What about escrow agreements
19 May 2023 - Frans Vanhaelewijck
Navigating Escrow Agreements: A Practical Approach for Software Companies
As a software company, you might encounter customers requesting an escrow agreement during contract negotiations. These agreements are designed to protect the customer’s interests if you, the software provider, are unable to deliver the product or services for any reason. In this blog post, we will discuss the rationale behind escrow agreements, explore various scenarios that can trigger them, and share a practical approach to handling such requests.
Understanding the Need for Escrow Agreements
Escrow agreements are not only about the possibility of a small company going bankrupt or out of business. They cover situations such as:
- Acquisition: If your company is acquired by a larger corporation that has no interest in the product used by your customer, the escrow agreement can ensure they still have access to the software code.
- Change of strategy: Your company may pivot and change direction, and as a consequence, no longer develop and support the product as customers expect.
Setting up an Escrow Agreement
These are the steps to be taken when setting up and executing an escrow agreement.
- Identify the parties involved:
- you as the software developer or licensor,
- your customer as the software user or licensee, and
- the company where you will deposit the software: the escrow agent.
- As it is the customer who is typically requesting the escrow agreement, you need to agree on a price that covers the cost of the escrow agent, but also your setup, management, and ongoing costs.
- Define the software: Clearly identify the software that is subject to the escrow agreement: product name and description, the software version, the source code, design and architecture documentation, and any related documentation on how to build and release versions of the software.
- Establish the terms and conditions: Specify the circumstances under which the software will be released from escrow (see above), the frequency of deposits, and the fees for the escrow agent.
- Choose an escrow agent as the neutral third party that holds the software in escrow and releases it according to the terms of the agreement.
- Sign the escrow agreement.
- Deposit the software: Once the contract is signed, the software must be deposited with the escrow agent. The escrow agent will typically verify that the software is complete and functional before accepting the deposit.
- Regularly deposit new versions of the software.
A Pragmatic Approach to Escrow Negotiations
As shown above, setting up an escrow agreement can be quite an undertaking: it’s time-consuming, costly, and requires significant resources from your team with no apparent immediate benefit.
When faced with a request for an escrow agreement, you could consider an alternative approach. Propose to your customer that you won’t enter into an escrow agreement immediately. Instead, include a clause in the contract stating that they can request an escrow setup at any time in the future, as long as you are still in business together and they continue to pay for your services.
Make it clear in the contract that if an escrow agreement is ever initiated, the customer will bear the associated costs. This includes fees for your effort, the escrow company and ongoing maintenance. Most customers will likely agree to this arrangement.
By adopting this approach, you can satisfy your customer’s need for security without incurring any immediate costs or obligations. As a bonus, you may never actually have to invoke the escrow clause, which means you can continue doing business without any disruptions. Keep this strategy in mind the next time you face a request for an escrow agreement; it could save you time, money, and hassle.