A recent case from the Sixth Circuit, addressing a source code agreement, highlights the importance of carefully specifying what happens to source code (and the trade secrets therein) after breach of the agreement.  In Epazz, Inc. v. National Quality Assurance USA, Inc.,[1] the Sixth Circuit affirmed the district court’s decision that a software licensee did not misappropriate a trade secret of the licensor when the licensee acquired the source code from an escrow agent, because the plain terms of the license agreement between the two authorized the release if the licensor breached. Further, the licensee did not commit misappropriation by hiring another provider to maintain and further develop the source code, where the license provided “the right . . . to use the . . . Material” upon breach of the agreement.

Jadian Enterprises (“Enterprises”) and National Quality Assurance (“NQA”) had a longstanding relationship whereby NQA used Enterprises’ software in support of NQA’s “registration and certification services.” As part of a Master Subscription Agreement between the two, they executed an Escrow Agreement to assuage NQA’s fears if Enterprise “couldn’t perform” or “keep up” with its Service requirements.  This required that the escrow agent retain the source code, and that the escrow agent give the source code to NQA in the event of a failure to perform by Enterprises, “for the sole purpose of continuing the benefits afforded” by the licensing agreement.

After Enterprises was later bought out by successor Jadian, Inc. (“Jadian”), Jadian failed to provide the same level of service as Enterprises, prompting NQA to halt paying subscription fees under the MSA and to request release of the source code from the escrow agent under the Escrow Agreement. The agent released the source code to NQA, who subsequently hired another provider to develop and maintain the source code.

Jadian and its owner, Epazz, Inc., then sued NQA for breach of contract and trade secret misappropriation. The district court granted summary judgment in favor of NQA, finding no misappropriation of a trade secret. The district court found that NQA properly requested the source code “[b]ased on Jadian’s breach of the MSA,” and that NQA’s subsequent use of the source code without paying fees was proper under the Escrow Agreement  because there was “no explicit language requiring NQA to pay,” and one of the conditions for release of payment was Jadian’s “failure . . . to function as a going concern,” which was met here, the court commenting that it “do[es] not see why NQA would need to pay fees based on the triggering event here—Jadian persistently failing at, and then entirely abandoning, its contractual support obligations.” Thus, NQA did not acquire the source code by improper means.

With respect to software licensing agreements, Epazz is a good reminder for both customers and trade secret owners alike to clearly define the metes and bounds of the use and/or transfer of trade secret material in case relationships later turn sour. Customers having doubts or concern as to a software vendor’s ability to perform should strongly consider escrow agreements, especially where the software is central or key to the customer’s operations or it has fears of the vendor going bankrupt. On the other hand, trade secret owners should ensure that customers are contractually bound to keep the trade secret confidential, and be prepared to give access to their source code language in the event it breaches an escrow agreement covering the same.

[1] No. 20-1552, 2021 U.S. App. LEXIS 25942 (6th Cir. Aug. 26, 2021).