Transition Service Agreements (TSA): Understanding the Key Considerations

Often, when a buyer purchases a specific business unit of a company, complexities arise for both buyer and seller as the business unit being sold frequently depends upon several services provided by the seller. At the time of closing, the buyer may not have the infrastructure, resources, or functionality to initially support these services. Transition services agreements (“TSAs”, for short) are effective tools in addressing these issues and can help ensure a smooth transition during the divestiture. A TSA is an agreement between the buyer and seller whereby the seller agrees to provide its services and know-how to the buyer for a specified period of time post-closing. Once the purchased business unit is able to be fully integrated into the buyer, those services become unnecessary. The TSA lays out the terms and conditions that will govern the provision of those services by the seller, and the costs to be paid by the buyer.

TSAs aren’t necessarily complex themselves, but they can be difficult to negotiate and draft, as the parties are motivated by conflicting goals: the buyer wants to maintain business continuity and ensure that it has time to establish critical functions for the business; the seller wants to complete its divestiture of the business and ensure that they’re being adequately compensated for their services. The seller’s motivations are particularly salient in recent years as COVID-19 and market volatility have pushed organizations to prioritize their core business and to quickly divest their non-core assets. Due to the varying needs of TSAs and the competing motivations of the buyer and seller, there are several key provisions of the TSA that a lawyer should be aware of in negotiating and drafting.

1. Define the Scope of Services – The services that the seller will need to provide under a TSA can vary widely depending on the context of the deal, some common services include human resources (e.g. benefits management), information technology or processing services, software, accounting, finance, and administration. In some cases, a TSA may even include facilities management services when the buyer subleases space from the seller. A TSA should not only identify the specific types of services that will be provided, but should explain those services with the appropriate level of detail necessary to ensure that both parties understand exactly what services will be performed. Because unanticipated pain points may arise during a transition, the TSA should also allow for flexibility through a provision wherein the parties can add any needed services that were inadvertently omitted. As this Deloitte Memo on TSAs suggests, a good practice for sellers is to consider defining the scope of services needed for a divestiture before a buyer is even identified.
2. Standard of Performance – The level of service that the seller must provide should also be explained. Rather than relying on the usual generic performance terms such as “commercially reasonable” and “best commercial efforts,” the TSA should outline how the services will be delivered. Including a requirement that the seller will deliver services to the business unit at the same standard and in the same manner as it has previously is a common practice. This ensures that the seller cannot technically perform under the TSA but fail to provide critical services to the buyer. At the very least, the parties should agree to some specificity such as a cap on the dollar value of services the seller will provide.
3. Remedies for Non-Performance – The parties should also consider how they will address issues in the provision of the services and how the seller can remedy non-performance. This is particularly salient in the event the seller has issues providing the critical services because key personnel leave the company or the seller runs into technical issues. And in the event that the seller fails to perform the services as agreed, a liquidated damages clause may be useful in motivating the seller to comply with the terms of the TSA.
4. Third Parties – Some of the services that the seller will provide to the buyer may be sourced from a third party vendor. The seller will need to ensure that it has sufficient rights under the contracts it has in place with third parties to provide those services to the buyer and whether consent from that third party is required. In some cases, it may be necessary for the third party to be engaged directly by the buyer. Additionally, if the buyer and seller are sharing confidential and sensitive information, consideration must be given to whether such information will or must be shared with a third party and, if so, how it will be protected.
5. Termination – The parties should clearly define how and when the TSA will terminate. It is advisable for the parties to set up an exit plan listing the steps the buyer will need to take in order to build, outsource, or terminate the functionality being provided under the TSA. The parties need to be realistic about these timelines. Sellers prefer when there is a definite end date because the whole motivation behind the divesture was to detach itself from the carved-out business unit. Conversely, the buyer will likely want more flexibility as to termination. If this is the case, the parties should consider a clause that would allow for the extension of services provided under the TSA, either individually or in the aggregate, and whether to increase the service cost of the services when the initial agreed upon term of the TSA has expired. This allows room for any potential hiccups in the exit plan while also disincentivizing the buyer to extend the TSA.

TSAs are unique to the transaction at hand, but the above are important considerations to think through with your client as you head into negotiating and drafting a TSA. Well-drafted TSAs are excellent tools to govern the relationship between parties after the closing of a divestiture, and to ensure continuity of a business. Identifying these thorny aspects of the TSA ahead of time will make the process of negotiating and drafting a TSA that much smoother.