The Who, When, Why and The Who, When, Why and How of Royalty AuditingHow of Royalty AuditingLive Webinar

Presented by Technology Transfer Tacticswww.technologytransfertactics.com239-263-0605

The Pervasive Underpayments of Royalties

“Studies have repeatedly shown that more than 3/4 of royalty

payments made by licensees are based on reports that contain errors,

misinterpretations, or omissions.” -Invotex presents updated aggregated results of nearly 15 years of royalty audit data in their latest

paper: Underpaid Royalties Are Pervasive, yet Proper License Management Maximizes Profits. Visit www.invotex.com for details

PanelistsGlenn Tautrims, CA, CFE is a Director with Global Royalty Audits Inc.

Prior to co-founding GRA in 2005, Glenn was a Vice President in a large international accounting firm, where he was responsible for implementing and overseeing its Canadian Revenue Recovery and Licensing Management practice. Glenn was also one of the original members of the team that created the Royalty Audit practice for the accounting firm in 1996. In addition to his experience in a range of industries, Glenn has presented papers and conducted seminars on various intellectual property issues including Conducting Royalty Audits and Licensing Management Best Practices. Some of the groups Glenn has addressed include the Association of University Technology Managers and the Licensing Executive Society.www.graudits.com

PanelistsMatthew A. Hurewitz, CPA, is Managing Partner at Hurewitz, Boschan & Co. LLP. The firm’s auditors have helped clients recover in excess of $50 million from royalty and participationcompliance audits. Its principals’ 25 years of professional experience, an international network of experts, and sophisticated computer analytics yield reliable, timely and cost-effective audit results. Auditors analyze voluminous data, often excavating through layers of records to expose buried but critical information. In most audits they find calculation errors, errors in contract interpretation, and a variety of other mistakes that may otherwise remain undiscovered. www.royaltyaudits.com

PanelistsRobert Baron is a partner at the law firm Ballard Spahr LLC, where he isVice Chair of the Intellectual Property Department, a partner in theLitigation Department, and a member of the Intellectual Property Litigation, Complex Commercial Litigation, Higher Education, and Life Sciences/Technology Groups. He regularly prosecutes and defends cases at the trial and appellate levels involving patent, copyright, trademark, and trade dress infringement; theft of trade secrets; licensing disputes; unfair competition; and business terminations. He has litigated royalty disputes, and advised clients on the use of audit provisions in royalty disputes. www.ballardspahr.com

Program Agenda

•Identifying major players•Desk audit versus a full royalty audit•License compliance program •Establish optimum audit schedules •License drafting tips

Identify all major players that should be on your audit team

Remember: Audits are one part of managing royalty compliance.

• Have a “royalty” team: (i) relationship person who knows the provision and the licensee,

and who is the main contact;

(ii) accountant who reviews royalty statement with relationship person

• External auditor• External/internal legal counsel• Director of Licensing / management• Principal inventor – for technical assistance if applicable

When you engage a formal audit, consult counsel and a good auditor.

Know when a desk audit is appropriate versus a full royalty audit•A desk audit can be a good “first check” of

the royalty statements, and appropriate when you want an initial assessment before committing to the costs of a full royalty audit.

•A desk audit is appropriate when the goal is to determine if basic provisions of the agreement are being adhered to, such as proper royalty rates or correct advance recoupment.

Know when a desk audit is appropriate versus a full royalty audit•Relationship with licensee•Size•Volume•Depth of reporting and external info•Errors and omissions noted•Complexity of agreement•Audit clause threshold

What should be included in your license compliance program

•Assign license to one person•Standardize procedures and royalty

reports•Summarize license terms•Physically recalculate royalty report•Confirm payment•Identify due dates•Consistent analysis of risk

What should be included in your license compliance program•Develop a good relationship with the

licensee.

•Require detailed royalty statements.▫ Units sold, regions where licensed product is made or

sold, gross and net sales, currencies sold and exchange rate used.

•Be proactive when you think there may be a problem.

License drafting tips

▫Penalties (e.g. late payments)▫Objection period▫Audit rights▫Reimbursement of audit costs▫Document retention period

Examples of underreporting and other non-compliance issues•Unreported / underreported:

▫Revenue▫Products▫Sales in specific territories

•Incorrect:▫Royalty rates▫Incorrect deductions/deductions

•Failure to obtain required licensor approval•Sales of unlicensed product categories•Late reporting

Reasons for underreporting and other non-compliance issues

▫People make mistakes Internal controls

▫People think differently/contract interpretation Deductions Communication

▫People even cheat

“Red flags” for targeting audit candidates and activity •Internal red flags

▫Warnings from inventor▫Known disputes on contract interpretation▫History of errors▫End of license term

“Red flags” for targeting audit candidates and activity •Licensee red flags

▫ Changes in communication▫ Unexpected swings in amounts reported▫ Submission of manual royalty statements instead of system generated royalty

statements▫ “Net Negative” sales reportings for a product▫ Licensee is experiencing financial hardship▫ Licensee operation-specific▫ Licensee claims in litigation (i.e., licensee states new product does not infringe

patent for similar technology)

•

“Red flags” for targeting audit candidates and activity

•External red flags▫Public reports of product sales do not jibe

with royalty statements▫Foreign subsidiaries

Keeping the peace while maintaining your audit rights • Understand that audits are an anticipated and

common business practice and don’t have to rock the boat.

• Hire a professional and experienced auditing firm that understands the importance of maintaining a your business relationships.

• What is goal?▫ Keep peace with important relationship, or ▫ Obtain information in a broken relationship, as

potential pre-cursor to litigation

Common mistakes to avoid

•Don’t assume communications with “independent auditor” are privileged.

Common mistakes to avoid

• When drafting the license agreement: Don’t leave room for ambiguity and misinterpretation

in key provisions of the agreement such as: royalty rates and escalations, applicable and excludable sales, allowable deductions from sales, the books and records that are to be provided to the auditors, expiration of audit rights and right to contest royalty statements.

Lack of specificity in royalty and audit provisions.

Make sure licensee cannot depress royalties via lower-than-market sales to affiliates.

Common mistakes to avoid

▫Failure to monitor licensees Comparison to license terms

Make it constant, proactive

Biggest mistake – Not auditing , because some licensors don’t realize how fruitful audits can be.

2nd biggest mistake - Waiting too long to audit, such that the audit window has closed for periods with significant activity.

Common mistakes to avoid

▫Failure to perform desk audits Search public information.

Materiality issues

Don’t confuse a desk audit with a full audit. There is much that cannot be detected by a desk audit and unless an auditor performs fieldwork and analyzes the books and records of the licensee.

Establishing optimum audit schedules

▫Product number▫Units sold, price and extended sales

amount▫Details of discounts allowed▫Royalty rate and royalty due▫Details of sales by country with foreign

exchange rate used▫Withholding taxes taken and prior

period adjustments

Questions?

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