Tech & Sourcing @ Morgan Lewis


Picking up where we left off last week, below are some additional distinctions for escrow arrangements in the software as a service (SaaS) context and related customer and vendor considerations.

SaaS Escrow Release Events

In both installed software and SaaS license deals, escrow release events—when the deposit materials are released to the customer—should include vendor bankruptcy events or the vendor otherwise ceasing to operate. However, “services failure” release events, which are typically limited to a vendor’s uncured material breach of its obligation to provide maintenance and support, may need to be expanded in the SaaS context in order to cover a vendor’s uncured material breach of its obligation to make the SaaS solution available to the customer. Where an “availability” or “uptime” service level commitment is included in the SaaS contract, those service level agreement (SLA) thresholds may be useful to determine when excessive “unavailability” is enough to trigger the release of the escrow materials.

From the customer’s standpoint, release events tied to recurring SLA failures (e.g., failures in 3 consecutive months or 4 out of any 12 months) or significant single failures (e.g., uptime that falls below 90% in any month) are desirable. However, vendors typically push hard to limit the remedies for these types of performance deficiencies to SLA credits and/or termination rights rather than escrow release.

From the vendor’s standpoint, the escrow release should be a worst-case scenario remedy that should be reserved for situations where the vendor is essentially entirely unable to provide what was promised under the contract (rather than merely performance deficiencies)—whether due to bankruptcy or other factors that result in the vendor’s continuing, uncured material breach of its obligations to provide the software.

Fees Following an Escrow Release

As we noted in a previous post on escrow agreements, customers generally must continue to pay any applicable license fees following an escrow release. In the traditional installed software licensing arrangement, the fees payable by the customer are split into license fees and maintenance and support fees, so the ongoing portion of the fees post-release include the license fees but not the maintenance and support fees.

In contrast, SaaS solutions often are provided under a single subscription fee model that is intended to compensate the vendor for granting access/license rights, meeting its hosting obligations, and performing maintenance, support, and updates. Upon the escrow release, the vendor is no longer performing either of the services components (i.e., hosting or maintenance/support/updates) but should typically still be entitled to compensation to license rights to their proprietary technology. So, while some amount of fees should continue to accrue, the parties should consider whether (and how) to reduce fees to attribute for the services that are no longer being provided. This is often a contentious point during negotiations, as the vendor would like to position a significant portion of the value of its SaaS offering as the right to access the proprietary technology itself, while the customer will argue that the vendor’s true value-add are the hosting and support services, which are no longer being provided by the vendor post-release.

The customer is unlikely to have sufficient insight into the vendor’s internal operations to determine the vendor’s true costs for each component of the SaaS solution, but the customer may be able to get an idea of what it would cost to expand its hosting capabilities (whether internally or through another third party vendor) and support staff in order to maintain the solution post-release. Based on this limited information, the customer and vendor business stakeholders will often agree on some percentage reduction in the fees post-release. The reduction may be viewed as more of an equitable concept from the customer’s standpoint, as in all likelihood the delta in fees will not cover the totality of the additional costs the customer will be required to incur in order to take over the SaaS solution post-release.

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, and be on the lookout for future posts in the series.