Audit clauses in IP licences: how easy it is to go astray ...

While IP abounds with exciting and sexy topics like infringement, damages and protectable subject matter, much of the really important work done by intellectual property practitioners goes more or less unloved and unnoticed -- until something goes wrong. Nick Briggs and Kerry Russell (of Shakespeares, solicitors) offer us a great example here with this note on audit clauses in IP licences. Most are never invoked; many are poorly drafted; but only the privileged few end up in front of a judge.  This is one of them.  Nick and Kerry explain:
The Audit Claws
Many intellectual property licences include "audit clauses". These give the licensor the right to enter the licensee’s premises and inspect relevant documents and materials in order to ensure that the licensee is complying specific provisions of the licence. These 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), a High Court, England and Wales, ruling of Deputy Judge David Halpern QC, serves as a reminder to IP licensors that, if they intend to rely on an audit clause, they should draft it clearly and in terms that set out precisely how an inspection should proceed. This decision also shows licensees how they might protect their businesses from over-zealous licensors who might be intent on using information gleaned for ulterior motives.

In this case 118 licensed its alleged intellectual property rights in a database of business contact details to IDS. This licence permitted IDS to use and sublicence these rights, subject to specific restrictions. It also provided that 118 could "clean" (or update) IDS's database. Predictably the licence agreement contained various provisions which enabled 118 to ensure that IDS was complying with its specific obligations under the licence:

  • First, 118 had the ability to review and approve IDS's standard terms and conditions which would enable it to review any proposed sublicences with IDS's customers, before 118 released its data. However, it was accepted that, in practice, 118 did not enforce its right of prior approval under this provision. 

  • Secondly, 118 was entitled to enter IDS's premises where copies of the database were used "for the purpose of ascertaining that the provisions of [the] Agreement [were] being complied with".

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

A 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 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 support of this application, 118 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 the latter's office, IT systems and documents. 118 sought an order that would enable it to have sight of all IDS’s customer contracts and financial information, not to mention copies of the extracts of its database which had been licensed to each of IDS's customers.

IDS vigorously contested this application, objecting that the vague wording of the audit clause did not allow for an inspection in the terms requested. What's more, and more importantly, if such wide-reaching access was granted, without the court imposing reasonable safeguards, 118 would gain access to IDS's highly confidential and commercially sensitive information, plus 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 that could have been made of that information, because the information would have been disclosed as a result of a specific performance of the contract. In contrast, if the information were to be disclosed in the course of the litigation in the normal way under disclosure, 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 contained no mechanism governing how the inspection would take place. Nor did it contain any provisions to protect either party’s commercial position. It read as follows:
“[IDS] undertakes and agrees with [118] that it will… permit any duly authorised representative of [118] 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 significant; it was particularly relevant here since it was accepted that 118 and IDS were competitors in the market.

Counsel for the IDS submitted that this lack of essential detail rendered the inspection clause unenforceable. Alternatively, if the clause was enforceable, it only let 118 check that IDS was storing and using its database in accordance with the terms of the licence (i.e. the database was being held securely and separately from IDS’s own database). Counsel submitted that the audit clause did not let 118 gain access to commercially sensitive information such as the identity of IDS's customers, or to the prices at which it sublicensed 118's data.

Deputy Judge Halpern QC accepted IDS's submissions. Although the parties had clearly agreed that 118 had a right of inspection, the purpose for which 118 was entitled to gain entry to IDS’s premises was not so clear -- nor was it apparent how the inspection would proceed thereafter. Since the audit clause lacked fundamental detail, the court would have been required, on 118's case, to imply provisions which go beyond the wording of the original clause, requiring re-writing the agreement. The judge therefore decided that the audit clause could not be the subject of an order for specific performance.

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

Deputy Judge Halpern QC did not intend his decision to have an effect on the trial judge's view of enforceability of the audit provision and on what relief, if any, 118 might secure for non-compliance. However, at this interim stage he found that the clause lacked sufficient detail to let him 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.
Shakespeares acted for IDS in these proceedings.

The IPKat wonders what sort of audit clause Shakespeare himself might have drafted. This might be a good challenge for a future readers' competition, he thinks.
Audit clauses in IP licences: how easy it is to go astray ... Audit clauses in IP licences: how easy it is to go astray ... Reviewed by Jeremy on Wednesday, December 03, 2014 Rating: 5

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