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The Dark Side of Licensing: How to Prepare for the Audit
In the classic movie When Harry Met Sally, Harry says, "When I buy a new book, I always read the last page first. That way, in case I die before I finish, I know how it ends. That, my friend, is a dark side." At the beginning of any licensing relationship, things always seem rosy and full of potential. We talk about royalties, advances, and guarantees with the dream of a relationship that will be enduring and fulfilling for both licensor and licensee. But licensees would do well to heed the advice of young Harry by giving in to their dark side and looking to what lies at the end of the story. Because what may be waiting for them there is an audit for which they are ill prepared.
Audit clauses are standard in almost every license agreement. They typically provide that the licensor has the right to review the licensee's records related to the sale of licensed products at least once a year. They also usually provide that if the auditor finds an underpayment of a certain scale (usually around 5%) then the licensee is responsible for the costs of the audit.
The audit clause itself is not something to be feared. It is a necessary means for the licensor to protect its interests and to guard against unscrupulous licensees. But it is a mistake to think that the clause is there solely to prevent malfeasance. Licensors have discovered that audit clauses can be a source of additional revenue. An audit is literally a way to make licensees pay for their mistakes. And sometimes those mistakes can be costly.
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