Audit Rights, Auditing

Refers to the right of a licensor to audit the licensee to determine whether all sales have been reported. Typically a license will provide that an audit is at the licensor’s expense, unless under-reporting (greater than some threshold, e.g., 3-5%) is found, at which point the licensee becomes liable for any underpayment plus any audit costs. Auditing is usually done by a third party accounting firm, but occasionally by other IP related consulting companies.

Although in theory over-reporting should be as frequent as under-reporting, it is highly unusual to find over-reporting in an audit. Indeed under-reporting is so common that companies that license broadly sometimes use auditing campaigns as a way to rapidly raise short-term revenue. Because such auditing can augment short-term revenue (albeit revenue that should have been paid over a long period of time), it can give the erroneous impression that overall license-royalties are rising dramatically, as are future revenues, leading to overvaluation of intellectual property and/or businesses. See Metering.