Tech & Sourcing @ Morgan Lewis


Picking up where we left off last week, below are some additional key issues to consider and address when negotiating source code escrow provisions.

  1. Duration of Source Code Use. The license grant following the source code escrow release event should specify the duration of the customer’s source code use rights. Typically, the source code license rights will have the same duration as the customer’s original license rights under the license agreement, as they may be renewed by the customer. This approach is consistent with section 365(n) of the U.S. Bankruptcy Code. Two typical source code use durations are as follows:
    1. If the original license is a term license and the customer elected to retain the license under section 365(n), the source code license would have the same term. The customer would have the right to renew the source code license using the same methodology as would be applied to renewals of the original license rights in the license agreement.
    2. If the original license is perpetual, the source code license would also be perpetual.
  2. Fees Following a Source Code Release. An important point for customers to remember is that they must continue to pay any applicable license fees following an escrow release. This requirement again stems from section 365(n), which requires licensees to continue to pay royalties for the license rights that they elect to retain. The definition of “royalties” has been interpreted broadly to include license fees. A few points to consider on this topic:
    1. If the customer’s original license rights are perpetual, with the license fees paid up-front, there may be no applicable license fees at the time of the source code release (in which case there would be no corresponding payment obligation from the customer).
    2. With subscription-based license models growing in popularity—where license fees are paid periodically over the course of the term of the license—customers should expect to continue paying the agreed-on periodic license fee for the term of the source code license (including any renewal terms with associated renewal pricing for license fees).
    3. Although customers must continue to pay applicable license fees following a release event, customers should state in their agreement that they are relieved from the obligation to pay maintenance and support fees because the vendor will no longer be providing maintenance and support to the customer (and the vendor is relieved of that obligation under section 365(n)). To support this relief, the maintenance and support fees under the license agreement should be separately identifiable from the license fees (e.g., as a separate line item or a percentage). If maintenance and support fees are not separately identifiable, the customer is at risk of being required to continue to pay the full lump sum, even though the vendor is no longer providing maintenance and support services.
  3. Does your contract match the escrow agreement? Your vendor may or may not have an existing escrow relationship with an escrow agent. It is important to confirm that the provisions of the vendor’s escrow agreement align with the release event definitions and other rights that have been negotiated in the license agreement. The approach for conducting this process may vary depending upon whether the vendor has an existing escrow relationship or the type of escrow relationship that is in place:
    1. If the vendor does not have a current escrow relationship, customers should confirm that the escrow agreement to be put in place between the vendor and the escrow agent will align with the release event definitions and other rights that have been negotiated in the license agreement.
    2. If the vendor does have an escrow relationship, the escrow agreement will likely follow one of two methodologies: a “master” escrow agreement that contemplates the software vendor having a single deposit maintained for the benefit of multiple customers or a customer-specific approach, where every escrow agreement and deposit is designed for one customer.
      • For a “master” agreement structure, the terms of the escrow agreement may not match up with your contractual description of the deposit materials and other source code escrow provisions, such as the definition of a release event. Customers should ask to see the escrow agreement and conduct the necessary diligence to determine whether any changes are needed. In many cases, the changes are accomplished by an amendment to the escrow agreement, and, if the vendor is required to create a separate escrow deposit for the benefit of one customer, the customer may be asked to bear the additional costs of the separate deposit.
      • For a customer-specific approach, similar to a vendor establishing a new escrow relationship, the customer should confirm that the customer-specific escrow agreement will align with the release event definitions and other rights that have been negotiated in the license agreement.
    These escrow agreements and/or amendments can take some time to negotiate and put into place with the escrow agent, so customers should initiate this effort soon after determining to pursue an escrow arrangement.

This post is part of our recurring “Contract Corner” series, which provides analysis of specific contract terms and clauses that may raise particular issues or problems. Check out our prior Contract Corner posts for more on contracts (including Part 1 on source code issues), and be on the lookout for future posts in the series.