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 13^th 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? 

Royalties in publishing agreements: when expectation leads to litigation

In Morse v Eaglemoss Publications Ltd [2013] EWHC 1507 (Ch), a Chancery Division (England and Wales) decision of Mrs Justice Proudman last month, the judge who kickstarted the whole Meltwater controversy in the UK over internet browsing and copyright infringement (see various blog posts here and here) found herself once again dealing with a copyright-flavoured issue, this time involving royalties.

In short, Morse was claiming royalties from Eaglemoss, basing his claim on publishing agreements which concerned a series of illustrated wildlife publications for the Reader's Digest magazine. In effect, the agreements let Eaglemoss make use of Morse's published work, Wildlife in Britain, by packaging a series for licensed publication and mail order sale by Reader's Digest.

Morse's first contention was that there had been a binding contract even before the agreements had been entered into; this was rejected, even though the parties had been co-operating on the basis of trust and informality. Morse however had better luck with the publishing agreements themselves: on their correct construction there was a licence between the parties which entitled Morse to a proportion of the royalties in the strict sense -- but not to any elements of the fixed payments from the Reader's Digest to Eaglemoss. According to Proudman J, Eaglemoss was, on the true construction of the licence, entitled to deduct the  cost of paying third party owners of copyright in the pictures from these royalty payments, even though Morse was entitled to an account of the sums expended on them. Finally, the pleas of Morse that the agreements should be rectified for unilateral mistake or that Eaglemoss owed him fiduciary duties and should have disclosed that it would be receiving the fixed payments from Reader's Digest were also dismissed.

This is one of those curiously old-fashioned cases in which the judge actually had to decide the case on the facts before her, rather than engaging in detailed analyses of the legal principles involved.  If any moral can be extracted from this action, it is contained in the fact that, wherever money is expected by one party from another, it is best to concretise that expectation in clear and unassailable terms from the outset -- however embarrassing it may seem at the time.  Understandings and expectations based on trust and mutual respect are all very well, but in the long run they so often lead to tears.

Asian Subsidiaries Royalty Rising

The London Financial Times has an interesting story today about rises in the royalty rates that Asian subsidiaries are expected to pay to their parent companies. Apparently a number of investment funds have been gaining exposure in Asian markets by buying shares in a locally listed subsidiary of a multinational company, such as Unilever or Nestlé. The investors are concerned by the recent rises in the rates of royalties paid by these local subsidiaries for the use of "shared services" such as research and development, marketing, branding etc. This author's experience with several such agreements suggests that rates between 5% and 8% are generally paid to recognise not just the goodwill in the company name but also, for industries in which innovation plays a key role, the use of patents and know-how. Thus Unilever's rise to a royalty rate 8% of sales from 3.5% does not seem unreasonable in this context. On the other hand, it is not surprising that that investors in Unliver's Indonesian subsidiary - who have happily collected dividends - are not happy. Uniliver justifies its rise by stating that the rise is about cost recovery and that the royalties are apparently subject to the same level of tax both at home as abroad.

One issue not pointed out in the article is that the rise in royalties paid to a UK company seems to coincide with the introduction of the UK's patent box regime under which revenue attributed to patented products is taxed at a lower rate. It is almost certain that a substantial proportion of the royalties from the Indonesian (and other foreign subsidiaries) will be based on patented products and thus the royalties will be taxed at an effective rate of 10% rather than the usual rate of 23% of coloration tax. This probably makes it rather interesting for a company like Unilever to repatriate as much as its revenue from overseas subsidiaries in the form of royalties on patented products. There is clearly tension here between the interests of investors in separately quoted companies that are interested in getting a maximum level of profits from the local companies and the interests of the parent company in repatriating its profits in a tax-efficient manner Such locally quoted subsidiaries have traditionally enjoyed a premium on their share price because they are regarded as being well-governed. It's clear also in many cases that they have benefited from an undervaluation of the use of the groups intellectual property. The Swiss company Holcim has only paid 1.5% to date - which is substantially under market value despite Holcim's technological innovation and the rise to 5% will still put it at the lower end of the going rates for royalties.

The article concludes that the authorities in the local regions should wake up to what is happening and ask whether the trend is welcome. From their point of view the grand is probably not welcome as it will reduce taxable profits locally. However, the rates being talked about are well in line for going rates negotiated at an arms length basis for the use of technology - and this point is not make in the arcticle.

Judge decides royalties -- and rules on the cost of drafting an IP licence

A news flash from Anti Copying in Design -- ACID -- reports that one of its members, Temple Island Collection, scored an early victory against New English Teas in the first of a two-part intellectual property case heard in the Patents County Court, England and Wales, which readers can find at [2011] EWPC  21. ACID says:

"Having settled the original dispute about the infringement of its iconic "Red Bus" image a dispute arose about the exact scope of settlement. ...

The first [issue for Judge Birss QC to settle] was the Royalties due under the settlement. New English had agreed to pay 5% of the trade sale price of all past and pending sales of the first image. Later, New English attempted to reduce the royalty on "multi-packs" by 66% on the basis that of the three items in the multipack only one featured the first image. Temple disagreed, saying that it was clear that the parties had in mind a 5% payment on the sale price of the product sold which included the image. Judge Birss QC agreed with Temple, the parties had not invented some complicated mechanism to decide the royalty and Temple's reflected the parties' intentions when viewed objectively.

The second issue was the amount of costs payable (by New English) for drafting a licence agreement, the rival figures being £500 and £2000. Judge Birss QC accepted Temple's submission that the time taken to draft the licence was not the only factor but that other factors, such as expertise and the value of the document to the parties, were relevant and awarded £1500.

The third issue was as to whether or not the settlement required New English to enter into a formal licence, and whether that licence should include an 'open book' accounting term. This depended upon Judge Birss QC analysing correspondence between the two parties' representatives, and he ruled there was no requirement to enter into a formal licence. The Judge however indicated that he would have included an open book term had he found a licence was required.

New English have had to pay over £14,000 to Temple Island for royalties and the licence agreement as well as a previous unpaid amount in costs ..."

It's good to see a trial judge getting stuck into the financial details so decisively, particularly in what was effectively a case management conference. This blogger can't recall a previous occasion in which a judge had to consider the cost of drafting a licence, either.  Can readers, particularly those from other jurisdictions, comment the cost of drafting on the facts of this case?

India: a follow-up

Just when you thought it couldn’t get more confusing … Following on from the previous post on the Microsoft shrink-wrap case, I came across a Advance Ruling given to GeoQuest Systems BV (a Dutch company) by the Indian authorities in August.

Remember that the Delhi Tax Appeal Tribunal pretty much held that all software payments are royalties, and withholding tax needs to be deducted from payments, even if for shrink-wrap boxed software? Well, the GeoQuest Advance Ruling concludes that a payment for the licensing of special purpose software does not constitute a royalty – so no withholding tax on payments made from India.

The customer was granted an exclusive, but non-transferable, right to use the software and the associated proprietary information. but no rights to modify the source code, make copies or transfer the software to any other person. The software had to be returned at the end of the licence period.

The Advance Ruling confirmed that:

• unless the right to directly exploit copyright in the software (by copying it, amending it or similar) is granted to the payer, the payment should not be considered a royalty under Indian domestic law; and


• a payment for the use of a product that has an embedded copyright is not the same thing as a payment for the use of the copyright.

Now, see, these points make sense. The Advance Ruling makes it clear that income from a supply of software constitutes business profits rather than a royalty, so that no withholding tax should apply. Now, could they just explain this to the Tax Appeal Tribunal?

International: Malta announces tax exemption for patent royalties

The Maltese Government approved a number of changes to their tax laws on 16th April 2010 – of particular interest on IP is the news that, with immediate effect, royalty and similar income derived from qualifying patents in respect of inventions will be exempt from Malta income tax (subject to conditions still to be announced, including a cap on the maximum amount that may be exempted – and the EU may well have some comments on the matter).

Malta has been reasonably tax-efficient for IP income, but this will put the country on a par with Ireland for patents, depending on the level of the cap. Under EU pressure, Ireland extended its exemption on patent royalty income to include royalties received in respect of non-Irish patents granted after 1 January 2008. A similar cut-off date for the Maltese exemption would seem to be likely, if only to appease the EU.

Royalties for decades to come

“Plans for Michael Jackson burial remain elusive day after funeral” reported the Guardian today, after the memorial services for the king of pop held yesterday. There is no question though that his music will keep him living on: Billboard reported that last week, Michael Jackson had a record eight albums out of the top 10 on the Top Pop Catalog Albums chart, and that this week, the entire top 10 is “all-Jackson, all the time. He alone has albums at Nos. 1-6 and Nos. 8-10 while a Jackson 5 title ("The Ultimate Collection") resides at No. 7.”

Jackson was also the most popular artist on Nokia's Comes With Music service last week: seven of the top ten downloaded songs were by Jackson, with the popularity rate going up from 21st most popular the week before.

This of course has also an effect on the royalty income streams which will now benefit the (debt-laden) estate. Melbourne’s The Age reports on the king’s most valuable assets:

Jackson's most valuable asset is his 50 per cent share in the Sony-ATV Music Publishing catalogue, which people with knowledge of the partnership value at between $US1.5 billion and $US2 billion. The partnership has about $US600 million in debt, one person said. In what is recognised as the shrewdest business move of his career, the singer bought the catalogue in 1985 for $US47.5 million. In the early 2000s, he borrowed $US300 million against it. That makes the value of Jackson's share, accounting for the debt, worth between $US150 million and $US400 million.

The so-called "Beatles catalogue" is famed for music written by John Lennon and Paul McCartney. It administers nearly all of the Beatles' greatest hits. Sony-ATV also oversees the publishing of performers as varied as Elvis Presley, Eminem and Bjork and is reportedly the fourth-largest music publisher in the world.

The catalogue generated between $US13 million and $US20 million for Jackson annually, said people close to the singer.

A second catalogue, Mijac Music Publishing, includes Jackson's music as a solo artist as well as songs by other acts, including Sly & The Family Stone, Curtis Mayfield and Ray Charles. People close to Jackson estimated its worth at $US100 million, but it is difficult to place a current value on it because of the tremendous sales of Jackson's music since he died.

It is reported that the superstar used to over-record for every album he produced throughout his remarkable career – so fans can live in hope that there will be many more records, books and movies coming out. Long live the king.

ECJ hearing on royalty payment reference

There was a hearing today before the Court of Justice of the European Communities in Case C-533/07, Falco Privatstiftung and Thomas Rabitsch v Gisela Weller-Lindhorst, a reference for a preliminary ruling lodged just over a year ago by the Oberster Gerichtshof (Austria). The questions referred are as follows:

"1. Is a contract under which the owner of an incorporeal right grants the other contracting party the right to use that right (a licence agreement) a contract regarding 'the provision of services' within the meaning of Article 5(1)(b) of Council Regulation (EC) No 44/2001 of 22 December 2000 on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters (the Brussels I Regulation, OJ 2001 L 12, p. 1.)?

2. If Question 1 is answered in the affirmative:

2.1. Is the service provided at each place in a Member State where use of the right is allowed under the contract and also actually occurs?

2.2. Or is the service provided where the licensor is domiciled or, as the case may be, at the place of the licensor's central administration?

2.3. If Question 2.1 or Question 2.2 is answered in the affirmative, does the court which thereby has jurisdiction also have the power to rule on royalties which result from use of the right in another Member State or in a third country?

3. If Question 1 or Questions 2.1 and 2.2 are answered in the negative: Is jurisdiction as regards payment of royalties under Article 5(1)(a) and (c) of the Brussels I Regulation still to be determined in accordance with the principles which result from the case-law of the Court of Justice on Article 5(1) of the Convention of 27 September 1968 on Jurisdiction and the Enforcement of Judgments in Civil and Commercial Matters (the Brussels Convention)?"

Does any reader know what this dispute is actually about? It's rare for cases involving IP licences to reach the upper echelons of European jurisprudence unless they concern market division, abuse of dominant position or some other competition-related issue. But this case looks as though it's about something to do with a licensor suing for his royalties and finding that jurisdictional/enforcement problems are barring his path. Any information, particularly from this blog's Austrian readers, would be welcome.

What's wrong with hi-tech royalties?

According to the Antitrust Hotch Potch weblog Dutch scholar and Howrey partner Damien Geradin (right) has presented a paper, "What's wrong with royalties in high technology industries" at the George Mason University School of Law and Microsoft Corporation’s second annual conference on The Law and Economics of Innovation: "Patents and the Commercialization of Innovation" last month in Arlington, Virginia. According to the abstract,

"Over the past few years, there has been an unprecedented degree of interest among competition authorities, scholars, Standard-Setting Organizations (hereafter, SSOs) and trade associations with respect to the level of royalties that are charged by holders of intellectual property rights (IPRs). For instance, in the past two years, the US Department of Justice (DoJ) granted business letter clearance to two SSOs - VITA and IEEE - to implement new IPR policies designed to control the IPR costs. In April 2007, the DoJ and the Federal Trade Commission (FTC) jointly released a report on Antitrust Enforcement and Intellectual Property Rights. But the interest is not limited to the United States. The European Commission is currently investigating the compatibility of certain licensing regimes and conduct within SSOs against EC competition law. Reflecting the debate at the policy level, scholars have produced a large body of legal and economic literature on IPR and standardization issues, including patent hold-up (where the patent holder exploits ill-gotten market power in excessive licensing fees) and royalty stacking (where multiple patents must be licensed and thus the royalty rates stack up to excessive amounts).

Against this background, this paper addresses the issue of whether something has gone wrong with royalties in high technology industries. This paper seeks to answer this question first by looking at a number of concrete scenarios where firms holding IPRs seek to obtain a return on their patent portfolios by licensing them. As will be seen, the behaviour of these firms essentially depends on whether they are vertically-integrated or non vertically-integrated. Vertically-integrated firms engage in research and development activities, patenting at least some of their inventions, and also manufacturing products based on their own innovations and the innovations produced by others. Non vertically-integrated firms, in contrast specialize in one or the other layers of production. Pure upstream firms conduct research and development activities and patent their innovations, but they do not engage in manufacturing. Downstream firms specialize in manufacturing, but do not engage in R&D".

Link to SSRN here [thank you Kristof Neefs of Laga, Belgium, for this item].

Customs duties on royalties and licence fees

The December 2007 issue of Global Intellectual Property Asset Management Report, (published by WorldTrade Executive), carries a brief article by Ben Goodger and Stefanie Slapke (both of Rouse & Co. International), "Are New Customs Duties on Royalties and License Fees Relating to Imported Goods on the Way? The authors write:

"Recent World Customs Organization (WCO) deliberations are likely to lead to major changes in the way trade mark royalties and licence fees relating to imported goods are currently being dealt with by Customs offices around the world. The changes look set to have a serious financial impact on both brand owners and licensees.

Although precise details of the changes are not yet available, IP owners should be aware, at least in general terms, of what is being proposed.

Background

How trademark royalties and license fees should be dealt with by Customs authorities has been the subject of ongoing debate within the WCO for some time. The issue is both complex and contentious.

Two years ago, a sub-committee of the WCO Technical Committee on Customs Valuation was established to examine the various national authorities’ current practice. We understand that at a recent meeting, this sub-committee decided that certain royalty payments that are not currently regarded as part of the dutiable value of imported goods should in future be included in the dutiable value.

Many of the WCO’s earlier conclusions on this subject have already been taken up by the European Commission’s Valuation Committee in its Commentary No. 11, issued earlier this year, which deals specifically with royalties and licence fees paid to a third party. It is likely that the Commission will also take up the proposed further changes.

Proposed Changes

The outcome of the most recent WCO Customs Valuation sub-committee deliberations is expected to be documented in April 2008. Although the precise content of the changes being proposed will not be known until April, it is clear that many trade mark royalties and licence fees that relate to imported goods and are not currently included in the dutiable value for Customs purposes will begin to be so included".

The authors then add that brand owners and trade mark licensees are well advised to keep a close watch on things. They expect the latest changes to be adopted promptly by Customs authorities, at least in Europe and suggest that, if European authorities are seen to be raising significant amounts of revenue from the imposition of additional duties, other countries will probably be quick to follow.