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Types of Escrow Agreements

There are basically two types of escrow agreements: two-party and three-party. In a two-party engagement, the vendor and escrow agent sign the escrow agreement. The customer is not a direct party to the contract, but signs a separate “beneficiary form,” which gives the customer the right to receive the source code on the occurrence of a release condition (as discussed below). Two-party agreements have the following characteristics:

■ They are generally used when a vendor signs a single escrow agreement for all of its customers.

■ Each customer signs a separate beneficiary form.

■ Customers may be required to pay a relatively small fee to become a beneficiary. There may also be certain copying and other fees if a release condition occurs.

■ The escrow agreement is presented to customers as essentially nonnegotiable, forcing customers to accept the all-important release conditions previously negotiated by the vendor and escrow agent.

■ Two-party agreements are more frequently found in smaller transactions and those involving software that does not require extensive customer customizations.

In three-party escrow arrangements, the customer, vendor, and escrow agent are all direct parties to the contract. Three-party agreements have the following characteristics:

■ Frequently found in larger transactions, particularly those involving customized software.

■ Fees to be paid by the customer are generally higher because the vendor is required to enter into an entirely new agreement for each customer who desires an escrow arrangement.

■ The agreement, particularly the release conditions, is capable of negotiation.

When talking about whether and to what extent an escrow agreement may be negotiated, it must be understood that, absent very unusual circumstances (e.g., a very large software vendor who does significant business with the escrow company and, therefore, has greater leverage to modify contract terms), the terms of the escrow agreement that relate to liability and other obligations of the escrow agent are generally very difficult, if not impossible, to negotiated. This is particularly true of large, well-established escrow companies. These largely nonnegotiable terms relating to the escrow agent’s liability and other obligations, however, should be contrasted with provisions relating to the release conditions for the source code. Those conditions can be freely negotiated. Whatever the vendor and customer agree upon, the escrow agent is generally willing to include in the escrow agreement. For ease of revision and to differentiate those terms from the rest of the agreement, release conditions are frequently set forth in an exhibit to the contract.

While the two- and three-party escrow arrangements described above are far and away the most common, one other arrangement is also possible: the selfescrow. As the name suggests, in a self-escrow arrangement, the vendor delivers a copy of the source code to the customer when the software license agreement is signed. Tlte agreement specifies that the customer may not use the source code unless a release condition occurs. In the meantime, the customer must keep the source locked in a secure container, usually a safe. The advantage of a self-escrow is that the customer has immediate access to the source code if a release condition occurs. In normal escrow arrangements using an escrow agent, there can be many weeks of delay in obtaining the source code. That timing may be essential in some business critical applications.

Self-escrow arrangements are rare, but they should be considered for highly critical applications or in situations involving smaller vendors who do not have an established relationship with a source code escrow agent.

Release Conditions

Every source code escrow agreement includes a list of release conditions. On the occurrence of any of those conditions, unless the vendor is disputing the occurrence, the escrow agent is contractually bound to furnish a copy of the source code to the customer. Since the release conditions will result in the customer obtaining a copy of the vendor’s most valuable asset (the source code), vendors are very reticent to include any but the most restrictive release conditions. Common conditions include:

■ Insolvency of the vendor.

■ The vendor is subject to voluntary or involuntary bankruptcy and fails to have the matter dismissed within thirty (30) days.

These conditions are frequently supplemented to add more robust protection for the customer:

■ The making of a general assignment by the vendor for the benefit of its creditors

■ In the event the vendor ceases to maintain and support the licensed software for reasons other than the customer’s failure to pay for, or election not to receive, maintenance and support services

■ Termination of the license agreement for breach by the vendor

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