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Licensing Audits from Licensees' Perspective
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 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.
Potential areas of liability are not simply a matter of miscalculating royalties. Licensing agreements often have detailed provisions about territorial restrictions, authorizations for suppliers, product approvals, sell-off rights and wind-down periods. A licensee that breaches those provisions could be liable for gross revenues received from the unauthorized sales, as well as interest accrued between the time of that sale and the audit. Coupled with the cost of the audit, the penalties for what seem like minor breaches can potentially eclipse the total profits the licensee earned.
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