Software Escrow Contracts: Key Points to Know

What is a Software Escrow Contract?

Software escrow is an arrangement between three parties: a software developer, a software user and an independent escrow agent. The process involves the developer of the software depositing with the escrow agent a copy of its source code or a compiled form (the "Deposit"). The source code is the uncompiled code written by the programer using a high-level programming language such as C# or Java. The compiled code is a specific processed form of the source code that the computer can run. The escrow agent holds the Deposit in escrow for the benefit of the software user.
The technology in the source code Deposit forms the basis of the software solution being deployed by the software developer. A software user may be using an application in its business of which the source code underlining the application is not the subject of a commercial agreement between the user and the software developer . The purpose of the software escrow contract is to ensure that access to the source code underlining the application will be available to the software user in the event the software developer is unable to continue to provide service and support for the application (such as in the event of bankruptcy of the software developer).
The terms of the software escrow contract address the circumstances under which the software user is to be provided access to the source code (which would include at the minimum the insolvency of the software developer), including both the issuance of a release of the Deposit held in escrow and provisions for the safe and secure use by the software user of the released Deposit (which would also include procedures for the destruction of such released Deposit once it has been successfully used).

Advantages of Software Escrow for Companies

In addition to providing proactive solutions that help mitigate risk, promote service continuity, and reduce the likelihood of legal disputes and regulatory compliance issues, software escrow benefits all parties. When all parties are equally invested in the escrow relationship, trust and confidence are created and confidence promotes ongoing success. Proper usage of the software escrow agreement ultimately benefits the escrower, escrow agent, and end user alike.
Further, software escrow can save companies money by avoiding costly interruptions in service continuity. Disaster recovery is not cheap and every disruption means lost revenue for your business. Escrowed source code and/or other software-relevant assets help reduce those downtimes. When events such as service interoperability failure or cybercrime occur, the company that owns the software can leverage the source code and proprietary assets held in escrow to implement a remedy.
Finally, software escrow mitigates risk for the following reasons:
While legally binding, software escrow agreements have the potential to benefit the businesses involved.

Components of a Software Escrow Agreement

A software escrow contract should include both Steven J. Ong’s essential elements and Gupta’s, as well as all of the following specifications between the parties:

• Depositor’s obligation to deposit source code and related materials under this agreement;
• Scope of source code and related materials to be deposited;
• Identification of other materials or components, if any, to be held in escrow by the escrow agent;
• Conditions upon which the escrow agent is authorized to release the source code and related materials being held in escrow, including depositors obligation to update the source code as technology changes over time;
• Conditions for ongoing payment of fees to the escrow agent, failure to pay the fee may constitute grounds for immediate release of source code, etc. to the licensee;
• Rights of licensee to confirm receipt of source code and other materials from depositors to the escrow agent by the date identified for release in the escrow contract;
• Confidentiality obligations of the escrow agent to the depositor, including the use of sinario encryption techniques to encode the contents of the source code and other materials being deposited in escrow, and the right for the depositor to inspect the encoding process and store an exact copy of the source code and related materials in their own vault or another secure location;
• Conditions under which the depositors may discontinue deposits to the escrow agent and retrieve source code and other materials deposited in escrow.

Selecting an Optimum Escrow Agent

When it comes to software escrow agreements, selecting a dependable and professional escrow agent is crucial to achieving the intended protection. An escrow agent is a trusted third party that holds a software developer’s source code and other technical information for a licensee’s benefit in the event that certain contractually-specified conditions are triggered. Therefore, choosing the right escrow agent can mean the difference between a successful contingency plan and a costly failure. It is important to look beyond the surface in choosing an escrow agent. Some of the necessary due diligence includes: Reputation: Does the escrow agent have a proven record of providing escrow services? Do they have a list of reputable clients? Are they owned by or affiliated with an escrow services provider? Experience: How long has the escrow agent been in business? Who are its key management personnel, and how much experience do they have? How many contracts does the agent oversee? How many applications are maintained in the escrows? How many requests have they received to release the source code in the past 12 months? What percentage of requests was satisfactorily resolved? With what frequency do they receive the source code files? How many of those files are successfully validated? Security: Is the escrow service provider sufficiently capitalized? Does the escrow agent have a business continuity plan to ensure that escrow deposits will continue to be maintained during a prolonged disruption to normal business operations? Are duplicate back-up files maintained off-site? Where are the escrow agent’s and its clients’ computer servers and network facilities located? Are they secured against intruders? Is the data encrypted? Are audits welcome (and is that an additional cost)? Are there access controls on the escrow agent’s files?

Typical Situations That May Require Escrow Release

The release of the source code held in escrow is intended to act as a safety net for licensee. Its purpose is to provide the licensee a path to receive, use, and modify the source code should one of several predefined circumstances arise. This is often referred to as an "enabling event," or a "release event," and usually negotiated and described as a list of specified conditions. Taking the example of a licensed software package, some of the key release events include, but are not limited to: Events precipitated by a vendor’s change of circumstances include the failure to properly maintain the software such that it meets the contractual functionality, failure to deliver bug fixes requested by licensee in a timely manner, or the misappropriation of proprietary information by the vendor (i.e., with respect to trade secrets , intellectual property or confidential information). Another such triggering event might be the merger or acquisition of the software vendor by a competitor. In such a case, the licensee will often have concerns about the degree to which its own confidential information may be safeguarded from use by the acquirer. If an escrow contract is properly drafted, the essential conditions necessary for an escrow release event will be reasonably heretofore mentioned; thus, the vendor, the licensee, and potentially the escrow agent and/or a third party auditor are in agreement on the circumstances under which the source code can be released from escrow. Then, if one of the specific pre-defined conditions have occurred, the escrow agent should follow the conditions outlined for release in the agreement. A thoughtful escrow contract should outline specifically each of the circumstances which will lead to a source code release, and under what conditions the licensed software will be distributed.

Legal Aspects of Software Escrow

Software escrow agreements, while generally centered on technology transfer and intellectual property protections, can involve complex legal considerations. For example, the precise parameters of what materials should be placed in escrow are often hotly contested as it is in a developer’s best interests to minimize what it deposits. A standard trope used by enterprise software customers is, "You’ll have a difficult time convincing us that the software installed when we signed the agreement is different from the software we will receive in escrow." As they say, the devil is in the details. Time and space preclude an examination of every potential legal issue, but a few are worth mentioning.
Software escrow agreements should define what constitutes a dispute, describing things like license violations and whether the contract is silent or whether a dispute must be related to the subject software. Disputes concerning whether software delivered in escrow is subject to escrow are also not uncommon.
One prominent area of litigation in this area concerns whether an end customer has a right to demand the source code of a software product they license. One answer is that the developer should have to make the developer’s source code completely available in escrow; otherwise, they may violate their contractual obligations under the escrow agreement. But that answer begs the question of what constitutes a violation. A recent court decision in December 2018 provides a roadmap for how escalatory remedies can be pursued through the courts.
The escrow process and the protocols for release under various conditions also deserve careful drafting attention particularly with reference to the proper functionality of the deposit and the appropriate testing of the escrow deliverables. While the deposit contractual requirements must be met, the end customer is under no obligation to test the escrow deposit for all the expected uses contained in the developed software. Although there are instances where escrow agents have sued their clients to compel them to review or test the deposit, recently cases have been prevailing that the escrow agent only has an obligation to exercise commercially reasonable efforts with respect to the validation and testing of the deposit deliverables submitted by the licensed end user.

FAQs as to Software Escrow

Q: What is software escrow?
A: Software escrow is a three-way agreement between a software vendor, a software user and an independent third-party queuing agent (the "Queuing Agent") that involves the deposit of source code and related materials necessary for the continued operation of a software or system product. The purpose of the agreement is to ensure the ongoing availability of materials for the protection of the software user if the software vendor stops maintaining and supporting the product for any reason.
Q: Why should a software escrow agreement be managed by an independent third party?
A: Because it is not enough that a vendor say, during the deal-making stage, that it will always support its products. Simply put, software companies come and go, and new products are introduced all the time. Many factors can affect the software vendor’s ability or desire to continue to develop, test and maintain a particular product line . A company’s internal escrow administration will typically not be considered sufficiently independent by users and clients to fairly assess a release request or verify the accuracy and completeness of an escrow deposit.
Q: What is the rights to possess and use the code approximately?
A: Those rights are usually a fair and reasonable approximation of what the user would have received under the software license. For example, if an originally purchased 1000 copy license had been upgraded to a 3000 copy license, the user would expect that the rights to the source code cover the 3000 copy license usage, provided there was no other limitation in the software license.
Q: Isn’t an escrow agent communicating with the vendor and user regarding the use of the deposits the best way to handle the process?
A: No. Users must be able to work directly with a fully independent agent, and a process that ensures a user will not be harassed by either the vendor or the agent over an escrow release decision.