October 18, 2016
One of the most important provisions in your textbook publishing contract is the audit clause, which will specify the conditions for how and when you can request and conduct an audit. In the absence of an audit clause, some publishers will still comply with a request to audit, although they are not contractually required to do so.
While the large publishers have calculated and paid royalties to thousands of authors, contract terms can vary, automated royalty systems have limitations, and the accounting teams at publishers are made up of human beings who can make mistakes. If an author wants a better understanding as to the calculation and accuracy of his or her royalties, the best course of action is to request a royalty audit.
A royalty audit allows the author, with the help of a professional auditor (typically an accountant) to conduct a review of the publisher’s underlying books and records that were used to calculate royalty payments. (See the end of this article for links to my other resources about royalties.)
Without the presence of an audit clause in your contract, publishers can deny audit requests and access to records, or limit the scope of audits such that the responses given by the publisher are useless in providing answers to questions sought by authors. And publishers are increasingly doing so. In many cases, authors can still gain access to their records through legal action, but that would be more painful and expensive for everyone involved, and some publishers bet that an author will give up because he or she will not have the financial or emotional resources to deal with a protracted lawsuit.
If you currently have a publishing contract without an audit clause, it can be added as an addendum to your existing contract(s). What actually ends up in the contract will depend on your negotiating position and the experience and skills of your advisors.
The following excerpts from a license agreement between Disney and The First Years for the use of Disney character copyrights on consumer products detail agreements on audits and maintaining records. This is a license for intellectual property rights in exchange for royalties, similar to a publishing contract.
“24. AUDITS AND MAINTAINING RECORDS
A. Licensee agrees to keep accurate records of all transactions relating to this Agreement and any prior agreement with Disney regarding the Licensed Material, including, without limitation, shipments to Licensee of Articles and components thereof, inventory records, records of sales and shipments by Licensee, and records of returns, and to preserve such records for the lesser of two (2) years after the expiration or termination of this Agreement or a period of seven (7) years.
B. Disney, or Disney’s representatives, shall have the right from
time to time, during Licensee’s normal business hours, …. to examine and make extracts and photocopies from all such records, including the general ledger, invoices and any other records which Disney reasonably deems appropriate to verify the accuracy of Licensee’s statements or Licensee’s performance hereunder……
C. If in an audit of Licensee’s records it is determined that there is a short fall of five percent (5%) or more in Royalties reported for any Royalty Payment Period, Licensee shall upon request from Disney reimburse Disney for the full out-of-pocket costs of the audit…
D. If Licensee has failed to keep adequate records for one or more Royalty Payment Periods, Disney will assume that the Royalties owed to Disney for such Royalty Payment Period(s) are equal to a reasonable amount, determined in Disney’s absolute discretion…”
I have never seen that kind of language and level of detail in a publishing contract! In many cases, publishing contracts do not contain an audit clause because authors don’t know that they can ask for one. In this case, the relationship is flipped, because Disney holds all the cards over its licensee, who likely would be thrilled to get the chance at a deal with one of the most recognizable media companies in the world.
While you may not be able to obtain audit rights as strong as Disney’s, here are five things to consider when negotiating the audit clause:
Timeframe for review. Some audit clauses may not contain the royalty periods that may be audited and others have a specified “look back” period. For obvious reasons, it is in the publisher’s best interest to limit this time period. If such a provision is present, authors should be ready and willing to audit their statements on a regular basis. Without a limitation, royalty auditors and authors can generally obtain access to records going back to the statute of limitations for contract claims in the state that governs the contract.
Documents available for review. Many audit clauses contain vague language such as “the relevant records maintained by the Publisher” or “all documents necessary to verify royalty payments.” This can be positive or negative, but it is ambiguous. In my experience in performing royalty audits and in assisting both licensors and licenses in disputes, detailing specific documents to be made available for review is preferable. While you may not know every document needed to gain satisfaction that your royalty payments are accurate, a list of the basic types of documents a royalty auditor would likely request should be included.
Time to complete audit. I highly recommend that authors get language that requires the publisher to respond to requests within a reasonable time period. It is true that publishers have limited resources to fulfill audit requests, but without this, publishers can stonewall indefinitely.
Choice of auditor. An author should have the right, at his or her own expense, to engage the royalty auditor of their choice. Some publishers will require that the auditor have a CPA designation or be from a nationally recognized accounting or consulting firm. This criterion is generally not burdensome for the author and ensures the assistance of a competent professional.
Payment of audit fee. To counterbalance the publisher’s power, authors should negotiate for the publisher to pay for the cost of the royalty audit. This payment responsibility is typically shifted if the auditor’s underpayment findings are in excess of some percentage (typically 5%). In addition to the obvious benefit to the author, it has a built in compliance function. Publishers are likely to pay closer attention to agreements with payment of audit fee language so that they are not responsible for professional services fees in addition to underpayment findings.
Authors may be hesitant to assert their audit rights for fear of upsetting their relationship with the publisher but they should remember that their publishing contract serves as the codification of a business relationship. Publishers are regularly faced with royalty audit requests as part of the normal course of business. Authors should not fear retaliation as they are entitled to a review of the underlying books and records supporting their royalty payments. An author can never be sure of accuracy of their payments unless they ask the right questions and receive the right information. A well-crafted audit clause will help to ensure this process runs smoothly.
This is the first in a series of posts in which I will share what in my experience are the most critical parts of the publishing contract to focus on to ensure the most accurate and equitable payment of your royalties. I caution that I am not an attorney and specific contract clauses should be negotiated by you and your publisher, ideally with the help of an experienced attorney in the industry. See TAA’s Professional Directory for a list of attorneys who specialize in textbook contracts.