David Marston and Eric Stein of PricewaterhouseCoopers LLP presented yesterday, September 28, 2005, at the event “Designing and Implementing an Effective License Compliance Program,” sponsored by the Silicon Valley Chapter of the Licensing Executives Society (“LES”), and provided some alarming insights into problems that exist with the enforcement of royalty terms in licensing agreements.

According to Marston and Stein, many companies have no one in charge of the royalty compliance process. Instead, it is common for compliance oversight to get pushed to the legal or accounting departments, which have other duties that get higher priority than royalty enforcement. As a result, Marston and Stein often find that no one is really monitoring the royalty payment process at all.

To enact an effective compliance program, Marston and Stein recommended that companies first establish a separate compliance group within the company whose only job is to monitor the royalty collection process, and that this group should conduct a handful of audits each year as a matter of course on some of the agreements. They also recommended sending out a general letter to all customers before commencing an audit program just to advise customers that the company was enacting a better compliance program and that they might receive an audit letter in the next few months. By taking these intial steps, they advised, customers will be reassured that they are not being singled out. Several months after the receipt of the general letter, Marston and Stein say that companies should then send out their first audit letters to select licensee customers. Interestingly enough, the speakers indicated that receipt of a general letter alone will often prompt companies to go back and take a look at old agreements and even to make a restatement of the royalties, particularly if the licensor company initiating the process has offered forgiveness of late charges for a period of time after receipt of the general letter. In the end, Marston and Stein suggested that this process can produce millions of dollars in unpaid royalties that were just slipping through the cracks.

As a lawyer who has drafted numerous royalty clauses, I was really taken back to hear how these royalty clauses were operating in practice. Clearly, it was a bit of a reality check on my practice and the gaps that can exist between what I draft and how it is enforced. Also, the presentation really brought to light how companies that are strapped for cash should look to an effective compliance program to finance some of the operating expenses necessary to run the company.

We should all ask ourselves what our companies or, in the case of outside service providers, what our clients are doing right now in the licensing compliance area. If licensing compliance efforts are generally as ineffective as Marston and Stein believe them to be, then we may be horrified to discover that our companies or our clients’ companies are losing millions of dollars each year in uncollected royalties.