A well-drafted escrow agreement can form an important component of the risk mitigation strategies used in information technology contracts.

The key to an effective escrow arrangement is to ensure that the licensee is able to access and use source code and other relevant materials to allow it, on the occurrence of certain events, to obtain ongoing support for software (whether provided by the licensee itself or a third party) with minimal disruption to the licensee's business.

Set out below are some key considerations for drafting effective escrow arrangements.

Description and deposit of escrow materials

The materials to be placed in escrow should include not only the source code itself, but also supporting documentation and other materials (such as software development tools). The escrow package should contain sufficient materials to enable the licensee, on release of the escrow package, to have everything it needs to maintain, operate and modify the software.

The escrow materials should remain 'in step' with the software being used by the licensee. To this end, the escrow agreement should require the software vendor to update the materials in escrow, within a specified period following the release of any updates that the licensee puts into operational use. Importantly, there may be a distinction between the most 'up-to-date' software and the 'correct' software (that is, the version of the software that the licensee is actually using). The escrow agreement aims to ensure the licensee can continue to get support for software in the event of certain triggering events, and it is therefore imperative that the materials in escrow are correct and current, in that they reflect the latest version of the software actually being used by the licensee.

An aid to the 'currency' obligation described above, is to oblige the escrow agent to maintain a register of all escrow materials deposited by the software vendor and notify the licensee of all such deposits.

It is also prudent to require the software vendor to warrant that the escrow materials are free from any virus, trojan, backdoor or other such code that may prevent the escrow materials from performing in accordance with the specifications contained in the relevant head agreement.

Verification of escrow materials

The licensee may require a right to analyse and conduct tests of the escrow materials to verify their accuracy and currency. In turn, the software vendor may require this verification to be undertaken by the escrow agent or an independent third party (in an effort to protect the valuable source code from access by the licensee prior to any triggering event).

Events giving rise to release of escrow materials

Ultimately, it is the events that trigger the release of the escrow materials that are at the heart of an effective escrow arrangement. The triggering events need to reflect situations which, should they occur, would result in the licensee being unable to continue using or maintaining the software unless it had ready access to the source code and related materials.

Trigger events should include:

  • cessation of maintenance services or a refusal by the software vendor to support the software; 

  • termination of the head agreement by the licensee for the software vendor's breach of contract or default; and

  • the software vendor suffering an insolvency-related event (such as its inability to pay its debts, cessation of its business, or its wind-up or liquidation).

Release of escrow materials

The process to be followed after the occurrence of a triggering event is also important in ensuring that the escrow arrangement is of practical value. The process needs to clearly set out timeframes within which each party must act. The release process should not include unnecessarily burdensome notification and objection procedures. The simpler the process is, the easier it will be for the licensee to enforce the escrow agreement should the software vendor prove unresponsive.

The software vendor may wish to include an alternative dispute resolution process that the parties must follow before commencing court proceedings. As in any commercial agreement, an alternative dispute resolution process may provide an efficient method for resolving disputes without recourse to the courts. However, a drawn-out informal dispute resolution process may prove detrimental to the licensee in a situation where the licensee requires prompt access to the escrow materials (especially where the software in question is business critical).

Rights on release

The escrow agreement must ensure that the licensee has a right to use all of the materials contained in the escrow package. It is usual that a head agreement will only grant rights in respect of object code and certain documentation and will also expressly prohibit the licensee from doing things like modifying the software. The licence granted in respect of the escrow package must allow the licensee (and preferably the licensee's service provider) to maintain, operate and modify the software.

Fees

The parties should review the escrow agent’s fees and ensure that the party responsible for payment is clearly identified and that any increases in such fees is ascertainable from the outset.

It is important to ensure that the payment of escrow fees is appropriately managed by the parties to the escrow agreement, especially where the escrow agreement specifically entitles the escrow agent to place a lien over the materials in escrow in the event the escrow fees are not paid.

Further, if the software vendor agrees to pay all (or even part) of the fees it is important to ensure that the escrow agreement continues even where the software vendor fails to make a payment. One way to achieve this is to require the escrow agent to notify the licensee of a failure to pay so as to give the licensee an opportunity to remedy the failure (and, where possible, recover the fees from the software vendor).

Loss of escrow materials

The escrow agent should be obliged to take all reasonable care to ensure the preservation, care, maintenance, safe custody and security of the escrow materials when they are in the escrow agent's possession, custody or control. The escrow agent should bear the risk of loss, theft, destruction or damage to the escrow materials while in the escrow agent's control. This could include an obligation to obtain a further copy of the materials in escrow, at the escrow agent's own expense.

Liability of escrow agent

An escrow agent will usually seek to limit its liability under the escrow agreement (including excluding its liability for consequential and indirect losses and damages and limiting its liability in all other instances to a specified amount) and may also require the software vendor and/or the licensee to indemnify it against all loss and damage that it may incur as a result of performance by the escrow agent of its obligations under the escrow agreement. Such provisions will need to be carefully considered by both the licensee and the software vendor.

Insurance

It is prudent to require the escrow agent to maintain professional indemnity insurance to ensure that any liabilities of the escrow agent can be realised.

Termination

The termination provisions should be drafted to ensure that where the escrow agent seeks to terminate the escrow agreement, adequate notice is provided as may be appropriate in the circumstances, particularly in relation to failure to pay an invoice by the payment date (see further the discussion above in relation to fees).

The termination provision should also address breach of the escrow agreement by the escrow agent (for example, failure to provide the escrow services) and insolvency on the part of the escrow agent. Further, an obligation should be included (either in the escrow agreement or the head agreement itself) to the effect that, if the escrow agreement is terminated on such grounds, the software vendor and the licensee must enter into a new escrow agreement with another escrow agent within a stipulated time period. Such an obligation will ensure that the escrow arrangements will not fall over simply because of the termination of the original escrow agreement.

Given the risk mitigation role of escrow agreements for service delivery and operational arrangements, the issues discussed above should be carefully considered by software licensees when a form of escrow agreement is proposed by a software vendor or escrow agent.

However, that being said it should be remembered that an escrow agreement is likely to be a 'weapon of last resort', where other more practical solutions have been exhausted. There may well be delays in enforcing an escrow arrangement and practical difficulties in sourcing technical expertise (other than from the software vendor) to support the software using the materials in escrow. As such, an escrow agreement should be viewed as a facet of risk mitigation, but not as a universal panacea.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.