Reed Smith Client Alerts

Authors: Carolyn E. Pepper

Type: Client Alerts

Audit provisions are very commonly found in commercial contracts, especially those which involve payment of a licence fee or royalty. They are often not the clauses which attract the most attention during contract negotiations. However, they are important clauses which warrant careful consideration. Here are our top 10 tips on contractual audits.

  1. Make sure that the purpose of the audit is clearly defined so that both parties understand what the audit is intended to achieve.
  2. Ensure that it is clear whether it is a single company or an entire group that is open to audit.
  3. Agree what information should be available for the audit and ensure that the information which can be inspected is sufficient to assess compliance with the agreement but not so wide that irrelevant information is available for inspection. The parties should consider whether specific exceptions to the documents that can be audited are required.
  4. Agree who can carry out the audit. Audits can be carried out by the auditing party itself or by the more usual method of appointing an independent auditor to carry out the audit on behalf of the auditing party. It is worth considering whether it would be appropriate for the parties to agree on the identity of the auditor or for there to be a right of veto over the chosen auditor.
  5. Think about what the auditor is entitled to do – are they simply allowed to inspect documents or can they copy them too? Should they destroy documents once the audit is finished?
  6. If an independent auditor is to be appointed, consider whether the audit clause should expressly state that the party being audited is able to view and correct any information being sent to the auditing party in advance of it being sent by the independent auditor.
  7. Think about whether an NDA between the independent auditor and the party being audited is appropriate or necessary.
  8. Ensure that it is clear what period of time is open to audit, how often audits can be carried out, when the right to audit or give notice to audit will expire and how long the party being audited should retain documents.
  9. Consider whether agreement is required on the timing of the audit process and how much notice must be given for an audit.
  10. Finally, consider who pays for the audit. It is common for the auditing party to bear the costs unless there is found to be a significant discrepancy during the audit.

Client Alert 2017-056