Sublicensing and Audits: Two Often Overlooked Provisions

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It’s a good idea to become knowledgeable about two often overlooked provisions in licensing agreements: sublicensing and audits.

Sublicenses

Under a sublicense, the licensee transfers some of its rights to another company that can make or sell your invention. For example, perhaps the licensee does not have a strong sales force in France, so it sublicenses the right to sell in France to a French company (assuming the French rights were included in the original license). The French company then pays money to the licensee who then pays you a portion of the sublicensing revenue, often 50%.

You may not like the idea of sublicensing because a different company -- perhaps a company with a philosophy or sales practices you don’t agree with -- is selling your invention. You can attempt to prohibit sublicensing altogether, but a better solution would be to require the licensee to seek out your prior approval before granting a sublicense. Keep in mind that licensees like to have the freedom to sublicense.

Audit Provisions

An audit provision provides who can audit the books and how often. Normally, a licensee will want to limit the frequency of audits. It is common for a licensee to limit the number of audits to once or twice a year. Also, the licensee will want several days’ notice before the audit is to occur. Five days’ is common.

The licensee may also seek to limit who can audit the books. For example, a licensee may request that you hire a Certified Public Accountant (CPA) to perform the audit. It will be more expensive for you to hire a CPA, and therefore we would recommend that you avoid this requirement. It would be less expensive if any accountant can serve as your representative for an audit. It also would be helpful to obtain the licensee’s cooperation by designating an individual at the licensee’s company to be available to assist you or your representatives.

Sometimes a licensee will attempt to prohibit a licensor from using an accounting firm that works on a contingency basis. Working on a contingency basis means that the company will not get paid unless it finds a discrepancy. Licensees are not comfortable with these firms because they believe that contingency accountants “manufacture” discrepancies in order to receive a bigger commission. As a general rule, we would recommend that you retain the right to use whomever you want as your representative for an audit.

Since you may not discover or suspect a discrepancy right away, you should negotiate an audit provision that requires the licensee to keep all books and records available for at least two years after the termination of the license agreement.

Because the licensee’s books may contain confidential information about sales and prices, your representative may be required to sign a confidentiality agreement. You may be requested to keep the information confidential. This is reasonable, although this confidentiality provision should not apply in the event of litigation about payments.

Finally, in the case of an underpayment in which you receive less money than you should, the license agreement should provide for a method of settling the dispute. Usually, there are three parts to this dispute resolution.

  • The licensee must promptly pay you the money you should have received. 
  • You should seek an interest payment. If you had received the proper payment in the first place, you could have deposited it in a bank and earned interest on it. 
  • You may seek to have the licensee pay for the costs of your audit if there is an underpayment. A licensee will not want to pay for the audit for just any discrepancy, only substantial ones. What counts as substantial? Some agreements set a dollar amount, for example; $1,000. Other agreements set a percentage; for example, if any underpayment was more than 2% of the amount paid.
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