Thursday, January 5, 2012

When should your require escrow agreements?

There are a number of different types of escrow agreements that could be created. In procurement
the most common are software source code escrow agreements and manufacturing package escrow agreements. Both types of documents normally require a breach or some other major event as a pre-condition of releasing the materials held in escrow along with language in the agreement that provides the buyer with a license grant to use those materials to support themselves in the future.

For manufacturing package escrows, for them to be of any value you would need to be have all the necessary tools and equipment or find a supplier that has those so you can use them to replicate the supplier’s manufacturing processes. The more unique the supplier’s processes or tools that they use internally, the more difficult it will be to have a cost effective approach to use the licensed documentation. Continuity of supply may be better protected with second sourcing or alternative sourcing than relying upon a escrow package. A second problem with manufacturing escrow package is they are not common. Suppliers will expect the buyer to pay the costs of the escrow agent. A third concern is always whether the package is correct and up to date. If a supplier is going bankrupt, and they failed to maintain the package, your remedy would be to stand in line behind all the other unsecured creditors to claim damages for breach. Collecting damages for breach does not provide you with products you need. Before requiring a manufacturing package escrow you need to determine whether it will really provide you with the desired protection when you need it.

As to software source code escrow provisions many companies may want supplier provided escrow on all the packages they purchase. To me it’s a business call that should be driven by several factors:
1.How critical is the application is to your business?,
2.How long and what cost would it take to change to another supplier?
3.How stable is the software?
4.How much you would need to modify or change the software in the future?
5.What is the cost to have the materials held?
6.How long would it take your people or a third party to understand the application and how it works to be able to support it or to make changes.For complex programs unless you were able to hire someone that thoroughly knew the program it could take multiple years to understand the program and its structure enough to make changes.

I’m a firm believer that if someone is prepared to provide something to me for no additional cost, I’m happy to let them do it even if I don’t need it or plan on relying upon it.If a supplier puts a master copy in escrow for all customers to potentially access, its an easy decision to make. For escrows that would require payment of the escrow agent’s cost I would go back to the business to review the real benefits and costs of using the escrow..

Is it critical? If no, I probably would not recommend paying for holding the materials in escrow.

Can it quickly and cheaply be replaced? If yes, I probably wouldn’t recommend paying for materials to be held in escrow?

How financially stable is the developer? If they are strong financially I probably wouldn't recommend paying for it..

How stable is the software? If it’s stable, I may not need the materials to be held in escrow so I wouldn’t pay for it.

Do I needed to be able to modify or change it in the future? If I did I would want to have it held in escrow.

How long would it take to use it? If it was going to require years and a substantial investment of people to be able to use it to support, modify, or change it, I would want to take that into account in terms of which is better. Continuing to support something that will be unique to you or investing in a new application where the supplier will be making and selling upgrades to their customer where it will cost much less for support.

Having an escrow does not provide you 100% protection if there is a problem. It provides you only part of what you may need. The key to its value is how long will it take for you to understand what you received so you can potentially use it. The second key is how much will it cost you to use and support it. It may be more than you want or can afford to pay.

These are decisions that the using business needs to decide.

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