deemed accepted.
Where Customer provides Company with electronic payment information to effectuate payment, Customer authorizes Company to charge for all Company Solutions listed on the Order or applicable invoice. Fees not paid when due may bear interest at a rate of up to one and one-half percent (1.5%) per month or the maximum rate permitted by law, whichever is lowest. Fees are non-cancellable, and payments made are non-refundable unless otherwise indicated in the Order or additional Solution Terms.
X.4 Taxes. All Fees are exclusive of, and Customer shall be responsible for, all applicable taxes, levies, or duties, excluding taxes based solely on Company’s income. Customer will pay all Fees free and clear of, and without reduction for, any VAT, GST, withholding, or similar taxes; any such taxes imposed on payments of Fees will be Customer’s responsibility, and Customer will provide receipts issued by the appropriate taxing authority to Company on request to establish that such taxes have been paid.
X.5 Failure to Pay. If Customer fails to pay any amount within thirty (30) days of the due date, Company may suspend the applicable Company Solutions related to Customer’s failure to pay. During any suspension, Company’s obligation to provide such Company Solutions shall cease until such time as Customer becomes current on its payment of the applicable Fees (including all past due amounts, costs of collection and applicable late payment fees). In the event of a default in the payment of an invoice, Customer will be responsible for all of Company’s costs of collection, including, but not limited to, court costs, filing fees and reasonable attorneys’ fees.
Fees
A well-drafted Fees clause:
- States the Fees are exclusive of taxes.
- Explain the Fees may apply to additional services but allow the SaaS provider to charge its then-current rate.
- States an additional Order may be required to document additional services.
- Emphasizes the Initial Term commitment as part of the consideration for the Fees.
(See example clause X.1 above.)
Initial Term
In enterprise SaaS deals especially, the Initial Term length is likely to be for multiple years. That means there’s a risk that a customer’s business could change and, along with it, the demand for the SaaS solution. This is especially true where the business model is to charge per seat.
Stating the Initial Term commitment is part of the consideration for the Fees provides language to cite if the SaaS provider agrees to work with the SaaS customer to negotiate a reduced commitment for the remainder of the term at a higher rate.
Fee Modifications
When drafting terms that relate to how and when Fees can be modified, make sure to:
- Explain how and when Fees may be increased.
- Allow for an Order to contain terms that control how Fees are increased.
- Provide the SaaS provider with the right to charge the customer for actual use.
Fee Escalation
SaaS providers that offer more than one SaaS product should avoid establishing a cap on price increases in the SaaS Agreement if it is intended to govern multiple SaaS products. On the other hand, customers prefer a fee escalation cap usually tied to a percentage increase over the last year so they can control and predict fee increases.
Instead, follow the best practice of stating the Order may establish a controlling term on price increases and then have the Order be where the SaaS provider memorializes the applicable price cap.
This allows the SaaS company to ensure a price cap is not implemented on a SaaS product that was added under the SaaS Agreement at a discount that would not have been offered by the business if it was understood there was a price cap on future increases.
More on Price Escalators
Subsection X.2 in the above example has the subheading “Changes to Fees” but this subsection may also appear as “Price Increases” or another variation similar in meaning. These terms are also referred to as price escalators (“Price Escalators”).
The Price Escalator strategy is the domain of Finance, but Legal should understand the frameworks and how to draft them. When drafting, reviewing, and negotiating Price Escalators there are three approaches to take:
- Fixed Percentage – cap increases on price at fixed percentage, e.g. 5% or 10%.
- Index – limit the increase on price to the percentage established in a recognized index. The Consumer Price Index (“CPI”) is the index most likely to be used in Price Escalators for a SaaS Agreement.
- Index + Fixed Percentage – limit the increase on price to the percentage established in a recognized index plus an additional fixed percentage.
Example Price Escalator:
X.X Index + Fixed Percentage
Commencing twelve (12) months after the Effective Date, recurring Fees may increase on an annual basis in an amount equal to the published percentage increase in the Consumer Price Index – All Urban Consumers (Current Series) for the immediately preceding 12-month period plus 5%.
Invoices
A well-drafted invoicing section will follow these best practices:
- Clearly state when invoicing commences.
- Excludes disputed invoices from when invoices must be paid but requires disputes to be raised before invoices are due.
- Has default Net 30 payment terms but contemplates that an Order may contain alternative payment terms.
- Has a late payment interest charge.
- State fees are non-cancellable and non-refundable.
(See example clause X.3 above.)
Billing
Notice the example in subsection X.3 above does not state whether invoices are in arrears or advance. If the billing cycle is annual, then it’s going to be in advance. However, often monthly invoices for SaaS are invoiced in arrears. But that’s not the best practice.
For SaaS companies that are unable to get customers to pay annually, the best practice is to charge in advance. To execute this strategy, account executives have to be prepared to explain the first bill will be larger for this reason, much in the way wireless carriers explain their bills to new customers.
(See example clause X.3 above.)
Taxes
A well-drafted tax clause will follow these best practices:
- State that Fees are exclusive from taxes.
- Establishes customer’s responsibility for payment of taxes.
- Allows the SaaS provider to request confirmation of tax payments.
(See example clause X.4 above.)
Failure to Pay
Make sure the Payment Terms address what happens if the Customer fails to pay on time. A good failure to pay clause:
- Gives the SaaS provider the right to suspend its performance.
- Makes the SaaS provider’s right to suspend as discretionary instead of automatic.
- Establishes customer’s responsibility for payment of taxes.
- Allows the SaaS provider to recover costs of collection.
(See example clause X.5 above.)
Right to Suspend
Do not have a SaaS contract terminate if a customer is delinquent. Instead, have a suspension right instead. Ensuring the contract has the flexibility to allow a customer to get current and for the parties’ relationship to continue is the best practice.
Automatic suspension and, worse, termination, are not aligned with developing a long-term business partnership. Having contract mechanisms that permit discretion allows the parties to work through problems amicably and continue the relationship when appropriate.
Third-Party Fees
Some SaaS providers need to pass through third-party fees. Make sure the third-party fees clause gives the SaaS provider the right to change the fees without notice. This is important as they do not control what the third party charges. On the customer side, be sure the fees are being passed through at cost, without a markup.
Example Third Party Fees Terms
X.Y Third-Party Fees. Company Solutions may include third-party Fees that flow through Company, but which are controlled by the third party. Changes to such third-party Fees may occur without notice and be backdated to the original date imposed by the third party on Company.
Subpoenas
In addition, some SaaS providers may have systems that store data that is often subject to subpoena. If that’s relevant to your SaaS solution, make sure the clause gives the SaaS provider the right to charge the customer for responding to subpoenas and legal processes. For SaaS providers that are required to expend professional services resources to prepare and extract data, having the ability to charge for that time may be meaningful.
Example Subpoenas Clause
X.Z Subpoenas / Service of Process Documentation Requests. Company may require Customer to pay for all costs directly incurred by Company in connection with responding to any subpoena or other legal process if directly related (i) to the Company Solutions provided to Customer under the Agreement or (ii) specifically requested by Customer. Any Fees incurred under this Section shall be subject to Company’s current time and materials rate for Professional Services.
The more certainty that a SaaS Agreement provides on Payment Terms from the outset, the less likely the parties will have disputes over payments. Consider these best practices when drafting, reviewing, and negotiating Payment Terms in your SaaS Agreement.
For more expert tips about SaaS Agreements:
- Check out Foster’s guest column called Mastering SaaS Agreements
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