Playing the advantage: how service credits keep contracts on track

With the World Cup in full swing, fans will be familiar with the referee’s ‘advantage’ rule. A foul may occur, but instead of stopping the game, play continues if it benefits the attacking team. Only later might the referee come back to deal with the infringement.

In commercial contracts, particularly outsourcing and service contracts, service credits perform a similar role.

What are service credits?

Service credits are pre-agreed financial adjustments (often deductions from fees) that apply when a supplier fails to meet agreed service levels. In simple terms, they provide an immediate, built-in consequence for underperformance, without the need to pause the contract or escalate into a dispute.

They are most commonly used in ongoing service arrangements – such as IT, facilities management or outsourcing – where performance can be measured over time.

Like advantage in football, they allow the commercial relationship to carry on without interruption, while still recognising that something has gone wrong.

What role do they play?

Service credits typically sit alongside service levels or KPIs, which measure how well a supplier is performing. If performance drops below the agreed standard, credits are triggered automatically.

Their key benefits are:

• Speed: no need to prove loss or pursue a claim
• Certainty: both parties know in advance what happens if standards slip
• Continuity: the contract keeps running, avoiding disruption.

In practice, they are often used as a performance management tool, not just a remedy.

While service credits are commercially useful, they must also be legally enforceable.

The penalty question – are service credits at risk?

One of the key legal issues with service credits is whether they could be challenged as an unenforceable penalty.

This matters because, in many cases, service credits are triggered by a failure to meet agreed service levels. If that failure amounts to a breach of contract, the associated financial consequence may be scrutinised under English law.

The Supreme Court’s decision in Makdessi v Cavendish Square Holdings BV [2015] reshaped how courts approach this question.

The case makes clear that a clause will not be enforceable if it is, in substance, a penalty without proper justification. To be valid, the clause must protect a legitimate interest of the innocent party in the performance of the contract. Importantly, that interest can go beyond simply recovering financial loss – for example, maintaining consistent service quality or discouraging repeated underperformance.

However, there are limits. A clause will be vulnerable if it’s extravagant, exorbitant or unconscionable, meaning that it imposes a detriment which is out of all proportion to that legitimate interest. Put simply, the clause must be commercially justifiable rather than punitive. If its purpose is merely to punish the breaching party, it’s unlikely to be enforceable.

Whether a service credit regime falls foul of this test will depend on the specific facts and the drafting of the clause. In practice, most well-structured service credit mechanisms are capable of being justified, particularly where they are calibrated to reflect the importance of the relevant service level and the impact of failure.

Common drafting pitfalls

Despite their usefulness, service credit regimes can cause problems if not carefully drafted. Common issues include:

• Unclear status: is the credit the only remedy, or can other claims still be brought? Ambiguity here can lead to disputes
• Getting the level wrong:
  • Too low: the supplier has little incentive to perform
  • Too high: the clause risks being challenged as a penalty
• Disconnect from reality: credits should reflect the importance of the service level and the real impact of failure, not arbitrary figures
• Over-reliance: service credits are not a complete solution. They work best alongside other rights, such as termination for persistent failure.

Final whistle

Service credits are a practical way to manage performance without derailing a commercial relationship. Like the referee allowing play to continue, they strike a balance between fairness and flow.

Get them right, and they keep the game moving. Get them wrong, and you may find the contract brought to a sudden halt anyway.