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Audit Rights - Use Em or Lose Em!

By Tom Buscaglia | Published Aug 07 2007 03:58 PM in Business and Law

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Most publisher contracts contain a provision that provides developers a right to periodically audit the publisherÆs financials related to their game in order to verify that the royalty credits and payments due the developer are properly calculated and accounted for. The audit is usually at the developerÆs expense. But, if a discrepancy of more than typically 5-10% is discovered, the cost of the audit is paid by the publisher. This protects the developer from any ômistakesö on the part of the publisher in determining the ônet proceedsö from which royalties are set or ôinadvertentö miscounting of units sold. It seems really simple and certainly sounds like a good thing for any business to do. There are few, if any, developers who would sign a publishing contract without an audit provision...at least none of my clients would.

HereÆs the odd part...the exercise of audit rights by developers is, in reality, fairly rare. I have asked developers about this. Even in cases where they felt that they were due royalties, I have had developers express a strong reluctance to exercise these rights because they think that to do so might create the perception that they didnÆt trust their publisher. Of course, this is not really a matter of trust. It is a matter of business sense. The continuing failure of developers to routinely exercise their audit rights creates a void into which the most lax accounting practices can easily fill on the publisherÆs end. You see, if developers donÆt enforce their audits rights there is no incentive for the publishers to use the necessary high degree of care in determining the appropriate royalties. This level of care takes time and time is money. So, if no one is going to audit, why bother. Not surprisingly, any slop usually lands on the publisherÆs side of the balance sheet. If any accounting errors do occur it is unlikely that they will result in a higher net revenue figure or more units sold.

LetÆs be serious here. Developers fortunate enough to make a game that puts them in a position to receive back-end royalties should be sure that they get every single dollar they are entitled to because it is an all too rare occasion. Sure for most developers itÆs a buyerÆs market and there are more developers looking for publishers than there are publishers looking for developers. So this may not seem like an easy decision, at least politically. But it sure is a simple financial one. Audits cost several thousand dollars. Compared to the budgets of most games, it is a small price to pay to make sure that you are getting everything you are due. Besides, it seems to me that the only publishers who would be offended by a developer enforcing its audit rights are probably not ones you should be doing business with in the first place. Developers can do worse than have publishers believe that they are competent business people willing to enforce their contractual rights. For example, they could be viewed as incompetent business people that are easily taken advantage of.

I was on a panel discussion at the Microsoft Meltdown in Seattle a few years ago where we were discussing publisher deals. This was a ôpre contract through gold masterö sort of discussion and prior to the presentation I asked the panelists that we go past the delivery of the game and include audits in our discussion. I almost forgot about it, but one of the panelists, a top tier developer, reminded me about this last topic of discussion as we were about to close. I soon found out why he remembered - numbers like these are hard to forget. At first I was a little surprised to hear him say that his studio always audits every publisher deal. Why? Because when they audited their first major deal they found 6 million dollars (yes...thatÆs $6,000,000.00) in royalties due them that had not been paid. Apparently the issue there was the manner in which the publisher had been calculating net proceeds rather than the number of unit sales. But, whether it is the methodology or simple accounting of units sold - an audit should reveal any errors.

Sure, there are only a few games that hit numbers like that and there are only a few developers in the top tier. But mid level independents that live from one game to the next are even more thinly capitalized and for many a few hundred thousand dollars in inadvertently omitted royalties could make the difference between success and survival.

Like a close friend of mine who does product acquisition for a major publisher says about dealing with a publisher, ôItÆs not my job to protect your financial interests and if the developer does not have the business sense to ask, then IÆm not going to offer.ö Just as this basic business principle applies to the negotiation of publisher contracts; it also applies to developer audits. If you donÆt ask, they will not offer. So, while the exercise of your audit rights is certainly an expense, it can often be money well spent. Review your contracts so that you are well aware of what your audit rights are and how to exercise them. Then, any time you are in a situation where you believe that you have reached, or are rapidly approaching, recoupment of advances under your publisher contract, you should consider calling an audit. Unless and until developers start asserting their rights in their business relationships with publishers they will continue to be perceived as business softies who are easily taken advantage of, and this isnÆt helping your business or anyone elseÆs.

Til next time, GL & HF.

Tom Buscaglia
The Game Attorney
www.GameAttorney.com
¬ 2007

[Tom Buscaglia, The Game Attorney, writes frequently on subjects of interest to game developers. The above article is for the information and education of members of the development community. Feel free to distribute or disseminate this article. But please include the legend "Copyright 200_, Thomas H. Buscaglia, Esquire" and an active link to in each article posted or published elsewhere. The sale or any other commercial exploitation of this article, in whole or in part, is strictly prohibited.]






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