Escrow Agreements: Traditional protection for new scenarios

April 30, 2004

Most software developers make available and license the object code (or computer readable version) of their software, imposing restrictions on reverse engineering and decompilation and maintaining strict confidentiality regarding source code and source materials (the uncompiled code, which allows someone familiar with the programming language to understand the software, what it does and how it operates).

Should a licensee wish to develop or maintain any software which it uses or a Web site which has been developed for it using a supplier’s proprietary software or tools, the licensee will usually need to go back to the supplier to procure such services. It is not possible for the licensee to do any of this without access to the supplier’s source code. Most licensees will enter into an ongoing maintenance and support agreement at the same time as purchasing a software licence and often would consider it impractical and uneconomic to develop third-party licensed software itself or by appointing a party other than the initial developer to do so. Similarly, on completion of a Web site, the customer will usually conclude a maintenance and support agreement providing for bug fixing and updates to the software used to create the site.

But recent years have seen many small software developers disappear with solvency problems and all too often a customer finds itself faced with a supplier who cannot or will not (or cannot satisfactorily) complete the development of certain software. This can occur midway through a project in which the customer may have invested heavily and access to the code for the customer then becomes vital.

These sorts of issues were highlighted in the case of Psychometric Services Ltd v Merant International Ltd in which Psychometric Services Ltd became dissatisfied with Merant’s services after having paid over £700,000 of charges under a contract for the development of a Web site which had initially capped fees at £195,000 (although a letter of variation purported to change this). Psychometric Services Limited required the source code to some of the software which was being developed in order to switch to an alternative supplier. In this particular case, Psychometric Services Ltd were awarded the injunction it required obliging Merant to provide the source code. The court was particularly concerned that a failure to grant the injunction would result in the collapse of Psychometric Services Ltd’s Internet business leading to unquantifiable losses and affecting employees, investors and clients as well as Psychometric Services Ltd itself.

No sensible purchaser of software will want to find itself on the brink of collapse before being able to access the source code and materials required in order to complete a development which is proving unsatisfactory and costly. Similarly, a user of software which is critical to the user’s business would not necessarily wish to invest in expensive new systems and software simply because its initial supplier has disappeared and it is unable to enforce the terms of a maintenance and support agreement.

Another increasingly common situation involves a supplier selling its business to another company. During the procurement process, customers often seek assurances regarding product “road maps” and the supplier’s commitment to the ongoing development and updating of the software the customer is procuring. Customers will often fear that such commitments may be of little value following a business sale since the acquiring company may have different priorities to the initial supplier.

Typical escrow arrangements

A common way for a licensee or user to seek to protect itself against a requirement to access a supplier’s confidential source code is to conclude an escrow agreement consisting of a tri-partite agreement with the supplier and a trusted third party.

Typically, this will include an obligation on the supplier to deposit the source code with the third party and to update the source code at regular intervals as updates and new releases of the same software are provided to licensees. The third party will charge for holding the source code securely and the agreement usually provides for the payment of its fees by the parties. Suppliers will often argue that the licensee should pay all the fees of the third party as well as trying to claim that they should be entitled to charge for the deposit of updated source materials since this is a time-consuming commitment distracting them from the provision of chargeable services to other customers.

The agreement will also specify a number of trigger or release events (such as the insolvency of the supplier, its breach of an agreement with the customer or some other event). The occurrence of a trigger event will entitle the user to serve a notice on the trusted third party (usually in a form appended to the agreement) and upon receipt of this notice the third party is obliged to release the source materials to the user.

Of course, the source code is a copyright work and the customer will need a licence to copy and use the source code once it has been released. From the user’s point of view, it is sensible to ensure that the source code licence is as broad as possible and certainly covers all anticipated activities as well as the right to allow contractors to use the code to assist the customer to achieve the objectives of the escrow agreement. The source code licence may be set out in the escrow agreement or there may be a reference to applicable licence terms in the customer’s initial agreement with the supplier.

Commercial escrow agents

In theory it is possible to appoint any willing party to fulfil the role of trusted third party in an escrow arrangement. In order to ensure the effectiveness of the arrangements, the user will seek to ensure that the third party has available secure storage facilities and is unlikely to go out of business in the near future. This means that users often think of solicitors firms or banks to fulfil the role.

There are a number of companies providing specialist escrow services to cover these sorts of arrangements. A common agent used by US companies is DSI Technology Escrow Services, Inc. In the UK, suppliers and purchasers often turn to NCC Group Ltd’s escrow division.

Effectiveness of escrow

It is often the case when discussing the possibility of escrow to try to reduce some of the risks outlined above that a customer will raise various concerns about the arrangements. The key concerns are usually:

· the source code will be incomplete or incomprehensible if ever released and therefore the escrow arrangement will involve time and money without achieving a real reduction in risk

· escrow agreements with commercial escrow agents are in standard form and the terms will not suit the particular arrangements being contemplated or put in place between the user and the supplier.

Testing and Verification

Of course, it is possible to examine materials when they are deposited with an escrow agent – which could go some way towards overcoming the first of the customer’s concerns. Indeed, NCC offers this service at different levels, with parties able to opt for standard integrity testing or a full verification service.

Suite of standard agreements

In addition to standard single and multi-user arrangements, there is now a full range of agreements available from escrow agents which would appear to cover the majority of circumstances where a user might seek this sort of protection. NCC has for some time offered a version that allows for regular deposits of source code throughout a software development project.

Recent additions to the suite of escrow agreements available from NCC include:

· an Information Single Licensee agreement

· an Application Services Provider multi-customer agreement

· a Single Lender agreement.

Information single licensee

This agreement does not cover source code but is intended to protect other technical information and documentation. This is referred to in the terms simply as “Material” and there is scope to include a description in a schedule so that the agreement can be used for all types of information and documents (such as design documentation or chemical formulae).

ASP multi agreement

It has become increasingly common for suppliers to offer users services or access to software via a Web site. These types of arrangements can be particularly attractive to small and medium-sized companies since the agreements are often structured so that the fees are calculated by reference to the extent to which the licensee makes use of the software or services rather than imposing a fixed or one-off fee. Suppliers in these arrangements have become known as application services providers.

NCC has produced an agreement allowing subscribers to this sort of service to obtain protection such that each of them will receive a copy of the deposited materials should a trigger event occur. Obviously, this type of arrangement will not be effective if the application services provider is providing a service which requires continual updating (such as access to a news database or similar) but the agreement should offer some protection for those licensees who use software packages in this kind of way.

Single lender agreement

The third new agreement introduced by the NCC deals with a specific (but, again, an increasingly common) scenario. The single lender agreement is designed to deal with parties who have entered into a loan agreement where the borrower has offered security over various assets, including software packages and intellectual property rights. Should the lender become entitled to enforce its security then the escrow arrangement ensures that the lender is able to access the source code which will allow it to understand the software packages or other products in which the intellectual property rights are vested.


It is commonly perceived to be impossible to amend the NCC’s agreements. In fact, in circumstances where customer or supplier clients wish to negotiate changes, the NCC team will highlight those provisions that are easily negotiable and those about which they have been advised to be less flexible.

Practical and effective protection?

It certainly seems that the range of materials and situations covered as standard by escrow agreements and the increasing commercial flexibility of escrow agents could provide licensees and others with a greater degree of protection against insolvency of suppliers or unwillingness to comply with contractual obligations. As increasing numbers of customers take advantage of the range of services which are available, it will be interesting to monitor the level of satisfaction amongst the unfortunate few (hopefully!) who are forced to exercise their rights under an escrow agreement.

Sherree Westell is a partner at Lewis Silkin and can be contacted by e-mail at The above is a general guide and is not intended to be comprehensive or apply to any specific circumstances.