The Software Escrow System

Norihisa OGAWA
Attorney at Law

1. The Licensor's Bankruptcy and the Use of Software

1.1 The Use of Software

(a) Use of a copy of software acquired for value

  A purchaser's use of a copy of packaged software or a TV game program for a personal computer has hitherto been considered not to be "copying" within the purview of the Copyright Act. Even if so considered, the owner of a copy of such program is authorized to copy or adapt it to the extent deemed necessary for his own use under 47bis of the Act.

(b) Use under a shrink-wrap contract

  On the question whether a contract can be validly concluded by the shrink-wrap method, negative opinions are in the majority. Where, however, the user has sent back a written assent to a proposed license contract, there is no question about its validity. The terms and conditions of a license contract includes conditions of use, prohibitions, scope of warranty, limitation of liability, surrender or destruction in case of violation of such terms, period of validity, etc. It is open to question whether the user is the owner of the copy of software or has been converted into a lessee by the license contract. This question is involved with the question whether Art. 47bis of the Act is a mandatory provision or a directory one.

(c) Use under a software license contract

  In the case of large-scale software or expensive software, it often happens that the licensor and the licensee enter into a software license contract to make a copy of software available to the latter.. In such case Art. 47bis is not applied, and the software will have to be used in accordance with the terms of the contract.

(d) Use under a license to duplicate software

  This type of use takes place where a software maker supplies one of its sales agents with a master program so that he may duplicate or customize it for end users, or where a maker sells its software to allow another maker to incorporate it into its software for sale.

1.2 Consequences of a Licensor's Bankruptcy

1.2.1 Legal Bankruptcy (Bankruptcy and Corporate Reorganization)

(1) The Problem of a Receiver' Status as a Third Person

  It is laid down in our case law that when a licensor goes into bankruptcy or corporate reorganization, the bankruptcy or reorganization receiver stands in the same position as attaching creditors (the receiver's status as a third person). From this it follows that a licensee cannot set up against the receiver a license to duplicate software or a license to adapt it which the licensor has granted him; because there is no law that allows a licensee to stand on his right against a third person, while the receiver can seek an injunction to ban such acts. But because under the Copyright Act the right to use is in itself not the exclusive right of a copyright owner, a user is free to use a program (if we grant that use of a program is not duplication). Also the owner of a copy of a program is under Art. 47bis of the Act free to make use of it, inclusive of duplication to the extent it is necessary.

  Out of the above four types of use of software, type (a) will not be affected, types (c) and (d) may possibly be enjoined, and type (b) depends upon how the license contract is construed.

(2) The Problem of Rescission of a Bilateral Contract Yet to Be Performed by Both Parties

  Art. 59 of the Bankruptcy Act and Art. 103 of the Corporate Reorganization Act authorize a receiver to rescind a bilateral contract unperformed on both sides. In the case of types (c) and (d) , the receiver can choose to rescind the contract where the royalty payable on a term basis is still unpaid, and the obligation to allow use (duplication) in the future is also unperformed. The user will then lose his right to use (to copy).

(3) U. S. Bankruptcy Act, Art. 365 (n)

  In 1988 the United States has added this provision to its Bankruptcy Act with a view to securing the continuance of license contracts during bankruptcy proceedings, with the result that in case of bankruptcy a licensee can choose to continue his license contract. In the case of (2) above, therefore, a licensee can preserve his right to use.

  In Japan similar legislation will be needed to solve the problem of rescission of a bilateral contract executory on both sides and to afford protection to licensees. As to the problem of the receiver's status as a third person, the registration system should also be amended so that the right to use by duplication etc. can be set up against a third person.

1.2.2 De Facto Bankruptcy

  When a licensor goes into de facto bankruptcy, a licensee or user does not lose his right to use software. But as a matter of fact he will experience difficulty in continuing to use it because the source code, maintenance data etc. will be lost and the whereabouts of the technical expert who developed it will become unknown.

1.3 Safekeeping of Materials

  It happens too often that at the time of a licensor's going bankrupt, a licensee of software will find documents such as its source program, specification, flow chart, other materials on its development dispersed and lost. De fact bankruptcy, or de lege bankruptcy, for that matter, seldom happens without causing confusion. In de lege bankruptcy a licensee is not always better off, for we cannot say those materials are preserved because the receiver is appointed by the court. The problem of the receiver's status as a third person or the problem of rescission of a bilateral contract unperformed on both sides cannot be solved except by resort to law in case of a frontal conflict of interests, but in reality they can be solved by negotiations between the licensee and the receiver. The dispersion of materials as a result of a licensor's bankruptcy that creates bad confusion by disrupting a continuous use of software is much worse. Besides it happens far more frequently, and indeed in Japan bankruptcy is de facto in the overwhelming majority of cases.

  In Europe and America software escrow is a measure used and well used, too, to meet such a situation. If this system is introduced into our country, we believe that a licensee or a user will be able to make a secured exploitation of his software asset by actually continuing its use undisturbed by his liecensor's bankruptcy.

  Incidentally, it may be added that software escrow serves as a precaution against dispersion of computer assets due to fires and other calamities as well as to a licensor's bankruptcy, but also as a means of the safekeeping of software as a security in a system of financing on software.

2. Outlines of Software Escrow

  This is a deposition-analogous mechanism for transferring ownership and possession of a copy and development materials of a source code from a licensor to a third person (an escrow agent) so that the escrow agent may transfer such ownership and possession to his licensee on occurrence of certain events or conditions.

image of escrow system

(1) Agreement:

  It is a tripartite trust-analogous agreement involving a licensor as depositor, his licensee as beneficiary, and an escrow agent.

(2) Deposit

  The licensor, in accordance with the escrow agreement, delivers the asset to be escowed, and transfers ownership of it, to the escrow agent. The escrowed asset consists of a copy of a source code etc. By virtue of transfer of ownership, it can be set up against an attaching receiver or creditor or the like.

  The deposit includes:

  There are several methods, technical and otherwise, of checking to ascertain whether the software licensed is duly deposited.

  In case of a version up, an additional deposit will be demanded as occasion calls.

(3) Custody

  The agent stores the escrowed asset in a sealed vessel, and keeps it with the care of a good custodian. Once the escrowed asset is sealed, the agent or any other person is prohibited from accessing it. The agent is bound in duty to observe confidentiality.

(4) Disclosure & Delivery

  On occurrence of certain events specified in the license agreement or the escrow agreement. such as the lisensor's being adjudged bankrupt, nonperformance of maintenance for a certain period of time, the licensor's closing his place of business, etc., the agent delivers the deposit and transfers ownership of it to the licensee upon his request.

(5) Notice

  In disclosure, the agent gives notice to the licensor for the purpose of confirming the licensee's request. If the licensor makes an objection, he withhold disclosure till the matter is settled between the parties. In case the notice does not arrive, or no answer is received, he makes discovery in accordance with the terms of the escrow agreement.

(6) Fee

  As a rule, it is on the licensor that the fee falls. But the licensee is allowed to pay it to secure the continuance of custody.