You may be thinking “why would there be an audit provision you have with another party?”.
Lots of reasons. Here are the top two reasons I can think of.
You might be entitled to a payment of royalties or some sort of commission under the terms of an agreement you have with another party.
Or you may have to pay something of this kind to them. In this sort of case, the audit will be literally a financial check.
The second has a wider remit. Some Clients will also include an audit provision which may have a mechanism so that they can check the amounts that you are charging them (assuming you are working on a time and expenses basis).
But the “audit” may not just be limited to financial information – it may be the right for the Client to more check that more generally you are complying with the terms of the Agreement.
Here is a (fairly extreme) example of the sort of thing an Agreement might include:
The Contractor will permit the Client or its duly authorised representative at any time to inspect or audit the Contractor’s books and records in order to verify that that sums paid under this Agreement are correct and that the Services have provided in accordance with the terms of this Agreement.
I’ve used an example for a Contractor and Client here but there could be a similar Agreement in a Licensing Agreement, Agency Agreement or Franchise Agreement etc.
In fact, this sort of provision could turn in any sort of contractual arrangement where one party might have a legitimate interest in checking up that the other is complying with the provisions of the Agreement.
What do you need to think about?
So if you are presented with such a clause, what points do you need to consider (I’m looking at this from the perspective of the Contractor – who is willing to co-operate within reason but is concerned about disruption to his or her business and the cost implications…).
How often should the Client/Licensor be able to exercise this right? It will depend on the duration and extent of the contract. Personally, I would aim for not more than once a year.
How much notice should be given before an audit can be carried out? Again, it will depend on the circumstances and whether specific people need to be there. As a minimum it should be “reasonable notice” but that is a bit vague so aim for eg 5 Working Days’ notice. (This may mean you need a definition of “Working Days”).
What hours do you want them turning up to audit? I guess this point ties in with the previous one. You will want the audit rights to be restricted to normal business hours on Working Days.
4. What can they have access to?
Think about the confidentiality issues relating to your other clients and business. It needs to be clear that you will only give the Client access to records relevant to them. Possibly, there may be a further restriction on what they can look at eg records for time and expenses work. How much time spent is probably irrelevant for work done on a fixed fee basis. In practice, how easily can you restrict what they see? Will you have to extract information rather than let them access your systems and records direct?
5. Where can they have access to the records?
Your place or theirs? Is access at your offices something that they want and are willing to give or can you just send (email or post) copies of the information to them to look at it?
6. Does it matter who carries out the audit?
Have you concerns about competitors? You may have concerns that the Client may appoint “representatives” to do the audit for them and that those representatives are part of their business may be competitors of yours. For example, many large accountancy firms also offer other types of services. If this is a concern, you would ideally want the right to consent to any third party involvement and ensure that any third parties were subject to a suitable confidentiality obligation.
7. Won’t it be disruptive?
Yes, probably if access has to be given at your offices. Apart from specifying the hours etc, there may not be much you can do about it other than say that they should carry out their auditing activities in such a way as to minimise disruption to your business activities.
8. Who pays?
Good question – this could be elaborated into who pays for what and in what circumstances. On the whole, the person who wants the audit pays for it. Having said that, some clauses provide that if the audit shows the Client was losing out in some way (this might be tied to a margin of error), then the Contractor will bear the cost. There is also the issue of who will bear the cost of any copies of documents made in connection with the audit to consider.
9. What about your staff time?
Who should bear the cost of this? If the audit is at your site then probably you will need to make staff available to provide information and answer questions. Should you be entitled to charge for this? Again, it will depend on the circumstances but it may be appropriate to give them a specified number of “free” hours’ assistance on the basis that they will pay for anything in excess of this at the usual rate.
10. How long does the right last?
What is reasonable after the end of the Agreement? 3 months, 6 months, a year? It will depend on the circumstances. This is, of course, a different issue from how long you will keep the relevant records – if they relate to tax or finance, this is probably going to be at least 6 years (and probably 6 plus 1) so that you can require with HMRC requirements.
Who’d have thought such a short clause could give rise to so many potential issues?
I hope you found this useful, please do share your thoughts in the comments section below.