Transition Service Agreement: Everything You Need to Know

A transition service agreement is a contract wherein the seller in a mergers and acquisition transaction is expected to provide continuing services in support of the post-closing company. Such services may include IT, HR, accounting, and other infrastructure support. An agreement to provide such service is common when the buyer lacks the system or management capabilities to absorb the acquisition on their own, but the seller does not. This situation may occur when a larger company sells off a division to a buyer with less infrastructural sophistication, such as a new company that has not had to time to establish such capabilities.

Drafting a Transition Service Agreement

Transitional service agreements can be very hard to manage if not properly defined. One can have a transitional service agreement that is a brief, back-office administrative service agreement where the fees will be set in the future and require no formal standards of performance, or one can have a comprehensive agreement with a well-defined scope, service level, fee arrangement, and data security/privacy provision. A poorly drafted service agreement can result in disputes between the two parties regarding the level of services that should be provided. An effective transitional service agreement should be sure to cover the following key points:

• Scope of services. This includes the specific services that will provided, the duration of the services, and the service standards expected. Pertaining to service standards, terms like “best commercial efforts,” “commercially reasonable,” and “reasonable” should be avoided due to their vagueness.
• Clear pricing mechanisms. This will cover the fee for services and any additional fees for additional services. Hourly NRE rates, unit pricing, transition timelines, deliverable testing, and phased milestones should be included.
• Dispute/non-performance resolution. Consequences for a failure to perform up to the standards of the contract should be put in place, as well as a system for resolving disputes, in general. Express liquidated damages and recovery against an escrow might be considered, as standard indemnities may not be a sufficient motivation.

Additional points to cover should also include:

• Audit and review rights.
• Third-party consents.
• How transition out of the service agreement will be accomplished.
• Liability allocation.

Such details should be worked out by the concerned parties as early on in the negotiation process as possible, with the ideal timeframe being in the due diligence phase.

Benefits of a properly implemented transition service agreement include:

• A faster close to a deal.
• A smoother transition.
• A less costly transition.
• A clean separation.
• Better end-state solutions.

Because a transition service agreement is but one component of a merger and acquisition deal, it will usually not include, or only have the most basic provisions for the following:

• Warranties.
• Indemnification.
• Business continuity.
• Disaster recovery.
• Service level agreements.

Data Confidentiality and Transition Service Agreements

Another important aspect to consider with transition service agreements is data confidentiality. Although most transition service agreements will include provisions for confidentiality, these are rarely sufficient to establish true data security. What both parties need to understand is that their relationship to one another will have fundamentally changed with the consummation of such a transition service agreement. Thus, security and data protection should be treated similarly to how it would be in an outsourcing relationship, and in such cases numerous countries that have data protection laws will require consent for the disclosure of personal information to third parties.

Depending on what type of information could be shared, including other requirements pertaining to the collection, protection, use, and disclosure of data could also be useful. This might include:

• Provisions in the privacy policies of the parties involved.
• Narrow access granting or licensing terms.
• An approval process to be run prior to the granting of access to data.
• Stringent personnel screening for those who access secure date internally.
• Strong warranties, indemnification provisions, and confidentiality requirements.
• Requirements for contractual obligations with any third parties.

Such requirements from third-party entities might include implementation of such security measures as:

• Firewalls.
• Data encryption.
• Secure file transfer protocol.
• Secure VPN access.
• Anti-malware/anti-virus software.

If you need help understanding data security or any other aspect of the transition service agreement, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.