License Inspection Services

It is a challenge for a licensor, who sublicenses its intellectual property ("IP") to licensee(s) and receives running royalties based on sales of the licensed products reported by the licensee, to ascertain whether the licensee has fully paid the amount of required royalties in compliance with the license agreement. Deloitte Forensic Services Team conducts license inspections on behalf of licensors to assist with assessment of the completeness of royalty revenues.

Risk of Underpaid Royalties

How can you deepen transparency and optimize revenue in your extended business relationships with licensees? Licensing arrangements can help companies build market share, contain costs, and enter new markets. Yet, to achieve these benefits, companies must carefully manage the risks associated with contracts and relationships with licensees. Especially when it comes to collecting the monies due under the license, licensee-reported royalty payments tend to be found incorrect. Often, the red flags of underreporting are detectable in the royalty reports and in the market trends of licensed products, such as:

<Red Flags of Underreporting>
 Discrepancies between the actual and the forecasts expected when the license contract was agreed
 Disproportionally smaller increase of royalties reported considering market growth of the licensed products
 Sudden decrease in royalties reported which does not follow the market trend
 Smaller reported royalties as compared to other licensees even after consideration of company size and geographical characteristics of the market
 Sudden decrease in the reported royalties after an M&A transaction involving the licensee

Our Team will conduct license inspections on behalf of licensors to assess the accuracy of the royalty calculation, pursuant to the audits rights in the license agreement.
In recent years, the market demand for license inspections has increased and there have been a greater number of cases where we have been engaged by Japanese licensors to carry out inspections of licensees located overseas such as in China, Taiwan or India. The followings are examples of target intellectual properties for the inspections:

 Mobile-phones (transmission method, chip or embedded software)
 Consumer electronics
 Medical drugs and pharmaceuticals
 Optical discs
 Luxury brands

Benefit of Adequate License Inspection

Benefit of License Inspections

Improvement of profitability
Collection of royalties under-reported in the past

The following are statistics concerning Deloitte's previous license inspections:
 Existence of incorrect royalty reporting: More than 80% of the inspections conducted
 Ratio of cases where under-reported amount exceeds the inspection fees charged by Deloitte: More than 90% of the inspections conducted
 Number of cases where burden of the inspection fees were transferred to the licensee according to the license agreement (most of the license agreements have a clause stating that the licensee shall pay the inspection fees in case that the under-reported royalties as a result of the inspection exceed certain percentage (normally 5 to 10%) of royalty amount the licensee had initially reported): More than 50% of the inspections conducted

Maximizing future royalty revenues (because the licensee will modify royalty calculation method as a result of the inspection)

Other benefits
 Deterrence to other licensees
 Obtaining understanding of licensee's business operations
 Enhancing transparency and credibility of future royalty reports by discussing the inspection findings and deficiencies of on-going contract with the licensee 

License Inspections

Phases and key activities
Deloitte Forensic Services Team has a broad range of industry experience and possesses knowledge regarding various forms of contractual licensing arrangements. We draw on our experience of accounting audits, fraud investigations and data analytics to assist clients in understanding and resolving complex business issues and licensing transactions by utilizing financial and technical skills with knowledge of regulatory bodies and specific industries. Our team takes a risk-based approach in which we identify the potential risk of underreporting by examining the licensee's accounting data and other information, interviewing relevant licensee's personnel, understanding the royalty-related clause of the licensing contract and utilizing our experiences in the industry. We can assist our clients in maximizing revenue from its intellectual property effectively and efficiently.

Step 1:Planning and preparation
 Obtain background information from the licensor and conduct an off-site study of licensee's business
 Establish understanding of the licensed products and its market situation
 Conduct detailed examination of the license agreement and royalty statements
 Dispatch, by the licensor, of an audit notification letter to the licensee
 Provide a document request list to the licensee
 Enter into an non-disclosure agreement with the licensee, when necessary

Step 2: Fieldwork at licensee's site
 Interviews with relevant personnel in charge of sales, accounting, royalty calculation and intellectual property
 Test and analyze completeness and accuracy of sales data provided
 Conduct sample testing and verify the supporting documents if any discrepancy
 Examine other compliance issues with the license agreement

Step 3: Follow-up and reporting
 Conduct follow-up tasks
 Communicate with licenser and licensee
 Discuss with licensee about the inspection findings
 Prepare working papers and draft the inspection report
 Discuss with licensee about the inspection findings
 Finalize and submit the inspection report to the licensor

Step 4: Support negotiations with the licensee
 Support the licensor in negotiating with the licensee for settlement
 Provide litigation support (when necessary)