Drafting successful audit clauses

16 February, 2015
by: Cripps

February 2015

 

Contractual rights are all very well and good, but without a means of enforcing them, they are often of little benefit. Audit rights can help you to determine whether a party to your contract is complying with their obligations, and determine what your damages are if they aren’t. Customers can ensure that suppliers are providing their services and calculating their fees correctly, and suppliers can ensure that customers are not misusing products.

 

The recent case of 118 Data Resource Ltd v IDS Data Services has highlighted that, despite their usefulness, a broadly drafted audit right is at risk of being unenforceable. 118 applied for summary judgment for their right to enforce an audit clause. 118 had licensed a database to their business rivals IDS, with a limited right to sublicense. IDS subsequently breached the terms of the agreement by sublicensing to another of 118’s competitors, and 118 sought to exercise their audit right. The court ruled that the audit right was not sufficiently clear to grant the order 118 sought.

 

In order to have a clear audit right, you will need to have a clear idea of what it is you want. You should consider the following when drafting a contractual audit clause:

 

Who? 118’s audit right allowed its authorised representatives to conduct the audit, and while this is acceptable, considering the potential confidentiality issues it may be advisable to allow for an independent third party to conduct the audit.

 

Where? You should consider which premises you will need access to. There is a risk that in defining the type of premises to be accessed, you will limit the scope of your audit.

 

Why? You will need to specify the purpose of the audit, as that will determine its scope. 118’s audit right was in order to ascertain that the contract was being complied with, which (when combined with the lack of detail as to what systems and records could be accessed) was not specific enough to avoid the clause being given a very narrow interpretation.

 

What then? You may need to consider what kind, and level, of access you will require. 118’s audit clause concerned entry to premises but did not specify any further access. Although it was clear that the intention was to permit access to the computer storing the database, the lack of restrictions on 118’s access to or use of the information meant the court was not willing to re-write the contract to allow for any access to IDS’s systems. If you do discover a breach during your audit, you will need to consider, and include, what you would do with the information or evidence or products. Finally, you may want to consider the cost of the audit, and under what circumstances the other party will have to pay for it.

 

Ultimately, however, you will have to weigh up the time and expense of agreeing an extensive and bespoke audit clause against the security it may give you. One alternative is an accompanying obligation on the other party to keep records regarding aspects of the contract, which will make answering the “Where?”, “Why?” and “What then?” questions considerably easier.