This is a complete no-no. There really is no justification for this whatsoever. What does "cover their bases" mean? As them to explain what they are trying to achieve and find other ways to assuage their concerns. The only legitimate thing is to have something in case you fail and they have "banked" on you. There is a legit way to solve that. basically if they want that tell them they should pay for an Escrow service…
It's entirely unreasonable for them to demand access to source code. The government and large corporations apparently disagree, or Microsoft wouldn't have their Shared Source Initiative. And for any nay-sayers in the crowd, that should be all that need be known: Microsoft thinks it's okay, and they have a lot more to lose than you do. The only legitimate thing is to have something in case you fail and they have "bank…
National agencies such as FBI are not threat to MS to become competitor, unlike OP’s client.