5 Ways to Reduce Risk in Cloud Agency Contracts

Mark Del BiancoBy Mark Del Bianco

One channel partner who recently refocused her business on selling cloud services describes the state of the indirect cloud sales channel as the “Wild West.” She said many cloud providers have a service that has proven to work for a small base of customers, but when they try to enlist channels to help broaden their market reach, it’s very apparent that they are unfamiliar with channel sales processes and incentives.

I would agree with her based on my experience as a channel contract lawyer. Compensation, for example, varies widely among cloud service providers as do rules of engagement and other terms and conditions of sales agency agreements. To complicate matters, many cloud providers offer month-to-month service and do not require long-term customer contracts, making it difficult to incentivize partners to sell. Add to that the inevitable consolidation of service providers over the next few years and you have all the components for a range war.

Does this sound familiar? It should — a similar situation occurred in the telecom space in the late 1990s. To put it another way, the major risks for channel partners looking to sell cloud services on a referral basis today are similar to the risks they faced trying to sell telecom services 15 years ago.

So, what are the risks you need to be aware of in the new cloud services world? Here are a few:

  • You will choose the wrong service providers and the wrong services to sell.
  • Your prospects will not understand what they are buying and their unrealistic expectations will not be met by what they buy.
  • A service provider whose services you sell will not pay some or all of the commissions you’ve earned, will go into bankruptcy or will be bought, and the buyer will stop paying your commissions

Some of these risks must be accepted. Service provider bankruptcy is one example. Nobody has figured out a foolproof way to make sure a sales agency contract survives a service provider’s bankruptcy.

However, you can mitigate some risks through smart business practices, such as:

  • Selecting the right portfolio of services to sell by educating yourself on the technology and talking to customers about the services they really need
  • Selecting the right service providers by looking at their financial stability and managerial experience
  • Educating your customers and not overhyping the ability of cloud services to solve their problems and met their needs
  • Facilitating communication between your customers and service providers, so that if customers become dissatisfied, you do not become the target of their wrath — whether it is legal action or simply trashing your reputation in the community.

In addition, some of the risks can be mitigated, if not solved, by protective provisions in your agency contracts with cloud service providers. Here are five areas where legal advice may be well advised:

1. Ensuring accurate commission payments when revenues potentially fluctuate greatly month to month

Make sure that you receive proper credit for existing business and confirm your commission accuracy on an ongoing basis. To reduce this risk, you need contract provisions requiring the service provider to give you a monthly report with specific data and the right to audit the underlying records to confirm the accuracy of commission payments. But clauses alone are not enough. You need to proactively review the reports and determine whether an audit is necessary. If you don’t have the time or aptitude for this task, then pay someone to do it for you.

2. Earning commission on renewals and upgrades

Ensure mechanisms are in place to give you the opportunity to be involved in renewals and upgrades. I say “be involved” because the evergreen model, which guarantees commissions on all sales to a referred customer, seems to be in jeopardy. Cloud service providers are pushing back. Unlike telecom providers, most cloud service providers do not offer automatic evergreen clauses. In many cases, the best outcome may be a clause requiring (a) your supplier to notify you of renewal and upgrade opportunities that its sales personnel become aware of, and (b) you to assist in the upsale. Even without that requirement, you always should remain engaged with your customers on an ongoing basis for their own protection.

3. Ensuring commission continuity if the service provider is acquired or merges

Given the certainty that there will be substantial consolidation in the cloud services market, you need to try to ensure that you continue to get paid even if your suppliers or their assets (i.e., customers) are acquired by new firms. The recent TDMI-Birch litigation is an illustration of this risk and how it can be mitigated. Birch purchased the assets of Navigator, a service provider with whom TDMI had a partner agreement. Birch (like most acquirers) believed it had purchased the assets without any of the associated liabilities, such as the TDMI partner contract. When Birch stopped paying commissions, TDMI sued. Birch was found liable, based on a clause in the partner agreement that deemed the agreement to be assigned to the buyer in the event of a change of control. The concept, if not the exact language, can help you in similar situations.

4. Reducing the risk of the service provider (or an acquirer) stopping or decreasing commission payments  

You should aim to reduce the service provider’s incentive to shortchange you on commissions by including attorney’s fee-shifting provisions in your agreement. Under the U.S. legal system, parties bear their own costs of litigation unless a specific law or a provision in the parties’ contract provides otherwise. Since there is no fee-shifting law covering breach of partner contracts and those contracts rarely contain fee-shifting provisions, service providers often roll the dice, discontinuing or lowering payments. They know that you will make a rational calculation — weighing the expense of litigation against the amount that is owed — before suing for commissions. If you are owed less than $50,000 or perhaps even $100,000, the likelihood of you taking legal action is slim because you can’t recover the cost of the attorney’s fees. Including a “loser pays winner’s attorney’s fees” clause changes the service provider’s calculation of whether to deliberately breach a commission agreement.

5. Ensuring indemnification against liability for service provider errors and service failures

Finally, you can reduce your risk of litigation costs with an indemnification clause for service provider errors and service failures. Such a clause is difficult to obtain, but worth seeking. Its value is greater now in these early years of the cloud services industry, given the lack of standardized products and services and the potentially unrealistic expectations of new customers. Even one customer lawsuit based on service provider negligence or overpromising can devastate your business — both in terms of cost and time spent on litigation.

The move to the cloud increases the business and technical complexity for channel partners like you. You will have to learn new technology and become more of a trusted adviser for your clients. While few channel partners can become experts on all the varieties of cloud services available, it is risky for you to rely on one or a small set of cloud products or services. You’ll need to find the delicate balance between breadth and depth and do what you can to protect yourself contractually along the way.

Mark Del Bianco, principal, Law Office of Mark C. Del Bianco, is based in the metropolitan Washington, D.C., area. His practice focuses on domestic and international telecom clients, particularly those implementing new technologies such as WiMAX, gigabit Ethernet and FTTH. Other clients include applications providers, channel sales agents and enterprise customers.
Twitter: @markdelb


Learn more in the session, “What Happens When Cloud Providers Don’t Perform?” at Cloud Partners, a Channel Partners event, Sept. 8-10, in New Orleans.

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