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Source Code Escrow When Entering into a Software License Agreement–Is it Necessary?

Our colleague, Hylan Fenster, shares his thoughts on source code escrow agreements:

Despite the burst of the dot.com bubble, many companies, notably small and mid-sized businesses, continue to rely on licensed software to perform their critical business operations. Source code escrow can provide the business with some protection if the software provider faces bankruptcy or stops maintenance or support for the licensed software.

Software License and Escrow Agreements

Licensees should ensure that their contracts with software providers contain provisions protecting source code rights. Source code is programming language written by a programmer that can be translated to machine language, which a computer would understand.  Unless a licensee has access to the source code, they cannot read or modify the program being licensed.  Licensees typically request source code escrow, which is the deposit of the source code of the software with a third party escrow agent.  Source code escrow is generally negotiated as a part of the initial software license agreement.  This request is made to ensure that the licensee will have continuing access to the software even if the licensor becomes defunct.   Pursuant to the specific terms of the contract, the escrow agent is authorized to release the source code to the licensee upon the occurrence of certain triggering events.

The licensor and licensee must agree not only whether to enter into a source code escrow agreement but also who should bear the expense.  Typically, a source code escrow agreement is entered into among the licensor, the business licensee and an unrelated third party escrow agent.

In addition, bankruptcy laws should be reviewed when drafting a source code escrow agreement as such laws may disallow the release of the source code escrow to the licensee, and the licensor’s creditors may be entitled to seize the licensor’s assets, which may include the escrowed source code.

Source code escrow agreements should provide for the following:

(i)               subject of the escrow,

(ii)              release events,

(iii)             duty of licensor to provide updates to the source code to the escrow agent,

(iv)             fees associated with the escrow agent’s services,

(v)              licensee’s rights upon release of the source code, and

(vi)             ongoing obligations of the escrow agent, if any.

The licensor will often resist entering into a source code escrow agreement due to the proprietary nature of the source code.  However, the licensee should be afforded some protection in the event the licensor is no longer complying with its obligations under the software license agreement.   A source code escrow provision in the license agreement protects the licensee and his business from potential events that may render the licensor unable to provide service or support.