Cedar Boschan brings us this unique perspective on contract compliance:
Even if contractual language is less than ideal, you can take action to ensure that licensees and business partners honor their agreements with your clients – and that your clients realize their full potential with respect to both earnings and contract renegotiation leverage.
1. Pay attention
Many of the claims a trusted royalty auditor makes are matters that could have been resolved without an audit. The moral: Don’t assume the business manager or the client is paying attention. Here are some things to look out for:
a. Track rights that “trigger” royalty rate escalations and payments:
i. Did you approve a reduced royalty rate on a “most favored nations” basis for one or more hit products? If so, requisition rate analysis before your client’s right to object expires.
ii. What contingent payments may be due your client? For example, a certain major record label frequently agrees to pay publishing fees worth hundreds of thousands of dollars upon certain criteria. Yet, many artists who are eligible for the fees have not sought to collect them. My firm is pleased to provide this service as part of an audit, but if attorneys and accountants tracked the clauses that were triggered, clients could receive the fees years earlier.
iii. What costs are not recoup-able? Thorough cost analysis requires a thorough auditor, but there are ways to identify problems by matching approval rights and other contractual provisions to charges on your clients’ royalty statements. For example, in the video game industry, contracts may require a publisher to credit a developer’s account upon its return of assets borrowed from the publisher. TIP: If the first statement of account has not been rendered yet, an attorney may wish to request a detailed cost accounting from a client’s licensee upon the release of a product, or possibly sooner. This should be analyzed immediately because, by the time product sales peak, it may be too late to audit costs.
b. Watch the clock if you want a shot at reducing the charges to your client’s account and claiming unpaid royalties. At Hurewitz, Boschan & Co., calls come in on a daily basis from potential clients who want to audit the royalties for a hit product … a decade after most of the sales occurred. If your client has a spike in earnings, depending on a number of factors, you could have as little as a year to audit those earnings. Further, as mentioned above, most of a project’s costs may be incurred early on – before there are royalty earnings. Calendar your client’s objection deadlines in connection with costs, not just earnings.
c. Read the news to know where the cash will come from tomorrow:
i. Follow relevant court proceedings. For example, if you represent recording artists, make sure you read the September 2010 9th Circuit opinion on appeal in the case of FBT Productions LLC v Aftermath Records, which may impact whether your clients are entitled to a royalty or half of net receipts in connection with music downloads.
ii. Share with clients and their accountants news of major industry settlement and license agreements if you expect that it will result in earnings for your client. Ask your client’s accountant to advise you if this income goes unreported.
iii. When their clients’ licensee is the subject of an upcoming merger or pending sale, savvy attorneys call me to discuss sending out audit notices (because the licensee might pay the client to go away, in order to look more attractive to a potential buyer).
iv. Join Twitter – it is a great resource for breaking IP legal and business news (follow me @Auditrix) – and read the trades for more in-depth analysis.
2. Audit strategically
Every client’s case is different, but that doesn’t stop attorneys from asking me for a rule of thumb to determine whether it makes sense to audit. Some say that if a client has $1 million in earnings, and the account is recouped or nearing recoupment, it will make sense to audit. This may be true, but I have conducted many successful audits for clients with less than $1 million in earnings and for reasons beyond financial recovery (i.e., to identify breaches of contract, to gain negotiation leverage). The question you should ask as your client’s counsel is not whether to audit, but how much to audit. This is because even clients where a full audit does not make sense may benefit greatly from a “desk audit,” and/or the “Pay Attention” tips above. Therefore, you must have in your network a trusted auditor review the circumstances of all of your clients and guide you in the cost/benefit analysis of determining the how deep to go, in order to ensure the best interests of the client are being served.
3. Know the game
a. The decision to advise a client to audit rests squarely on your shoulders. (Often, if an attorney does not suggest an audit, nobody will – not even a business manager, unless the business manager happens to do audits, which may present a conflict of interest, incidentally.)
b. Don’t depend on the client to initiate an audit. Many clients come to their first audit believing that their business partners would never shortchange them. Sadly, these clients couldn’t be more wrong in most cases. Further, many licensees will try to make a licensor feel guilty for asking questions or initiating an audit. As a client advisor, you must understand that this is a business tactic of licensees and if you chose professional auditors, they will be respectful of maintaining your clients’ business relationships.
c. Tolling agreements are the norm. In the old days, staff employed at major companies responded to audit requests and settle an audit. Not so, today. Nowadays, the companies we audit refuse to provide more documents, while the documents that they agree to provide can take months or years to be produced. Therefore, it is often necessary to enter into tolling agreements so that the clock on the statute of limitations stops ticking while the audit is completed. Not every auditor is aware of this, so as an attorney, you need to be.
d. Be prepared to go to court. It isn’t common, but some audits don’t settle until they reach “the courthouse steps,” while others raise matters that land in court. This is one reason why your client’s licensee or business partner must believe that your client may consider litigation. (In my experience, licensees who know your client cannot afford a lawsuit may respond to an audit by refusing to provide key information and denying your client’s audit claims.) Therefore, be willing and ready to request tolling agreements and file a complaint to begin moving forward with a lawsuit if the licensee does not cooperate with your client’s audit or other deadlines. This has a few implications:
i. When you choose an auditor, you may be choosing an expert witness as well.
ii. If you need your auditor to serve as an expert witness, do not engage your auditor on a contingency basis. If you do, your auditor cannot serve as an expert witness because he or she will have a financial stake in the outcome of the case.
iii. Plan the communication strategy and discuss with the auditor what types of work product may be discoverable. I often communicate solely with the legal counsel of my clients and not directly with the clients in order to preserve attorney-client privilege. Discuss this with your client and the auditor up-front.
iv. If you are a transactional attorney, is there a litigator you trust to whom you can refer your client? Your auditor may be able to refer your client to a strong litigator.
Implementing the above steps – paying attention, auditing strategically and knowing “the game” – may deliver impressive results, such as additional payments to your clients and possibly the power to renegotiate their contracts. However, you will need more than this article. Working with a trusted auditor to tailor proactive strategies to your clients’ unique needs goes much further, and it will help you build a legal practice with loyal lifetime clients
In the meantime, please share: Do you have a strategy or system for tracking contractual rights? As an attorney, how do you work with auditors and business managers? Do you share your clients’ contracts with their accountants? Confess: Have you worked to negotiate contingent compensation for a successful client, only to have that provision go unchecked until now?
Cedar Boschan’s royalty audit firm Hurewitz, Boschan & Co. LLP serves those with intellectual property rights interests. The firm focuses on royalty, participation and other contract compliance audit consulting services. It also provides litigation support (such as damage theories and expert witness testimony), administration and statement preparation, and forensic investigations. Cedar can be reached at firstname.lastname@example.org or (310) 882-6381.