Escrow Arrangement, is a private contract only

• Introduction

Escrow Arrangements, are generally private arrangements between the parties as there is a shift of trust from Licensing Party to neutral person for commercial or non-commercial reasons. Such arrangements could be to safeguard interest of Licensee whose interest would get affected in circumstances not within control of the Licensor or Licensee as the case may be, like business or regulatory compulsions.

• At least 3 parties are needed to have an escrow arrangement

Before we move on to understand escrow arrangement we need to know that such arrangements requires at least 3 parties, hence it is generally a tripartite arrangement.

There is a must to at least have an owner, a beneficiary and an agent. An Agent is generally an “Agent in Trust” or called as “Escrow Agent”. Such Agent has to be neutral and reliable in eyes of other parties. The Owner is person who owns the escrow material/money, under law or any other contract pursuant to which this agreement is getting executed. The Beneficiary is the person who would be finally benefited by such arrangements or receiver of escrow material or money upon the trigger of release events. There can be more than one beneficiary or more than one owner but there has to one agent to complete an escrow arrangement.

If the concern of Beneficiary is to comply with regulations then it may even enter into an arrangement with “Owner” to become an “Agent” by taking the obligations of agent or look for economical means like locker facility to ensure the copies of source code are stored. Such arrangement brings in the element of bias and/or flaws in the control over the escrow material. While such arrangement is convenient and economical but the person acting in place of Agent has onus to prove that his actions are not bias and has to take utmost care to create evidences in his favour to prove his diligence and legitimacy.

• Escrow Arrangements can be done for

Generally the escrow arrangements are for the following:-

1. Distribution or apportionment of Money, which is expected to be received by one party (a person, legally or contractually, entitled to receive it, for the purpose of this paper, can be referred to as “Owner”) but need to be distributed or shared with others as they are acting as a partners, subcontractors or beneficiary under a fiduciary relationship or any contractual arrangement with precondition to have escrow account as the only means of receipt of the payment. Eg. collection of rent, collection of payment against the bills already discounted privately or performance or scope been subcontracted, etc
2. Release of Source Code of software and access thereto; free of infringement or charges or fees for such access. Under such arrangement the Author or Owner enters into an agreement with Beneficiary to allow access to source code of the software, in such a manner that the Beneficiary can integrate, channelize, rectify, modify or improvise the software by making use of the source code. Generally it is permitted for internal and non-commercial purpose only. Such changes are installed as patches and updates that are necessary for smooth functioning of the software.
3. There can be escrow arrangement of anything as long as one party (“Beneficiary”) believes that such material or thing is very crucial and necessary to protect its interest and the other party (“Owner”) consents for it.

• Release Conditions and usage thereof

Owner and Beneficiary can decide the terms and conditions of release. Generally, person getting benefitted from this arrangement has to initiate for such request to the Owner or this can be an expectations set at the time of procuring license for the software. Owner by executing this agreement binds himself to release the escrow material or money on happening of such events. The release events can be recurring in nature during the tenure of the escrow arrangement or it can be a single event after which the escrow arrangement shall terminate. Release conditions can be like (a) multiple or single instance for type 1 (“Payment of Money”) immediately upon receipt of the payment in the proportion agreed after deduction of charges of escrow arrangement or (b) single instance for type 2 (“Source Code of Software”) release the source code if (i) business line of the software is shutdown (ii) Owner [or Owner Company] has been declared insolvent as per prevailing Insolvency Law or Bankrupt as per prevailing Bankruptcy Law or  winds up as per prevailing Companies Law depending upon the jurisdiction that deals with his/her citizenship or its registration.

Parties may generally agree to link the terms of usage to ensure fair & just use of the escrow money or material but it is purely dependent on the nature of escrow material or money which is getting released. To quote an example for first type (“Payment of Money”), release of rent money is to be first utilized for paying of legal dues and charges attached to the rented property and then for its maintenance and may be thereafter for development, expansion or extension.  To quote an example for second type (“Source code of software”), use of the source code for correcting or improvising the software, for internal purpose only, no commercial exploitation, limiting the access to employees or beneficiary itself, and so on.

• Legal Positions

While I can understand that escrow agreements shall be governed by the agreed substantial law therein but then what governs the release events/conditions esp the events which has to have sanctity of local authority like insolvency, bankruptcy, winding-up, etc? In my view, before we can answer the same we need to assess the facts of such events by passing it through (a) the substantial law agreed; and (b) the law that would govern the agreed release events. In my view, the substantial law shall govern the interpretation of the provisions of escrow agreement but if law governing the release event is different from the agreed substantial law then possibility of conflict of interpretation can delay the trigger for release of escrow material or money. This can lead to absurd meaning at time and to be fair and keep the law close to the facts especially when the sanctity of local authority is necessary to ascertain at the trigger event. (It dealt in brief through an example in following paragraph captioned as “What should be the substantial law and jurisdiction? Why?”)

   

This escrow agreement is not different from other agreements hence all elements of valid and enforceable contract under agreed substantial law shall apply to this agreement. Rights under escrow arrangements are rights in personam and not in rem, hence the enforceability is dependent on the articulation of intention of the parties therein and not otherwise.

Talking specifically on type 2 “source code of software”, the owners right is a right in rem hence protected in absolute terms under prevailing copyrights law, but with the change and strong intervention of authority, legislatures and governing bodies by way of anti-trust laws or competition laws or establishment of commissions, which have tried to carve out or plug in exceptions or concessions by having overriding effect of such laws over the copyright laws. This has been done to help the striving competitors to allow them to compete with similar, compatible or comparable products and ensure free and fair market for customers.   

Business Reality speaks, irrespective of legal position of the Owner, the competitive environment compels the owner to compromise to sign an escrow arrangement as there is threat to lose the business if the customer decides to switch or discontinue or continue without any improvements. Especially after the entry of open source software providers the need of developed software and its source code has considerably reduced. The market share and price of proprietary software has gone down. The trend of use of software is further undergoing change by having Software as a Service (SaaS) model, it will have its own challenges besides the custody of versions of source code, as expectation of client can fall within the ‘S’-expectation i.e. speed, safety, security, smooth-transit, sole (exclusive), severable and sailable (smooth migration) outcome of their apprehension of high latency, poor data management and protection, migration difficulty from one platform to other and most important the cost of such work. (I will cover this in my cloud computing and various kind of sharing/outsourcing services like SaaS, IaaS, etc)

The software under escrow are generally the customizable software (not the off-the-shelf software) i.e. development over the base product or bespoke kind of software, to suit the customers operational and dynamic market expectation. Such expectations can be single client centric or industry specific at large hence constant development to incorporate regulatory and operational changes by way of modification to base source code becomes a crucial and core for business sustainability to both i.e. the Beneficiary and Owner. While development continues the protection from theft, piracy and expunge of latest version of the source code, is on the highest raider of the Beneficiary’s concern. On the other hand, such development generates revenue to the Owner, in addition to license and maintenance revenue, hence such escrow arrangement are result of business compulsion.

• What should be the substantial law and jurisdiction? Why?

To explain I would like to take you through one of my negotiation experience, wherein Owner and Beneficiary were registered in India whereas Agent was registered in UK. The legal cell of Beneficiary was also controlled from UK. The comfort of both beneficiary and Agent was to have English Law with UK as an exclusive jurisdiction but I being the Attorney for the Owner, it was not in Owner’s interest to agree to UK jurisdiction for many reasons, few of them are listed hereunder:-

• 1.     First Apprehension for the Owner was ‘Unknown Place and Unknown Law’, which would mean that the Owner needs to hire a highly paid lawyer/arbitrator(s) in UK to get any relief through court or arbitration. This would definitely pinch the pocket of the Owner heavily and contractually balance of inconvenience would burden the Owner more than the other two. Especially, in absence of any consideration to incentivize the Owner, agreeing to UK would be unreasonable and unfair. No doubt, as an attorney advising on the English law was within my control but handling litigation or arbitration was commercially beyond my reach. In other words, having English Law and UK jurisdiction would increase the cost of litigation as well as could create vicious circle of interpretation where reference of Indian Law would have to be made in ascertaining the release events.
• 2.     The difference of exchange currency rate, between the two countries was approx 69 times higher than Indian Rupee.
• 3.     Most important, the issues between the Owner and Beneficiary under the Contract though both being from India would have to be settled as per English Laws to arrive at breach or no breach situation.
• 4.     The law that governs the License, maintenance, or development contract pursuant to which this escrow arrangement is proposed, was also to be considered which both the Beneficiary and Agent were completely ignoring it.
• 5.     It was necessary to assess the process of enforcement of award or order. Further, the nature of disputes and it’s impact on Owner. Further, it had to be enforced against Indian entity (“Beneficiary”) or foreign entity (“Agent”) or against assets of these entities? In case if UK is considered as exclusive jurisdiction or seat of arbitration then all the order and award have to go through the civil proceedings to be enforced and executable against Indian Entity which means following of dual process causing inconvenience to both Owner and Beneficiary.
• 6.     Theft, piracy or breach of trust by Agent, were some of the apprehension of Owner which was adequately protected by the Owner’s right in rem over the copyrighted material i.e. source code of software. Further, there were adequate law in UK to govern and protect the transfer of proprietary information and copyrighted material. Hence in my view the probability of enforcing the contractual right in any proceeding against the Agent and Beneficiary was rare to happen but with the Beneficiary could not be avoided and as the governing law was Indian law under the licensing contract hence accepting any other countries law was absurd thought when we know that escrow agreement is supplement agreement to License Agreement.
• 7.     Concern of Agent was also of similar nature so finding a balance to move forward was necessary. In my view, when the Agent had decided to do business with Indian client then the Agent need to be aware and abide by the law of the land and apprehension of been unaware of Indian Law would in my view be called as an argument with fiction.
• 8.     I was thinking loud, can a single contract be governed by laws of two different nations? When various disputes under contract could stem out to be exclusive to the affecting party under the contract then by crafting the disputes which are exclusively between the Beneficiary and Agent can a law which is acceptable by two parties in a tripartite be applied to govern their relationship like in this case English Law for disputes between the Beneficiary and Agent. If so then all the other disputes could be governed by Indian Law. This would have a win-win situation to some extent as some concerns of each party were getting addressed. To quote some relevant examples in escrow arrangement, the disputes arising due to non-payments and any reciprocal obligations between Agent and Beneficiary could be settled in UK under English Law.
• 9.     Further, in an escrow arrangement where Owner is not getting any direct financial benefit what incentive would propel Owner to put his hand under the stone.

So to conclude, we have to make holistic assessment of all the questions, probability of happenings, and financial burden in exchange of return expected pursuant to this arrangement.

It would be interesting to know various provisions of laws in India that would safeguard the interest of Owner. In other words offences, violations and infringements with respect to source code (as a copyrighted material) is well covered under Sections 409, 420 and 120B of Indian Penal Code, 1860, Section 65 of the Information Technology Act, 2000 (and and other applicable provisions and amendment thereof) and Section 63 of the Copyright Act, 1957.