Guard Your E-business Against Tech Pitfalls With Software Escrow

This article will help practitioners advise their clients on how to protect themselves against such an event.

Software Escrow to the Rescue

Software escrow means that the software owner or vendor (the “licensor”) deposits the software source code with a third-party escrow agent. Escrow is typically requested by a party licensing software (the “licensee”) to ensure maintenance and updating of the software. Software escrow ensures that your business is protected from disaster, bankruptcy and other problems software licensors might encounter. The software source code is released to the licensee if the licensor:

• Files for bankruptcy;
• Fails to maintain the software; or
• Other defined events occur.

You don't want your company at the mercy of licensors' risks, which result from problems you can't control. Using source code escrow means that if your licensor doesn't come through, another developer or your own programmers can step in, and maintain and update the vital software systems that keep your company and customers happy.

In a February report on business continuity planning, research firm Gartner Group wrote that all source code must be escrowed. But, the company wrote, “Few software vendors offer escrow accounts of their own accord” and that “such accounts must be specifically negotiated into software license contracts.” Vendors may hint or otherwise suggest they don't support escrow pacts, but they have to if they are to meet their clients' needs. “Any vendor that refuses should lose its preferred vendor status,” Gartner wrote.

Many licensors in the current economic climate readily agree to source code escrow in order to be competitive. Reducing risk with escrow means that licensees can use start-up software vendors who may have a better product but more risk associated with their product or company. A licensee's use of source code escrow means that it can take advantage of software and technology alternatives that are better, newer or cheaper – or all three – without undue risk.

The beauty of source code escrow is that it serves not only the interests of licensees but also those of the developers. While placing their crown jewels in the hands of an outside party might sound risky, it can protect a business' interests as well. Deposit of source code escrow can help developers with copyright and trade secret protection, for instance. If another party later makes copyright or trade secret claims, escrow can provide a record of the licensor's creation date and proof of efforts taken to maintain confidentiality of trade secrets.

Selecting an Escrow Agent

Either the licensor or licensee will choose the escrow agent. Often, the licensor opts to select and pay for the agent so that the software owner can select which third party will store and handle its source code. Additionally, the licensor might have more than one licensee requesting escrow and will combine those licensees under one agreement to simplify record keeping and contract negotiation.

If you are a licensee purchasing the software, consider these points:

• You will want to ensure that you are a signing party to the escrow agreement with direct contact with an experienced professional escrow agent, which ensures direct dealing at the time of signing, or the ability to contact this agent later.
• It's generally best to start with the standard contracts from the agent, which usually best detail the handling of the source code deposit process.
• Your agent must be flexible in allowing you to insert other critical clauses that protect your interests as licensee or licensor.
• Be sure to select an escrow agent who is experienced in contract management, and provides technical verification.
• Be certain that the agent has insurance in case you need to make a claim against the agent later on.
• You would do well to also consider inserting a clause in the license agreement containing the following points: |
  • That you agree to escrow;
  • The general escrow agreement terms;
  • A description of the source code to be deposited; and
  • Specifying the agent.

This clause might define a certain time period within which the escrow must be established after the license agreement is executed. If this clause deadline isn't enforced, then a licensee can end up feeling helpless.

Andrea Lin, CEO of Pareto Strategy Inc., Danville, CA, which specializes in strategic marketing consulting for enterprise software companies, believes this timeframe provision is very important.

“Software firms generally negotiate the general terms of the escrow into the license with a specified timeframe in which the escrow will be completed after the license is signed,” Lin said. “This provides a great balance as clients need to know they will have adequate protection, yet developers don't want to delay sales waiting for the completion of the escrow.”

Whether the escrow agreement is signed before or after the license agreement, your company still must follow up to ensure deposits are made in a timely fashion throughout the life of the software and, if not, take prompt appropriate legal action to remedy the problem.

Intellectual Property Protection Through the Development Trail

Besides the benefit of marketplace competitiveness, the licensor can enhance its intellectual property protection by following the development trail left by source code escrow deposits. Escrow deposits can provide a clear audit trail of the software's development that will verify the product's genealogy. This can be helpful evidence in court.

Trade Secret Law. If the developer has taken appropriate steps to protect the source code in accordance with trade secret law, then this protection usually exists in the code. Using an escrow agent and having your escrow agreement include confidentiality clauses can help demonstrate two matters of legal importance:

• That the licensor has taken steps to keep the information confidential; and
• That the licensor had certain ideas ' that is, trade secrets ' as of certain dates.

Trademark Law. Under trademark law, the date of first use in commerce is a matter of great importance. So, the escrow deposit date of the source code, assuming the compiled software included use of the trademark ' for example, on a splash screen or as otherwise indicative of trademark use in commerce ' can offer valuable records in a trademark dispute.

Copyright and Patent Law. In copyright infringement cases, the heart of the matter is often who developed the item first; in other words, who stole from whom. It is common for a defendant to claim that he or she developed the work prior to the plaintiff and that it is, in fact, the plaintiff who copied the work. If your business has deposited your source code in escrow, then you have a third-party verifiable record of the date on which your code was developed and a copy of the exact code from that date. Similarly, having that verification and record date can be helpful in patenting software.

Key Source Code Escrow Agreement Terms

The agreement should outline procedures for deposit and handling of the code by the licensor and agent, including which components, such as updates, customizations, and how often deposits should occur. How the agent is to receive the code, and where and how it is to be stored, should also be addressed.

The agreement also must define the procedures for releasing the code after an event triggering release. These should include:

• Notice to the parties;
• Deadlines for response and counter argument; and
• Opportunity to seek a court order;

All parties should also be subject to confidentiality regarding the code, including the agent and licensee after receipt.

Events Triggering Code Release

The agreement should state which events would result in release of the code to the licensee. These, some of which were mentioned earlier, might include:

• Licensor filing for bankruptcy;
• Licensor breaching license agreement;
• Licensor failing to provide maintenance as agreed; or
• Licensor becoming a new entity through merger or acquisition.

The licensor should always try to limit release events to failure to provide software maintenance and updates; the other requirements are less important and depend on the bargaining power of the licensee. If the licensor continues to perform in accordance with the license agreement, then there is no reason to justify release of the source code, as this might have serious negative financial effects on the licensor and cause the event the process seeks to avoid: the licensor going out of business

Source Code License

The agreement should include a license grant to the licensee in the event of release of the code. This grant should outline how the licensee may use the code (maintenance only) and should handle the code (keeping it confidential, etc.). If the licensee wants to include broader goals, such as creation of derivative works, enhancements, resale, sublicense or other uses, then these goals should be negotiated into this section.

Other important clauses include a warranty from the licensor that the code will compile correctly, a force majeure clause, and indemnification and liability limits.

Editor's Note: The following article is one of a series on using software escrow to protect e-business, a topic that's well discussed in the e-trade business and one that generated a lot of buzz at the recent Computer Law Association conference in Washington, DC.

Medium and large-sized enterprises are increasingly reliant on software systems, but these businesses face a conundrum: due to current market conditions, their software vendors are simultaneously less viable.

So, if they make a large software investment, how can they protect themselves in the event that the software company goes out of business?

This article will help practitioners advise their clients on how to protect themselves against such an event.

Software Escrow to the Rescue

Software escrow means that the software owner or vendor (the “licensor”) deposits the software source code with a third-party escrow agent. Escrow is typically requested by a party licensing software (the “licensee”) to ensure maintenance and updating of the software. Software escrow ensures that your business is protected from disaster, bankruptcy and other problems software licensors might encounter. The software source code is released to the licensee if the licensor:

• Files for bankruptcy;
• Fails to maintain the software; or
• Other defined events occur.

You don't want your company at the mercy of licensors' risks, which result from problems you can't control. Using source code escrow means that if your licensor doesn't come through, another developer or your own programmers can step in, and maintain and update the vital software systems that keep your company and customers happy.

In a February report on business continuity planning, research firm Gartner Group wrote that all source code must be escrowed. But, the company wrote, “Few software vendors offer escrow accounts of their own accord” and that “such accounts must be specifically negotiated into software license contracts.” Vendors may hint or otherwise suggest they don't support escrow pacts, but they have to if they are to meet their clients' needs. “Any vendor that refuses should lose its preferred vendor status,” Gartner wrote.

Many licensors in the current economic climate readily agree to source code escrow in order to be competitive. Reducing risk with escrow means that licensees can use start-up software vendors who may have a better product but more risk associated with their product or company. A licensee's use of source code escrow means that it can take advantage of software and technology alternatives that are better, newer or cheaper – or all three – without undue risk.

The beauty of source code escrow is that it serves not only the interests of licensees but also those of the developers. While placing their crown jewels in the hands of an outside party might sound risky, it can protect a business' interests as well. Deposit of source code escrow can help developers with copyright and trade secret protection, for instance. If another party later makes copyright or trade secret claims, escrow can provide a record of the licensor's creation date and proof of efforts taken to maintain confidentiality of trade secrets.

Selecting an Escrow Agent

Either the licensor or licensee will choose the escrow agent. Often, the licensor opts to select and pay for the agent so that the software owner can select which third party will store and handle its source code. Additionally, the licensor might have more than one licensee requesting escrow and will combine those licensees under one agreement to simplify record keeping and contract negotiation.

If you are a licensee purchasing the software, consider these points:

• You will want to ensure that you are a signing party to the escrow agreement with direct contact with an experienced professional escrow agent, which ensures direct dealing at the time of signing, or the ability to contact this agent later.
• It's generally best to start with the standard contracts from the agent, which usually best detail the handling of the source code deposit process.
• Your agent must be flexible in allowing you to insert other critical clauses that protect your interests as licensee or licensor.
• Be sure to select an escrow agent who is experienced in contract management, and provides technical verification.
• Be certain that the agent has insurance in case you need to make a claim against the agent later on.
• You would do well to also consider inserting a clause in the license agreement containing the following points: |
  • That you agree to escrow;
  • The general escrow agreement terms;
  • A description of the source code to be deposited; and
  • Specifying the agent.

This clause might define a certain time period within which the escrow must be established after the license agreement is executed. If this clause deadline isn't enforced, then a licensee can end up feeling helpless.

Andrea Lin, CEO of Pareto Strategy Inc., Danville, CA, which specializes in strategic marketing consulting for enterprise software companies, believes this timeframe provision is very important.

“Software firms generally negotiate the general terms of the escrow into the license with a specified timeframe in which the escrow will be completed after the license is signed,” Lin said. “This provides a great balance as clients need to know they will have adequate protection, yet developers don't want to delay sales waiting for the completion of the escrow.”

Whether the escrow agreement is signed before or after the license agreement, your company still must follow up to ensure deposits are made in a timely fashion throughout the life of the software and, if not, take prompt appropriate legal action to remedy the problem.

Intellectual Property Protection Through the Development Trail

Besides the benefit of marketplace competitiveness, the licensor can enhance its intellectual property protection by following the development trail left by source code escrow deposits. Escrow deposits can provide a clear audit trail of the software's development that will verify the product's genealogy. This can be helpful evidence in court.

Trade Secret Law. If the developer has taken appropriate steps to protect the source code in accordance with trade secret law, then this protection usually exists in the code. Using an escrow agent and having your escrow agreement include confidentiality clauses can help demonstrate two matters of legal importance:

• That the licensor has taken steps to keep the information confidential; and
• That the licensor had certain ideas ' that is, trade secrets ' as of certain dates.

Trademark Law. Under trademark law, the date of first use in commerce is a matter of great importance. So, the escrow deposit date of the source code, assuming the compiled software included use of the trademark ' for example, on a splash screen or as otherwise indicative of trademark use in commerce ' can offer valuable records in a trademark dispute.

Copyright and Patent Law. In copyright infringement cases, the heart of the matter is often who developed the item first; in other words, who stole from whom. It is common for a defendant to claim that he or she developed the work prior to the plaintiff and that it is, in fact, the plaintiff who copied the work. If your business has deposited your source code in escrow, then you have a third-party verifiable record of the date on which your code was developed and a copy of the exact code from that date. Similarly, having that verification and record date can be helpful in patenting software.

Key Source Code Escrow Agreement Terms

The agreement should outline procedures for deposit and handling of the code by the licensor and agent, including which components, such as updates, customizations, and how often deposits should occur. How the agent is to receive the code, and where and how it is to be stored, should also be addressed.

The agreement also must define the procedures for releasing the code after an event triggering release. These should include:

• Notice to the parties;
• Deadlines for response and counter argument; and
• Opportunity to seek a court order;

All parties should also be subject to confidentiality regarding the code, including the agent and licensee after receipt.

Events Triggering Code Release

The agreement should state which events would result in release of the code to the licensee. These, some of which were mentioned earlier, might include:

• Licensor filing for bankruptcy;
• Licensor breaching license agreement;
• Licensor failing to provide maintenance as agreed; or
• Licensor becoming a new entity through merger or acquisition.

The licensor should always try to limit release events to failure to provide software maintenance and updates; the other requirements are less important and depend on the bargaining power of the licensee. If the licensor continues to perform in accordance with the license agreement, then there is no reason to justify release of the source code, as this might have serious negative financial effects on the licensor and cause the event the process seeks to avoid: the licensor going out of business

Source Code License

The agreement should include a license grant to the licensee in the event of release of the code. This grant should outline how the licensee may use the code (maintenance only) and should handle the code (keeping it confidential, etc.). If the licensee wants to include broader goals, such as creation of derivative works, enhancements, resale, sublicense or other uses, then these goals should be negotiated into this section.

Other important clauses include a warranty from the licensor that the code will compile correctly, a force majeure clause, and indemnification and liability limits.