Point of No Return: When to Take a Client to Court

No service industry company wants its client to end up on the other side of a lawsuit. But even though industry lawyers advise against it, sometimes going to court is the only option available to survive the toxic fumes that remain after a business relationship has gone up in flames.

The first thing to understand about the customer lawsuit is that it is a very rare occurrence among B2B service providers. Long-term contracts and relationships are hard to come by in this industry. This is even more true for nearshore and offshore providers who already have to deal with the negative opinions that some U.S. customers may have about their operating model.

“Software is not a litigious industry. With anything outsourcing-related, service providers really value the contracts they sign; to them, each one is incredibly valuable. It’s rare for a contract like that to lead to a lawsuit,” he commented. Gabriela SmithFounder and Managing Partner of Texas-based law firm GNS Law.

Conventional industry wisdom among SLA lawyers is that client lawsuits should remain locked away behind thick glass, accessible only in moments of real danger. All available options should be explored before pressing the big red button.

“If a lawsuit does occur, its cost should be significantly lower than the benefits it could bring to the service provider,” he said. Daniel GuzmanSenior Legal Counsel at cloud solutions company Escala 24X7. “The damages need to be assessed (before a lawsuit is considered). SLAs usually contain clauses that aim to avoid any controversy through mediation, conciliation or even arbitration before the case goes to court.”

Nevertheless, there are situations in which the company’s legal department will not oppose the initiation of legal proceedings.

More than debt

You’d think most service providers would be willing to take their customers to court when money is involved. But even then, industry lawyers advise against it. The general view among lawyers is that failure to pay alone isn’t enough to trigger a lawsuit.

“The problems should be serious enough to justify filing a lawsuit,” he commented. Ameyalli AmadorContract Analyst at Nielsen. “For example, if a customer breaches confidentiality; if code is shared (without consent); or if the service platform is shared in a way that benefits a third party.”

“Even then, you would have to assess whether the harm caused justifies a lawsuit,” Ameyalli added. “Most SaaS contracts, both B2B and B2C, have a conciliation clause and/or mediation before the hearing.”

“I believe that a lawsuit against a customer should only occur when the breach of contract is so damaging that it causes not only financial but also reputational damage,” added Daniel Guzmán. “Only when all possibilities have been exhausted without success and the breach causes significant damage (to the service provider) should a lawsuit be considered.”

Another thorny issue in nearshore contracts is talent poaching. Tech companies are always hungry for high-quality developers, so it’s not uncommon for them to try to hire talent directly from a nearshore staffing agency after a very successful “test run.”

“This is especially common in staffing deals. The company will provide the client with talent, the client will fall in love with that developer and try to hire him or her directly,” noted Gabriela Smith.

“But there are also agreements there,” she added. “If there was a clause in the contract about not soliciting customers and the customer violated it, then he will have to compensate the service provider in some way. If there is no such clause, well, he has the right to help himself.”

The bill should be big enough

When lawsuits arise over money included in SLAs, the amount should be large enough to justify the legal costs and potential reputational damage.

“If the client doesn’t have the money, and the software company has provided hundreds of thousands of dollars in products, services or development, then there are legal conflicts. But even then, before going to court, we try to negotiate. Tactics vary from company to company,” commented Gabriela Smith.

“In our 10 years as a technology company, I’ve only seen one case where we’ve had to sue a client, and that involved a lot of money,” Smith added. “I’ve seen a lot of nonpayment cases. In those cases, we usually send a demand letter for the money owed. We end up negotiating with the client, who usually pays at least a percentage of what’s owed.”

Lawsuits are a harsh reality of business relationships in the service sector. Yet legal experts emphasize time and again that they should be considered a last resort in dealing with a very difficult situation.

“I don’t think suing a customer should be a common practice in the service industry. In all my years of experience, I’ve never gotten to that point (suing a customer),” said Daniel Guzman.

“I can’t give you specific examples (of lawsuits against customers), but if a lawsuit does happen, its cost should be much lower than the benefits it could bring to the service provider,” Amayelli Amador added.