Friday 11 October 2013

Should You Hire An Auditor To Ensure You Are Obtaining All of Your Royalties? Invotex Thinks You Should Hire It and Here is Why.

Invotex is an accounting, financial and economic consulting firm that provides expert services in litigation, forensic and valuation support; intellectual property services; insurance services; and restructuring and investigation services.  As part of its suite of intellectual property services, Invotex offers royalty audits and compliance services.  And, as Professor Crouch at the excellent Patently O Blog recently noted, Invotex has released its 13th Annual Invotex Royalty Compliance Report.  The report's headline states, in part, “89% of Audited Licensees Underreport and Underpay Royalties.”  According to Invotex, there has been a trend up in underreporting and underpaying royalties since it started creating reports in 2007.  The audits included in the report appear to be of companies that Invotex was hired to audit.  It is unclear, however, how many companies were audited by Invotex for this report; although the press release notes that “hundreds of agreements” have been audited by Invotex and Invotex has recovered “$150 million in underpaid royalties.”  Invotex states that:

Underreported Royalties as a Percent of Reported Royalties
In our examinations, we found that in a high percentage of cases, licensees owed the licensor more than two times the amount paid in royalties. As a percentage of reported royalties, we found that of all licensees:

·         25% underreport the royalties they owe by more than 100% of the total amount reported

·         7% underreport the royalties they owe by 50 to 99% of the total amount reported

·         8% underreport the royalties they owe by 25 to 49%

·         11% underreport the royalties they owe by 11 - 24%

·         11% underreport the royalties they owe by 6 to 10%

·         27% underreport royalties they owe by 1 to 5%

·         11% accurately report royalties owed

Invotex also helpfully reports the reasons for underreporting.  Notably, the report states that, “56% underreport sales; [and] questionable license interpretation accounts for 44% of the total misreported dollar amount.”  Apparently, Invotex has, perhaps unsurprisingly, found that licensees will interpret certain terms such as “the definition of the product to how to calculate the sale” in ways that result in lower royalty amounts.  This interpretation issue can be the result of poor drafting and Invotex notes that, “outright fraud is a rare occurrence.”   The report states other sources of underreported royalty amounts including: Royalties from Disallowed Deductions; Math Errors; Royalty Rate Errors; Unreported Sublicenses; Transfer Prices; and Unreported Benchmarks and Milestones.  Invotex also reports that it audited a major pharmaceutical company on behalf of a research university and found that, “Based on our audit, an underpayment of more than 75% of what had originally been reported to the client was uncovered and paid to our client. This underpayment was based on the overestimation of discounts, the use of transfer prices instead of third party pricing and the misclassification of sublicensee revenue.”

In a recent article in Corporate Counsel, Invotex’s Deborah R. Stewart and Judy A. Byrd offer advice for how to maximize the opportunity to receive 100% of the royalties you are entitled.  Ms. Stewart and Ms. Byrd provide a sage “Takeaway”:

The role of in-house counsel is changing. Many corporate counsel are now evaluated not only on effectiveness and efficiency, but increasingly, on how they contribute to the company’s financial bottom line. Capturing the full value of your corporate royalties will increase your firm’s revenue. The solution may be easier than you realize.

Best practice dictates a systematic license compliance program that includes royalty audits. Audits typically generate positive results for the licensor and can turn your “cost center” into a revenue-generating resource.

IP licensing is one of the most significant and fastest-growing sources of an organization’s earnings, yet it remains one of the most poorly managed and underutilized assets. Managing a successful licensee compliance program is like managing everything else. It takes time and interest to keep it on track.

Are the experiences of readers of this blog similar in discovering underreporting of royalties? 


Tim Jackson said...

But is this reporting on a representative sample of licences?

Presumably Invotex is not saying that there is underreporting in 89% of all licences. Just in 89% of the cases where they have been called in.

However, a licensor would only call them in if it already had reasonable grounds to suspect that there was underreporting.

Mike Mireles said...

Mr. Jackson,

Thank you, those are both excellent points. There is certainly some selection bias. My guess is that Invotex's main point is that if you need an auditor, they are the best firm for the job. I do think they are also trying to make the secondary point that there probably is underreporting in many licenses because of the nature of the causes of underreporting that they have found. Best, Mike

Suleman said...

I think even in successful organised companies many a licence gets forgotten by licensors and licensees. Someone I knew recently recruited to a well known company identified lots of licences they never knew they had, and no longer needed. It's hard enough sometimes to get a company to keep a list of it patent cases. Often they don't have a centralised list. I would imagine licence obligations are even more chaotically documented in many organisations.