Audit Clauses in Licences – Be Careful What You Wish for!

December 4, 2014

Many licences of IPRs include the right for a licensor to enter onto the licensee’s premises and inspect relevant documents and materials in order to ensure that specific provisions of the licence are being complied with. These audit clauses are useful as a way of enabling the licensor to police compliance with the agreement.  For example, they provide a means of enabling the licensor to check that the correct level of royalties is being paid, or that any specific restrictions in the licence are being adhered to.  

The recent judgment in 118 Data Resource Limited v IDS Data Services Limited and others [2014] EWHC 3629 (Ch), in which our firm acted for the successful defendant, will serve as a reminder to licensors of IP to ensure that any audit clauses upon which they intend to rely are drafted clearly and in terms which set out precisely how an inspection should proceed, and shows licensees how they might protect their business from overly zealous licensors who might be intent on using information gleaned for ulterior motives.  

In this case the claimant, 118 Data Resource Limited, licensed its alleged intellectual property rights in a database of business contact details to the first defendant, IDS Data Services Limited. The licence permitted IDS to use and sub-licence these rights, subject to specific restrictions. The licence agreement also provided that IDS’s own database would be ‘cleaned’ (or updated) by the claimant.  

As expected, the licence agreement contained various provisions which enabled the claimant to ensure that the first defendant was complying with its specific obligations under the licence.  

Firstly, the claimant had the ability to review and approve IDS’s standard terms and conditions which would enable it to review any proposed sub-licences with IDS’s customers, prior to the data of 118 Data Resource being released (ie a right of prior approval of the terms). However, it was accepted that, in practice, 118 Data Resource did not enforce its rights under this provision.  

Secondly, the agreement provided that the claimant could enter the premises of IDS where copies of the database were used ‘for the purpose of ascertaining that the provisions of [the] Agreement [were] being complied with’.  

Crucially, however, this particular audit clause did not set out any further detail about how such an inspection would proceed.  

The substantive dispute between the parties is ongoing. The litigation is complex and involves alleged infringement of a web of IP rights including database rights, copyright and confidential information, in addition to issues surrounding breaches of the terms of the IP licence.  

118 Data Resource issued an interim application which focused on a request for specific performance of the rights it believed it had under the audit clause of the licence. In its application, the claimant sought to rely upon the audit clause, together with its right to prior approval of IDS’s standard terms and conditions, to gain essentially unrestricted access to IDS’s office, IT systems and documents. 118 Data Resource requested a court order which would enable it to have sight of all of the IDS customer contracts and financial information, together with copies of the extracts of the database of 118 Data Resource which had been licensed to each of IDS’s customers. 

IDS strongly contested the claimant’s application on the basis that the vague wording of the audit clause did not allow for an inspection in the terms sought by the claimant. Furthermore, and most importantly, IDS argued that, if such wide-reaching access was granted (without the court implying reasonable safeguarding provisions), 118 Data Resource would gain access to highly confidential and commercially sensitive information, as well as information which was the subject of legal privilege in the main litigation.  Had the application succeeded, there would have been no restriction on the use the claimant could have made of that information because the information would have been disclosed as a result of a specific performance of the contract. By way of contrast, were the information to be disclosed in the course of the litigation in the normal way under disclosure then the information could only have been used for the purposes of the litigation and not for any wider commercial purpose. 

The audit clause as drafted did not provide any mechanism governing how the inspection would take place, and did not contain any provisions to protect either party’s commercial position. It read as follows: 

‘[IDS] undertakes and agrees with [the claimant] that it will… permit any duly authorised representative of [the claimant] on reasonable prior notice to enter into any of its premises where any copies of [the database] are used, for the purpose of ascertaining that the provisions of this Agreement are being complied with.’ 

The lack of any such mechanism was a significant issue and was particularly relevant in this case, as it was accepted that 118 Data Resource and IDS were competitors in the market. 

Counsel for IDS submitted that the inspection clause was unenforceable due to this lack of essential detail. Alternatively, if the clause was enforceable, it only permitted 118 Data Resource to check that IDS was storing and using the claimant’s database in accordance with the terms of the licence (ie the database was being held securely and separately from IDS’s own database). Counsel submitted that the audit clause did not allow the claimant to gain access to commercially sensitive information such as the identity of IDS customers, or the prices at which the claimant’s data was sub-licensed.  

Deputy Judge Halpern QC, who heard the application, accepted the IDS submissions. He was satisfied that, although it was clear that the parties had agreed that the claimant had a right of inspection, it was not clear for what purpose the claimant was entitled to gain entry to IDS’s premises, nor how the inspection would proceed thereafter. The audit clause lacked fundamental detail, and the court would have been required on the claimant’s case to imply provisions which go beyond the wording of the original clause, and involved re-writing the agreement. DJ Halpern QC therefore decided that the audit clause could not be the subject of an order for specific performance on the claimant’s interim application. 

DJ Halpern QC also decided that, if the audit clause was sufficiently clear to be enforceable, it was not intended to allow 118 Data Resource unrestricted access to IDS’s general financial and customer information. The audit clause only permitted the claimant to inspect the premises where the database was ‘used’ and by implication this limited the inspection to checking only that the database was being stored and used correctly. 118 Data Resource could police other restrictions in the licence by enforcing its right of prior approval of the standard terms and conditions of IDS, but even this did not allow it access to customer names and price information. 

It is important to be clear that DJ Halpern QC did not intend for his decision to impact on the trial judge’s view of enforceability of the audit provision and what relief, if any, the claimant may be entitled to for non-compliance. However, at an interim stage, DJ Halpern QC found that the clause lacked sufficient detail to allow the court to draw up a clear order for specific performance. As counsel for IDS argued, the court was required to imply a raft of safeguarding provisions which could not ‘stand on the shoulders’ of the audit clause as drafted in the licence.  

This decision outlines the importance of ensuring that audit provisions in licences are drafted in precise terms, to reduce the risk that they cannot be relied upon and to ensure that the party being inspected can know clearly what is required.

Nick Briggs heads up the Intellectual Property team at Shakespeares. Nick advises companies and individuals looking to exploit and enforce their IP rights and has litigated in a variety of technical fields.

Kerry Russell is a solicitor specialising in intellectual property at Shakespeares. Kerry’s expertise centres around contentious IP disputes, although she also has experience in drafting and advising on IP licences and assignments.