Liability and the cloud

I saw an interesting article about cloud provider liability limits, including some quotes from my esteemed colleague Drue Reeves (via Gartner’s acquisition of Burton). A quote in an article about Eli Lilly and Amazon also caught my eye: Tanya Forsheit, founding partner at the Information Law Group, “advised companies to walk away from the business if the cloud provider is not willing to negotiate on liability.”

I frankly think that this advice is both foolish and unrealistic.

Let’s get something straight: Every single IT company out there takes measures to strongly limit its liability in the case something goes wrong. For service providers — data center outsourcers, Web hosting companies, and cloud providers among them — their contracts usually specify that the maximum that they’re liable for, regardless of what happens, is related in some way to the fees paid for service.

Liability is different from an SLA payout. The terms of service-level agreements and their financial penalties vary significantly from provider to provider. SLA payouts are usually limited to 100% of one month of service fees, and may be limited to less. Liability, on the other hand, in most service provider contracts, specifically refers to a limitation of liability clause, which basically states the maximum amount of damages that can be claimed in a lawsuit.

It’s important to note that liability is not a new issue in the cloud. It’s an issue for all outsourced services. Prior to the cloud, any service provider who had their contracts written by a lawyer would always have a limitation of liability clause in there. Nobody should be surprised that cloud providers are doing the same thing. Service providers have generally limited their liability to some multiple of service fees, and not to the actual damage to the customer’s business. This is usually semi-negotiable, i.e., it might be six months of service fees, twelve months of fees, some flat cap, etc., but it’s never unlimited.

For years, Gartner’s e-commerce clients have wanted service providers to be liable for things like revenues lost if the site is down. (American Eagle Outfitters no doubt wishes it could hold IBM’s feet to the fire with that, right now.) Service providers have steadfastly refused, though back a decade or so, the insurance industry had considered whether it was reasonable to offer insurance for this kind of thing.

Yes, you’re taking a risk by outsourcing. But you’re also taking risks when you insource. Contract clauses are not a substitute for trust in the provider, or any kind of proxy indicating quality. (Indeed, a few years back, small SaaS providers often gave away so much money in SLA refunds for outages that we advised clients not to use SLAs as a discounting mechanism!) You are trying to ensure that the provider has financial incentive to be responsible, but just as importantly, a culture and operational track record of responsibility, and that you are taking a reasonable risk. Unlimited liability does not change your personal accountability for the sourcing decision and the results thereof.

In practice, the likelihood that you’re going to sue your hosting provider is vanishingly tiny. The likelihood that it will actually go to trial, rather than being settled in arbitration, is just about nil. The liability limitation just doesn’t matter that much, especially when you take into account what you and the provider are going to be paying your lawyers.

Bottom line: There are better places to focus your contract-negotiating and due-diligence efforts with a cloud provider, than worrying about the limitation-of-liability clause. (I’ve got a detailed research note on cloud SLAs coming out in the future that will go into all of these issues; stay tuned.)

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Posted on August 24, 2010, in Industry and tagged , , . Bookmark the permalink. Leave a comment.

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