Supreme Court confirms audit report qualified basis to claim royalty

On February 27 2017 the Supreme Court affirmed the IP Court’s judgment at appellate level, allowing a patent owner and licensor to claim for underpaid royalties based on an audit report conducted with the licensee’s consent, even when such an audit report did not follow the audit procedure required in the licence agreement.

The plaintiff in the royalty dispute was a worldwide Fortune 25 enterprise and the owner of patents in its industry. As the result of the patent owner’s settlement with its competitor in global patent litigation several years ago, the patent owner entered into a patent licence agreement with the defendant. Under the patent licence agreement, the patent owner agreed to license certain patents to the defendant, allowing the defendant to manufacturer certain products, with the defendant to pay royalties to the licensor based on the quantity of the licensed product sold. The patent licence agreement included an audit clause allowing the licensor to audit the books and records of the licence products. The licensor, with the licensee’s consent, conducted an audit through an accounting firm designated by the licensor.  The audit report issued thereafter by the accountant revealed the underpayment of millions of royalties.

The licensor filed civil litigation against the licensee for the underpaid royalties plus interest and audit fees based on the patent licence agreement. The licensee argued that the conducted audit did not fully comply with the procedure required by the patent licence agreement and that, due to these flaws, the audit report should not be adopted as the basis for the licensor’s royalty claim as well as the licensor’s claims for interests and audit fees. At the district court level the IP Court ruled partially in favour of the defendant and partially in favour of the plaintiff, stating that the audit report could not be adopted because of its non-compliance with the patent licence agreement, but that the defendant must still pay a certain amount of royalties as confirmed by the defendant during negotiation meetings before the litigation. Both parties appealed.

At the appellate level, the IP Court reversed the lower court judgment, stating that the audit report, although not fully compliant with the patent licence agreement, was still qualified evidence in civil litigation. Thus, the IP Court rendered a judgment in favour of the licensor based on the audit report, ordering that the licensee must pay the royalties owed, the interests thereof and the audit fee thereof. The licensee appealed to the Supreme Court, which rejected the appeal.

The IP Court stated that the conclusion of an audit report made in compliance with a patent licence agreement is binding on both the licensor and the licensee. However, an audit report not compliant with a patent licence agreement does not lose its qualification as evidence in civil litigation. The IP Court's decision to adopt the audit report, which was affirmed by the Supreme Court, lowered the hurdle for a licensor to claim royalties to which it is entitled, particularly in circumstances where a new audit is near impossible due to the licensee’s resistance and rejection.