Addressing Addressing

Addressing

Technology

Escrow in the

RFP Stage







26 s Contract Management / July 2004

A small up-front cost can provide significant value by keeping critical applications

running in the face of vendor problems.

B Y F R A N K B RU N O









Companies in almost every industry Technology escrow services are technology is unprotected. Recovering

license software for their mission- imperative when two or more parties the source code and maintenance

critical applications. From supply are negotiating a license for mission- materials by other means, such as

chain applications to inventory man- critical technology. The contracts through the court system, can take

agement, accounting, customer service, management group, together with years, and by then, the company’s

or logistics, if you are in a contract the IT procurement group and the operations and resources that were

management position involved with compliance or legal department set tied to that technology can be lost.

software licensing, you need to have up the agreement.

a good working knowledge of technol- If a technology licensee is con- The Buyer’s Side

ogy escrow agreements. This article cerned that the developer will for Knowledge about the best practices

will focus on the buyers, or licensees, some reason in the future no longer surrounding technology escrow is

of software and how they can negoti- provide support, the licensee should imperative. Buyers, or licensees, are

ate the best escrow agreement, request that an escrow agreement be realizing that the face of technology

starting at the RFP or “request for put into place. This means that the escrow is changing. Where escrow

proposal” phase. technology (usually software source was once just a checklist item, savvy

Most contract managers who have code and any other component neces- licensees are now using escrow as a

been through software licensing nego- sary to allow the licensee to maintain tool to protect themselves from any

tiations are familiar with technology the technology independently) is number of unfortunate conditions

escrow. However, the issue of technol- placed into an escrow deposit account. with the software vendor.

ogy escrow—which protects the Once the escrow agreement is executed, In the past, many contract managers

licensee if something happens to the the licensee becomes the “beneficiary” involved in licensing software knew

software developer—is often an after- of these materials, contingent on enough to ask, “Will the software

thought and added into negotiations certain release conditions. source code be held in escrow?”

at the last minute. For the best pro- If a release condition occurs (such When the answer from the developer

tection, contract managers should as if the developer ceases operations was “yes,” they happily moved on

include technology escrow as part or stops supporting the technology to the next issue without scrutinizing

of the initial RFP and should work for other reasons), the licensee gains the terms and conditions of an escrow

to include terms and conditions that access to the deposit materials. This agreement or specifying exactly what

will offer the best protection possible. enables the licensee to maintain the they would need to continue to support

This article provides contract technology independently and to keep an application in the event the vendor

managers with practical advice on the mission-critical application up could not continue to support it.

negotiating optimal protection for the and running. To create an escrow agreement that

software that runs their company’s It is important for the contract really provides leverage, the contract

business and points out the pitfalls manager to understand that there are

associated with letting the software different levels of escrow protection. About the Author

vendor drive the process. Some agreements release source code FRANK BRUNO is a business strategist

only under the condition of bankruptcy; with DSI Technology Escrow Services,

Overview of Technology Escrow others take into account much wider an Iron Mountain Company. He consults

Technology escrow is like an insur- reaching release conditions. It is up to with corporations and contract manage-

ance policy for your mission-critical the contract negotiators to determine ment professionals throughout the

software applications that is signed the level of protection required and to United States on intellectual property

at the same time as the license agree- make sure the escrow agreement is protection. Send comments on this

ment. However, many companies do crafted to their specifications. article to cm@ncmahq.org.

not take the time to understand how Without a technology escrow agree-

technology escrow can protect them. ment, a licensee’s investment in



July 2004 / Contract Management s 27

T E C H N O L O G Y E S C R O W I N T H E R F P S T A G E







s Avoid litigation; and

Gartner Inc., a leading technology

s Minimize risk of loss.

research and advisory firm, has stated

Why Start with the RFP?

its belief that “it is necessary for all So, you’ve decided that establishing

an escrow account is important for

s o u rc e c o d e t o b e e s c ro w e d .” 1 a certain software application. Why

should you introduce escrow at the

time of the RFP? Starting the escrow

agreement process early cannot be

manager needs to be an active partici- or “ceasing to do business” as the emphasized enough. This lets you

pant in the process. In fact, the conditions for releasing source code. drive the process, formulate a budget

licensee organization should be pre- However, as a licensee, you can craft for escrow, and include the appropri-

pared to drive the escrow process release terms around lack of support ate budget in the total licensing cost.

and to pay for the coverage to put or other issues important to you. These As with car insurance, a relatively

a comprehensive agreement in place. items give the licensee leverage if the small up-front cost can prevent major

Simply getting a “yes, we’ve got vendor does not provide promised expenditures down the road in the

escrow” response from a vendor and maintenance or support. The terms event of problems. An escrow agree-

then letting it handle the details of also can let a user organization define ment and verification testing should

an escrow agreement without close when it upgrades to a new version be evaluated and included in the

supervision is a common mistake of the software or can specify what budget. If escrow is an afterthought,

many user organizations make. materials should be included in the you are likely to hear, “This wasn’t

Some basic questions a contract escrow deposit in addition to just the part of our budget.”

manager should consider before source code rather than having this When you have determined your

licensing new software include controlled by the vendor. shortlist of vendors, you can set cer-

the following: If source code is released, you want tain bid conditions in regard to

to make sure that your IT organiza- escrow. First, you should request that

s Should this software source code tion can get the application up and the software source code be placed

be put in an escrow account? running as quickly and as smoothly into escrow; more importantly, it needs

as possible. To do this most effectively, to be a condition of your escrow

s If so, which release conditions some level of verification testing is agreement, not the vendor’s. Second,

are important to me? recommended. Verification strengthens you will want potential vendors to fill

the leverage value of the escrow by out a deposit questionnaire to specify

s If the source code is released, will ensuring that the materials necessary what elements are included in the

my organization be able to replicate to recreate the application development escrow deposit. This lists the necessary

the application? environment are in the escrow account. deposit materials and an explanation

A properly drafted escrow arrange- of the time and investment required

A good rule of thumb for placing soft- ment that maximizes a licensee’s to recreate the application develop-

ware source code into escrow is if it is protection will accomplish the follow- ment environment. If these elements

considered “mission-critical” for your ing goals: are set forth as a condition of doing

business. If this particular software business, you are likely to get agree-

application affects revenue, productiv- s Provide leverage after the license ment from the vendors. Remember,

ity, customer-service levels, or public has been signed; they are trying to win your business,

safety or supports other applications and this is one condition that they

that affect these things, you should s Allow timely access to the source can accommodate to do that.

execute an escrow agreement. Some code and maintenance materials; As you start to narrow the playing

licensees, especially in financial field to choose a vendor, you will be

industries, make it a practice to s Enable quick recreation of the appli- testing its software and evaluating

escrow all software that is not “out cation development environment; pricing. You will want to determine

of the box.” Others go through a risk a cost for escrow and verification

assessment to review their tolerance s Give options to control future of the deposit contents from your

for the loss of an application. software upgrade timetables; escrow agent. This cost can then be

Which release conditions are impor- built into the overall program budget.

tant? Many vendor-driven escrow s Satisfy legal compliance; If you have assumed ownership of

agreements specify only “bankruptcy” the escrow process from the very



28 s Contract Management / July 2004

T E C H N O L O G Y E S C R O W I N T H E R F P S T A G E







beginning, closing the deal should be licensees do not sign, and are not Unless your software is fairly basic

a cinch. The escrow agreement should party to, the agreement. and the only condition you are con-

be signed at the same time as the Two-party agreements exist to satis- cerned about is bankruptcy, you

licensing agreement and should be fy relatively simple requirements for should insist on a three-party agree-

filed as an exhibit to the license. escrow. This allows a developer to put ment, even though this generally

All parties who receive a copy of the an escrow agreement in place quickly means that you will need to accept

license also should receive the escrow and inexpensively to cover multiple some or all of the costs.

agreement. licenses to different licensees when the A three-party agreement involves

By negotiating a strong escrow licenses are sufficiently similar to be the developer, the licensee, and an

agreement, you are supporting your nearly “off-the-shelf.” Two-party agree- escrow agent negotiating and signing

software license agreement and ments are routinely paid for by the an escrow agreement. Many larger

decreasing your total cost of ownership. developer. Often, these types of agree- organizations set up a master agree-

Gartner, Inc., reports, ments are triggered by one release event, ment and have new vendors sign onto

such as bankruptcy or court order. this master agreement to simplify the

Enterprises that focus primarily on pur-

chase price often end up overpaying for

software. Price represents no more than

50 percent of the value in a software

negotiation. Total cost of ownership is

determined largely by terms and conditions

that accompany a contract.2



With an effective escrow agreement

in place, you are adding to the value

of your software license.



A Three-Party Agreement

Three parties are usually involved

in an escrow agreement: the company

licensing the technology (the licensee),

the company that developed the tech-

nology (the developer), and the escrow

agent—a neutral third party that vaults

the source code and administers the

agreement. Attorneys also generally

represent the licensee and the developer

to help them craft the most favorable

terms for their client. As stated previ-

ously, whichever party initiates and

drives the escrow agreement is typi-

cally the party that maintains the

more favorable position with respect

to the terms and conditions.

Although three parties are usually

involved, escrow agreements can take

the form of either “two-party agree-

ments” or “three-party agreements.”

The two-party agreement is signed by

the developer and escrow agent only,

although a two-party agreement may

have a large number of licensee

beneficiaries. The developer, having

pre-negotiated the escrow terms,

simply names the licensees and

maintains total control over licensee

enrollments and terminations. The



July 2004 / Contract Management s 29

T E C H N O L O G Y E S C R O W I N T H E R F P S T A G E







these terms.

Reason for the Release of Escrowed Percentage One aspect of an escrow agreement

Source Code of Requests that is particularly important is

“Under what conditions is the soft-

Loss of support . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30% ware source code released?” To

strengthen your escrow protection,

Cease business operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22% ensure that the release language is

not tied to only one release event,

Bankruptcy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20% such as bankruptcy or court order.

A commonly held misconception

Depositor’s request . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9% about technology escrow is that bank-

ruptcy is the only release event.

Demand release . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6% Although some simple agreements

can be set up this way, it benefits the

Payment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2% licensee to strengthen its escrow pro-

tection by using a more wide-ranging

Court order . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1% set of release conditions. Your attor-

ney and escrow agent can provide a

Breach of obligation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . <1% comprehensive listing of release con-

ditions that can be used for better

Merger. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . <1% protection and leverage against lack

of developer support.

Transfer of assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . <1% Table 1 demonstrates the wide

range of reasons that licensees request

an escrow release.3

Table 1. Escrow Release Reasons Loss of support (not bankruptcy) is

the number-one reason for requesting

process. The terms and conditions for At the very least, the following line an escrow release. By including “loss

escrow and the licensee’s right to veri- items should be clearly defined and of support” as a release condition,

fy the escrow contents should be enforceable: licensees can use their escrow agree-

negotiated before the execution of the ment as leverage, if necessary, and

license agreement, and the two docu- s Deposit update process can request a source code release to

ments—license agreement and escrow and frequency, get a developer to respond quickly to

agreement—should be signed at the previously unrecognized concerns.

same sitting. To simplify matters, the s Release conditions, The source code does not always end

escrow agreement can be inserted as up being released in these situations,

an exhibit or rider to the licensing s Objection period limited, but the developer knows the customer

agreement. has this option, and this situation may

Licensees should never sign a s Contrary instructions, trigger it to start providing the

license agreement without signing an promised support.

escrow agreement at the same time; s Release process, Note that bankruptcy—the basic

otherwise, the escrow agreement may release condition used in many two-

become a distant and abandoned s Right to use after a release, party agreements—represents only 20

afterthought to be remembered only percent of the release requests.

when it is too late. As a contract man- s Deposit contents, Ceasing business operations (without

ager for a licensee, insist on a actually filing Chapter 11 or Chapter

three-party escrow agreement that s Verification rights, 7 bankruptcy) comes in second, with

enables you to review, modify, and 22 percent, and is a release condition

sign the agreement, even if you have s Payor of fees, and that is not covered by some basic

to pay for the privilege. agreements.

s Dispute resolutions A real-life example demonstrates

Terms and Conditions and controlling law. the power that a licensee can have by

Terms and conditions generally are defining the terms of an escrow agree-

customized for each agreement. Any These items will not be covered in ment. A large oil company licensed in

concerns you have about the developer detail in this article, but your escrow excess of $100 million worth of soft-

should be addressed in the agreement. agent and attorney can assist you with ware each year, and approximately



30 s Contract Management / July 2004

T E C H N O L O G Y E S C R O W I N T H E R F P S T A G E







15 software packages were in escrow at s Execute both at the same time;

any time. To ensure that its mission- To help assess your business

critical applications were protected, s Verify deposit contents immediately;

the oil company negotiated a “we needs for an escrow arrangement

decide” clause in its escrow agree- s Address and cure any deficiencies

ments. This clause meant that it could immediately after the verification and to determine your company’s

request the release of the source code test and retest (retesting is typically

for any reason. The oil company done at the expense of the develop- level of risk, download a detailed

admits this was a difficult term to er, but only if you make it a term

negotiate, and if used, it would allow of your agreement); checklist at www.dsiescrow.com/

an arbitration process that could allow

the vendor to seek damages after the s Work with a reliable escrow agent; and checklist.

deposit was released.

However, this clause paid off for the s Stay involved!

oil company, when it requested source Endnotes

code after discovering that the suppli- Escrow as Leverage for Licensees 1. Gartner, Inc., Midsized Enterprise

er of its imaging software was being More and more licensee organizations Summit Continuity Questions,

acquired by another firm. The oil are developing escrow best practices Feb. 6, 2003.

company invoked the “we decide” to safeguard their technology and

2. Gartner, Inc., Management Update:

clause and had the vendor’s source intellectual property assets.

Lower TCO through Effective Software

code within two weeks. PricewaterhouseCoopers believes Contract Terms and Conditions, Sept. 3,

that intellectual property is one of the 2003. Accessed at www.gartner.com.

A Process Timeline most important elements in the value

3. Research by DSI Technology Escrow

The process chronology for creating of major corporations. Some analysts

Services on historical requests for

the escrow agreement should occur estimate that as much as 90 percent of escrow. Statistics do not include

along the lines of the bullets that fol- the value of the world’s top 2,000 enter- requests for releases processed by

low. (Again, remember to start early prises in 2007 will consist of intellectual acquired companies Fort Knox and

and budget for escrow!) property of one sort or another.6 SourceFile before 2000.

Licensees are starting to pose ques- 4. A risk assessment formula created by DSI

s Conduct a risk assessment to tions, such as “What if my front-end can be found at www.dsiescrow.com/

determine the need for escrow point of sale software isn’t supported faq/measurerisk.cfm.

and verification;4 tomorrow?” and “What if the vendor

5. A reputable escrow agent can provide

for my logistics software is acquired?” you with a deposit questionnaire.

s Include technology escrow The escrow process is beginning to

6. PricewaterhouseCoopers, Building and

as a bid condition in your RFP; play a pivotal role in the software

Enforcing Intellectual Property Value:

acquisition process as licensees

An International Guide for the

s Require a three-party agreement realize their dependence on mission- Boardroom 2003.

drafted by your organization critical applications.

as a condition of doing business; If positioned as a condition for doing

business, most vendors will agree to

s Have potential vendors fill out an escrow agreement with specific

a deposit questionnaire5 during terms and conditions that you negoti-

the vendor selection process; ate to win your business. If you drive

the process, technology escrow not

s Obtain a quote for escrow and only provides catastrophic insurance

verification testing from your (i.e., if the vendor goes bankrupt) but

escrow agent; also gives your company leverage with

the vendor in the case of lack of sup-

s Include the cost of escrow port or other damaging scenarios.

and verification in your budget; Licensees also are realizing that by

taking control of the escrow process

s Negotiate a well-defined, fair, and paying for escrow and verification

and balanced escrow agreement; on their terms, a small up-front cost

can provide major value by keeping

s Include your escrow agreement as an critical applications up and running

exhibit/rider to the license agreement; in the face of vendor problems. CM



July 2004 / Contract Management s 31