A patent and license portfolio can provide a consistent and reliable revenue stream. However, many companies have technology, trademarks, and merchandising opportunities that are not fully exploited. Even if fully licensed, there is often considerable upside available via vigilant enforcement of audit provisions to ensure all amounts due are paid. Unlike almost any other business transaction, additional royalties drop to the company’s bottom line, so greater attention here often yields disproportionate results.
Once a license is obtained, many companies tend to sit back and watch the checks roll in. Often, little analysis is performed to assess whether those checks reflect accurate reporting of contractual obligations. Comparisons with supporting documents provided in order to support the checks are unlikely to provide insight into what is not being reported. Without examination of the underlying records from which the information is derived, there will always be a question of completeness. Depending on the basis for the royalty formula, investigations of additional costs and allocations are likely appropriate. Such examinations of the licensee’s private data are often only contractually allowed by third party auditors. For a list of common licensee under-reporting errors, see this article. For more advice, see Best Practices in Royalty Audits.
Importantly, most license agreements provide that if the audit identifies additional royalties (usually with a threshold of around two to five percent of what was initially reported), the licensee pays for the audit’s cost. Such cost-shifting provisions mean that there is often no ultimate cost associated with finding these additional profits.
While first time audits usually have the largest findings, the expectation of regular audits is a strong incentive for future ongoing compliance. A licensee is less likely to underreport if the licensor engages in a regular audit program. If problems continue, a licensor may want to modify or terminate the existing licensing agreement. Past material noncompliance with the existing agreement is often necessary for any such termination.