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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Escrow

An "escrow" is an arrangement where a third-party holds something that was agreed by the parties that may be released in the event certain events occur.  The most common use of escrow in procurement contracts deal with both continuity of use or continuity of supply. For example, a software license agreement may require that Source Code be held in escrow for potential release to the Licensee if certain events occur so the Licensee may continue to use and make future changes or corrections to the Software that they licensed.  A Buyer might require the escrow of a “Manufacturing Package" in the event certain events occur so the Buyer can continue to make or have the product or equipment made without the Supplier so they have continuity of supply for both Production or Service requirements. Other types of activities could potentially require escrow if the Supplier had something that was unique in the provision of the good or service where Buyer could not quickly or inexpensively migrate to another Supplier in the event of a problem.  Escrows are always used in conjunction with a license to use the materials that were held in escrow..

Escrows require several things:

1. The agreement of the parties that certain materials will be provided to be held in escrow.
2. The establishment of an agreement with the third party (an Escrow Agent) for them to hold the materials until an event occurs that triggers the release of the materials to the other party.
3. License language that establishes how the materials may be used if they are released by the Escrow Agent and what, if any, royalties may be required.
4. The events or actions are cause for the Buyer to request the release of the escrowed materials from the Escrow Agent.

  

Escrows are usually established using two documents. In the agreement between the Buyer and Supplier or between the Licensee and Licensor, that Agreement will:

1. Require the establishment of the escrow,
2. Require the placing of it with the third party and the timing for placing the materials with the escrow agent.
3. Describe the contents that are required in the escrow,
4. Describe the responsibilities of the Supplier or Licensor to maintain, update and keep the Escrow current.
5. Audit rights provided to Buyer or a third party to verify compliance
6. The triggering events that will allow for the Buyer or Licensee to demand the release or the escrowed materials.
7. The license granted for the use of the escrowed materials.
8. Any license fee that must be paid for the use of the materials and when the license will be royalty free.

The second agreement is the Escrow Agent agreement that is signed by the Buyer, Supplier and the Escrow agent (or Licensor, Licensee and Escrow Agent). The Escrow Agent Agreement will usually contain:

1. The coordinators for the escrow from all three companies.
2. The responsibility for the payment of fees to the Escrow Agent for performing their services.
3. The responsibilities of the Supplier / Licensor in establishing and maintaining the escrow materials current.
4. The responsibilities of the Buyer/Licensee, if any
5. The responsibilities of the Escrow Agent.
6. The triggering events or procedure that is used for demanding release of the escrowed materials including notifications to the Suplier or Licensor that demand had been made.
7. How it will be released and the responsibilities of the Buyer/Licensee in the materials that are released.
8. Remedies that the Supplier or Licensor may have if the release was not warranted.

The real value of any escrow will always be dependent upon the Buyer or Licensor's ability to use the 
materials and license to meet the their future needs.  As the Buyer or Licensee may not have the resources or capabilities to internally use the materials most licenses should provide for the Buyer to have the right to have a third party use the escrowed materials and license to perform things within the scope of the license on behalf of the Buyer or Licensee. If the Supplier or Licensor was having a 
third party perform the work on their behalf,  the agreement between the Buyer and Supplier as part of the license grant the Buyer should have the right to use that third party and require that the Supplier
assist them in establishing a relationship with that third party.  For example if the Supplier had the manufacture of the product performed by a contract manufacturer, the Buyer would want the right to 
have the product continued to be produced by the contract manufacturer and have the Supplier assist the Buyer in establishing that relationship so there will be a quick transition.