Legal Definitions - audit privilege

Audit privilege, also known as "audit rights," refers to a specific contractual provision, typically found in intellectual property licensing agreements. This provision grants the owner of the intellectual property (the licensor) the contractual right to examine the financial records, sales data, and other relevant business documents of the party using that intellectual property (the licensee).

The primary purpose of this right is to ensure that the licensee is accurately reporting usage and sales, and consequently, paying the correct amount of royalties or fees as stipulated in the agreement. It provides the licensor with a mechanism to verify compliance and prevent underpayment.

Here are a few examples to illustrate how audit privilege works:

• Software Licensing: A company that develops specialized project management software (the licensor) grants a license to a large construction firm (the licensee) to use its software across multiple projects. The licensing agreement states that the construction firm will pay an annual fee based on the number of active users accessing the software. The audit privilege clause allows the software company to periodically review the construction firm's internal user logs and financial records related to software usage. This ensures the construction firm is accurately reporting its user count and paying the correct annual fees, rather than underreporting to reduce costs.

• Brand and Trademark Licensing: A well-known fashion designer (the licensor) licenses her brand name and signature patterns to a textile manufacturer (the licensee) to produce a line of home furnishings. The agreement specifies that the designer will receive a percentage of the gross sales of these licensed products as royalties. The audit privilege allows the designer's representatives to inspect the manufacturer's sales reports, production records, and financial statements pertaining to the licensed home furnishings. This verifies that the manufacturer is correctly calculating and remitting the agreed-upon royalty payments based on actual sales figures.

• Patent Licensing in Pharmaceuticals: A pharmaceutical research firm (the licensor) holds a patent for a unique compound used in a new allergy medication. It licenses this patent to a larger drug manufacturer (the licensee) to produce and distribute the medication globally. The royalty structure is based on the volume of the patented compound produced and sold by the drug manufacturer. The research firm's audit privilege enables it to examine the drug manufacturer's production logs, inventory records, and sales invoices for the allergy medication. This ensures that the drug manufacturer is accurately reporting the quantities produced and sold, thereby guaranteeing the research firm receives its full and proper royalty payments.