Licensing Advice from Chris Muggleton

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Audits and Record Keeping(Posted: 03-04-2009)

By Chris Muggleton

Hello!

As promised and no doubt eagerly awaited this month we are going to talk about Audits and Record Keeping.

Some Licensors feel hesitant to audit their Licensees for fear of damaging the business relationship which has sometimes been built up over a number of years. Performing an audit should be seen as a natural part of the business relationship and should be conducted in a professional yet sensitive way. It is advisable that a Licensee is audited by rotation every two to three years, and certainly at least three months before the term of their License Agreement expires.

It is imperative that any Audit and Record Keeping clause incorporate the following:

·          That the Licensor has the right to audit for the purposes of verify Royalties declared;

·          The type of documents and records that the Licensee shall maintain, for how long such documents are to be kept (usually for two years after the expiration of the License Agreement) and that copies of these may be made and retained by the royalty auditors;

·          Where the Licensee is part of a group of affiliated companies, the audit may extend to those Licensee affiliated companies should License Articles be sold or transferred between the Affiliates;

·          Where the audit identifies a shortfall in Royalties reported in excess of a specified percentage, the Licensor is entitled to have the cost of the audit reimbursed by the Licensee.  The percentage trigger of reimbursement has traditionally been 5%, however increasingly we are seeing an industry shift as Licensors lower this to 3%;

·          That audit findings will incur interest at the specified contractual rate of interest.

Whenever we are approached by a client to put together an Audit Program we are asked two questions: 1) how much is it going to cost and 2) how much money are we going to find.

Obviously the cost of the audit is dependent on a number of criteria (but feel free to get in touch). Our advice is that Auditing should not be seen as a cost but as a source of future revenue.  All Auditors would concur not only that the vast majority of audits result in additional monies owed to the Licensor, a significant number of these also result in the actual cost of the audit being paid by the Licensee.

How much additional revenue will be found? This is almost impossible to gauge without actually performing the audit. Although the majority of audits do result in additional royalties owed, it is important to see the audit beyond the financial reward.  The audit process is about reviewing the License Agreement in its entirety and should be seen as a way of confirming that all terms of a contract are being complied with, whether dealing with the product approval process or permitted deductions from the royalty basis.  Invariably, there are significant issues disclosed for both the Licensor and Licensee that ultimately benefit the ongoing business relationship.

As ever we have only scratched the surface, if you would like to know more do feel free to get in touch. I can be reached at chris@licensingadvice.com

Next month I will discuss Affiliates.

Chris