As we ride out the wave of the COVID-19 pandemic, companies continue to prepare for the unexpected. The impact on our economy will no doubt lead to vendor disagreements, litigation, and bankruptcies or business closures – especially as smaller companies struggle to stay afloat. Now is the time to advise clients to actively re-evaluate their software and technology acquisitions, and consider software escrow as a risk mitigation tool to support business-critical technology.
Here are three areas you should think about as you advise clients on acquiring and/or maintaining the technology they use to run their businesses. No doubt you have already recommended software escrow for risk mitigation, but as reported in The National Law Review, licensees and licensors need to prepare for potential bankruptcies caused by COVID-19. That’s why paying attention to the details around an escrow agreement are especially important now.
- Make sure the software escrow agreement is actually in place. You advised your clients to set up escrow for a business-critical technology, but did the escrow agreement get set up? As a best practice, we advise that the escrow agreement is signed and set up at the same time the software license is signed. This takes care of escrow when it is still top of mind. If the statement “the escrow shall be set up within 90 days after the execution of the main agreement” sounds familiar, there is a good chance the escrow could have been forgotten. Last year, Iron Mountain data shows that 32% of all escrow inquiries ended up inactive and closed. We believe that despite good intentions, people forget to do escrow. Advise your clients to review their agreements to ensure that their escrow protection is in place. Too often, companies think they have an active escrow agreement place, however, when circumstances arise, and they need to release the escrow deposit, they realize it was never set up. If your client is unsure of the status, engage with your escrow agent to get the specifics on the agreement and when it was put into effect.
- Once escrow is in place, is it going to work? You’ve worked with your client to negotiate and set up an escrow account with a professional escrow agent. But, has your client been actively involved in managing the escrow? Suggest they go back and look at the escrow agreement and ask these questions:
- Are the contacts for both sides of the escrow updated? The designated contact for an escrow agreement has specific responsibilities. You don’t want to find out important notices are being sent to individuals who are no longer employed or simply not involved.
- When was the last update of source code? Does the code in escrow match the version that your client is using? It’s essential to know what’s in your software escrow deposit. A good escrow deposit schedule should run parallel with the development of the solution it supports. At a minimum, every time there is a release of a new version of the solution, there should be a deposit in the escrow account.
- When was the code verified for completeness and accuracy? With Iron Mountain, customers have four levels of escrow verification to choose from. Did you know your client can negotiate to inspect the deposit themselves to ensure that source code along with third-party tools, build instructions, and other necessary information are present? They also have the option to have a third party review it. Reach out to your escrow agent for help to ensure all of these protections are in place.
- Escrow releases are expected to increase—check your release conditions. An escrow release happens when the developer is unable to support the product for reasons specified in the escrow agreement—such as bankruptcy, obsolescence, merger or acquisition—and the escrow materials are released to the licensee to that they can keep their business up and running. Year-to-date in 2020, Iron Mountain has seen a 175% increase in release requests—and the financial crisis impact is just starting to hit small developers. Early stage software developers with series A or B funding could run into liquidity issues. Providers in hard hit industries like the airlines and hospitality are facing serious concerns about their businesses if they are unable to pivot. We believe that maintenance/support and bankruptcy (Chapter 11 and Chapter 7) will be common release conditions in the wake of the COVID-19 pandemic. However, small startups without the ability to file for formal bankruptcy protection will more likely take the path of dissolution or ceasing to do business in ordinary course. Work with your client to take account of the release conditions they have in place for critical vendors and advise companies to evaluate their vendors’ risk profile to include escrow.
Risk mitigation is important to your clients—otherwise they wouldn’t be working with you. Make sure that all of the benefits of a software escrow agreement are available to them. The best escrow arrangements have a process, and as a legal advisor, you have an obligation to make sure your clients are protected.
