If you are a commercial transactions lawyer or a sourcing or supply chain professional, it’s likely that you’ve been asked (probably more than once) to assist with a transition services agreement (TSA) in connection with an M&A transaction. Depending upon the complexity of the transition services arrangement and the criticality of the services being provided, TSAs can range from short-form ongoing back office administration services agreements with an agreement to set fees and no formal performance standards, to comprehensive service agreements with a defined scope, service levels, variable fee arrangements and detailed data security and privacy provisions.

When the complexity of a TSA moves towards the latter example above, the M&A lawyer or business lead will often look to the commercial transaction and/or sourcing or supply chain counterpart to assist with the structuring and negotiating of the TSA. Negotiating the structure of a TSA can involve a laundry list of issues, including provisions or separate documents outlining responsibility for one-time segregation/separation activities, ongoing services and assets, how incumbent third-party services arrangements will be handled during the “transition” period, business continuity requirements, audit rights, insurance requirements, data protection obligations and allocation of liability.

Commercial transaction and sourcing or supply chain representatives are tapped for their knowledge of and experience with services agreements, since that is what TSAs essentially are at their core (just for a shorter or “interim” period).

Set forth below are key issues to consider when structuring and negotiating a TSA.

  1. Understand the Scope
    • Have a clearly defined strategy for how the post-closing company will operate, both immediately following closing and on a long-term basis.
    • Be prepared to identify the specific services that will be provided, appropriate service standards and applicable costs and expenses.
    • Consider allowing the scope of the TSA to remain flexible without the need for formal amendment, as the needs of the service recipient may change post-closing.
  2. Differentiate Between Services Provided By the Seller / Purchaser and Services Provided by Third Parties
    • Determine if the service provider has sufficient rights under its existing up-stream contracts and licenses to provide the requested services itself, or whether third-party agreements and licenses need to be entered into or amended.
    • Consider the criticality and complexity of the requested services and the costs and timing of entering into or amending third-party agreements (keeping in mind that third parties may have meaningful leverage and little incentive to provide short-term or transitional services).
  3. Define the Performance Requirements
    • Service levels must be defined in the TSA or the supporting documentation with the right level of detail, allowing the parties to understand exactly how the requested services must be performed, but without giving the service provider any contractual “outs.”
    • Avoid defaulting to “reasonable,” “commercially reasonable,” “best commercial efforts” and similar standards of performance that could allow the service provider to technically perform in accordance with the TSA, but without actually providing the requested services in a manner that gives the service recipient the benefit of its bargain.
  4. Consider the Consequences for Non-Performance of Service Levels
    • A service provider may have little incentive to perform in accordance with the service levels set in the TSA and its supporting documentation after closing unless there are credits or express liquidated damages that can be recovered by the service recipient—standard indemnities with the usual thresholds and caps may not provide adequate motivation.
    • Examine the size of credits or express liquidated damages in the context of the likely costs of business disruption and service replacement, as direct damages may be difficult or impossible to prove.
    • Consider recovery against an escrow for inadequate performance under the TSA. Specific indemnities that are not subject to thresholds or caps will provide the greatest service provider motivation, though they may be difficult to obtain as part of the larger acquisition transaction.
  5. Outline the Plan If There Are Major Service Continuity Issues
    • It is common for TSAs to contain arbitration clauses or clauses requiring the parties to bring a lawsuit if there are major service continuity issues, however, a service recipient may not want to invest the time and resources needed to comply with these traditional dispute resolution options for anything but the most egregious failures.
    • Consider including escalation clauses that allow for internal representatives of the service provider and service recipient to settle continuity issues amicably.
    • Take into account whether there is any need for enhanced business continuity or disaster recovery plans.
  6. Specify the Pricing Mechanisms and Think About Renewals and Extensions
    • Clearly articulated, objective pricing terms are critical. Unit pricing, hourly NRE rates, deliverable testing and acceptance procedures, transition timelines and phased milestones are all useful mechanisms to make pricing terms as objective as possible.
    • It is important for the service recipient to have the ability to renew the term of the TSA with agreed-upon pricing increases for the renewal terms.
  7. Determine What Third Party Consents Are Required
    • Third party consents should be identified as early in the diligence phase as possible, as the related services could require significant time to properly transition.
    • Third party consent fees may be significant and should be considered as part of the larger economic understanding of the M&A transaction.
  8. Understand the Data Accessed/Used/Processed, Ensure Appropriate Data Safeguards Are In Place and Include Responsibilities If There is a Data Breach
    • The parties to a TSA need to understand whether there will be personally identifiable, HIPAA-related or other sensitive or confidential information used in connection with the services being performed.
    • If so, consider implementing appropriate safeguards for the service provider, service recipient and their respective employees and contractors, including technical access controls, export controls, human resources/personnel controls and strong non-use and nondisclosure covenants.
    • Carefully worded warranties and indemnification obligations should be considered in the event that there is a data breach.
  9. Include Review and Audit Rights and Consider Regulatory Requirements
    • Understand the service recipient’s review and audit needs, including whether it needs additional review and audit rights of the service provider’s upstream third-party contractors.
    • While general audit rights are common in TSAs, consider whether specific audit rights for the service recipient, regulatory agencies, or other third parties are necessary for the service recipient to comply with its own policies, or legal/regulatory obligations.
  10. Allocate/Cap Liability
    • The allocation of liabilities will often follow the leverage and allocation of liabilities in the principal acquisition documents.
    • Careful consideration should be given to whether, and to what extent, the service provider is responsible for the failures of its own third-party contractors.
    • It is common for a TSA to include a waiver of indirect damages (i.e. consequential, punitive, diminution in value, etc.) and contain individual and aggregate caps on direct damages. Consider appropriate exclusions to these waivers and caps, such as breaches of confidentiality, gross negligence, willful misconduct, infringement and misappropriation.
    • Consider offset rights for the service recipient.

Often, a TSA is considered an ancillary agreement and is not given a lot of thought until late in the transaction by people without a lot of experience dealing with service arrangements. Depending upon the services that are being provided, a TSA can be a complex and sometimes contentious document. As commercial transaction lawyers, we continue to try to impress upon our M&A colleagues that involving the appropriate subject matter experts (such as us!) early in the process will lead to a clearer and more “thought-out” contractual arrangement that will allow the parties to consider and negotiate compliance and other requirements.