As the name suggests, a right to audit clause is a provision in a contract that gives one party the right to audit another party to the contract. This clause is commonly included in various types of agreements, such as vendor agreements, licensing agreements, partnership agreements, and more.
Purpose of the right to audit
The purpose of a right to audit clause is to provide transparency, accountability, and verification mechanisms to ensure that the obligations outlined in the contract are being met. In certain contexts, it also gives one or both parties the right to audit the information security practices of the other party when confidential information is being shared. It further allows the auditing party to verify that the financial transactions, performance metrics, or other aspects of the agreement are being accurately reported and that any relevant payments, royalties, fees, or other considerations are being calculated and remitted correctly.
This clause helps assure that the other party will take proper measures to conduct themselves appropriately in carrying out their contractual obligations.
A right to audit clause can also safeguard the outsourcing of the contracted work without the other party’s knowledge. As illustrated in the examples below, a right to audit clause offers more transparency and accountability, disincentivizing parties from surreptitiously outsourcing the work and exposing the other party to unknown third parties and risks.
Key points about the right to audit
- Transparency: by granting one party the legal authority to access and review the records, processes, or activities of the other party as outlined in the contract. This transparency serves to create openness and visibility into the operations and actions of the audited party, and so reduces unknown exposure to risks.
- Accountability and verification: by establishing a framework for monitoring, verifying, and enforcing the responsibilities and commitments of both parties in a contract, allowing the contracting parties an opportunity to "check in" and do quality control, in some cases even before the due date of the deliverable.
- Risk mitigation: these clauses are particularly important in areas in which information security and confidentiality is crucial. Being able to audit the other party in these ways provides assurance that financial transactions, performance metrics, data handling, or other relevant aspects of the contract are being properly executed and adhere to industry standards and laws. It helps mitigate risks, detect errors or non-compliance issues, and enables corrective actions to be taken if necessary.
Examples of right to audit clauses
Right to Audit Clause in Vendor Contracts
Example: “The Purchaser shall have the right to audit Vendor's records and facilities related to the performance of this Agreement. Such audits may be conducted by the Purchaser or its authorized representatives at reasonable times during normal business hours upon providing [X] days' written notice to Vendor. The purpose of such audits is to ensure compliance with the terms of this Agreement and to verify the accuracy of Vendor's performance.”
In vendor contracts, the right to audit clause grants the purchasing party (“Purchaser”) the authority to conduct audits or assessments of the vendor’s activities, records, and performance to ensure compliance with the terms of the contract. It also helps the Purchaser ensure that the vendor’s performance aligns with the agreed-upon terms and standards.
Depending on how comprehensive the parties wish their contract to be, they might include additional provisions that cover the following about the agreed-upon audit:
- scope and method, reporting requirements, frequency;
- confidentiality; and
- how disputes should be handled if any issues arise during or after the audit.
Such additional provisions might look like this:
“Scope and Methodology: The audit shall cover the following areas: [List specific areas, processes, or activities subject to audit, such as pricing, quality control, delivery timelines, and regulatory compliance]. The audit will be conducted in accordance with industry best practices and any relevant standards specified in this Agreement.
Access and Documentation: Vendor shall provide the Purchaser or its authorized representatives with access to all relevant records, documents, and facilities necessary for the audit. This includes, but is not limited to, invoices, contracts, quality control records, and any other documentation pertinent to the audit scope.
Reporting and Remediation: Following the audit, the Purchaser will provide Vendor with a written report detailing the findings, including any identified discrepancies, non-compliance issues, or areas for improvement. Vendor agrees to promptly address and rectify any deficiencies or discrepancies identified during the audit. In the event of non-compliance, the parties shall work together to develop and implement a corrective action plan.
Confidentiality: Both parties agree to maintain the confidentiality of any proprietary, sensitive, or confidential information disclosed during the audit. All audit-related findings and communications shall be treated as confidential, unless otherwise required by law or regulatory authorities.
Costs: The Purchaser shall bear all costs associated with the audit, including any expenses incurred by the Purchaser's representatives during the audit process.
Dispute Resolution: Any disputes arising from the audit findings shall be resolved in accordance with the dispute resolution provisions set forth in this Agreement.
Frequency: Audits shall be conducted [annually/quarterly] during the term of this Agreement and upon reasonable request by either party.”
This type of all-inclusive clause is often included in agreements where a business engages a vendor or supplier to provide goods, services, or other deliverables. IThis might be especially important in relationships where there is a reliance on the vendor's goods or services to meet timely business needs or regulatory requirements.
Audit Rights in the Information and Cyber-Security Context
Example: “The Company shall have the right to conduct cybersecurity audits of the Vendor's systems, processes, and controls as they pertain to the services provided under this Agreement. These audits aim to ensure the security, confidentiality, and integrity of the data and systems involved in the performance of this Agreement.
Scope and Methodology: The audit shall encompass the following areas: [List specific cybersecurity areas, such as data protection measures, access controls, encryption, incident response procedures, and compliance with relevant cybersecurity standards or regulations]. The audit will be conducted using industry-recognized cybersecurity frameworks and best practices, as well as any security requirements outlined in this Agreement.
Access and Documentation: Vendor agrees to provide the Purchaser or its designated representatives with access to relevant systems, networks, logs, and documentation necessary for the audit. This includes providing the necessary technical information and facilitating any required on-site or remote assessments.
Reporting and Remediation: Upon completion of the audit, the Purchaser will provide Vendor with a written report detailing the audit findings, including any identified vulnerabilities, gaps, or areas of non-compliance. Vendor agrees to promptly address and remediate any identified cybersecurity issues in a timely manner. In the case of serious security risks, both parties will collaborate to implement immediate corrective actions.
Confidentiality: Both parties acknowledge and agree to maintain the confidentiality of any sensitive or proprietary information shared during the audit process. Audit findings and communications shall be treated as confidential, with disclosure limited to those who need-to-know for the purpose of addressing identified cybersecurity concerns.
Costs: All costs related to the cybersecurity audit, including expenses incurred by the Purchaser's audit team, shall be borne by the Purchaser.
Dispute Resolution: Any disputes arising from the audit findings or their interpretations shall be resolved in accordance with the dispute resolution provisions outlined in this Agreement.
Frequency: Cybersecurity audits shall be conducted [annually/semi-annually/quarterly] during the term of this Agreement. Additional audits may be conducted upon reasonable request or in response to security incidents.”
In contracts involving the exchange of sensitive data, including a right to audit clause allows one to verify that the other party is implementing adequate data protection and cybersecurity measures.
For example, large financial and healthcare organizations might have hundreds of business partners and vendor organizations to which they outsource various types of activities. A well-drafted right to audit clause in the context of information security helps to establish accountability, transparency, and a mutual understanding of security expectations between contracting parties. Importantly, a right to audit clause in these situations can also bake into its contract the requirement that outsourced vendors adhere to other existing regulations with regard to information security.
Right to Audit Clause Example for Publishers or Licensee/Licensors Regarding Royalties
Example: “Licensor shall have the right, which it may exercise no more than [how often audits may occur, such as once in any Contract Year], to audit the books and records of the Licensee to determine if the Licensee's royalty statements are full, fair and accurate. In the event that the Licensor desires to exercise its audit rights, it shall have access to the Licensee's books, records and related documentation as contemplated in Schedule [schedule].
The audit may be conducted by the Licensor's designated firm of certified public accountants, who shall be reasonably acceptable to the Licensee. The Licensor's right to audit the Licensee's books and records as defined in Schedule [schedule] shall terminate as to any period preceding [length of period, such as two years] before the royalty statements being audited.”
An alternate and more comprehensive provision might include language such as:
“Company shall maintain books and records which you may examine, at your expense. You may make those examinations only for the purpose of verifying the accuracy of royalty accountings rendered to you under paragraph [section]. You may make such an examination only [once] during each twelve-month period, only [once] for a particular accounting period, and only within [# of years] after the end of an accounting period with respect to accountings during the period concerned. You may make those examinations only during Company's usual business hours, on reasonable written notice for a reasonably convenient time, and at the place where Company keeps the books and records to be examined. The parties may agree to appoint a qualified royalty auditor to make such an examination.
If, in the course of the audit of royalties payable to you under [section], you and Company agree in writing that there has been an under-crediting of royalties to your royalty account(s) hereunder, Company will pay interest to you on any portion of such agreed-upon under-crediting of royalties that is paid to you at the time of such agreement, at the prime rate in effect on the date on which Company is deemed to have sent you the royalty statement for the last accounting period covered by the examination, as such rate is quoted in the "Money Rate" section of The Wall Street Journal (or, if The Wall Street Journal is discontinued or is no longer quoting such rate, any other similarly reputable published source), calculated from the date such royalties were payable.
You acknowledge that Company's books and records contain confidential trade information and you warrant and represent that neither you nor your representatives shall communicate to others or use on behalf of any other person any facts or information obtained as a result of such examination of Company's books and records.
If you have any objections to a royalty statement, you shall give Company express notice of that objection and your reasons therefor within [# of years] after the end of an accounting period with respect to accountings during the period concerned. Each royalty statement shall become conclusively binding on you at the end of that [# of years] period, and you shall no longer have any right to make any other objections to the statement.”
Including a right to audit clause in a publishing or licensing contract gives the author or creator a mechanism to verify that they are receiving accurate royalties based on actual sales and distribution figures. Like the other examples of right to audit clauses, this clause can enhance transparency, accountability, and trust between the creator and the publisher. As with any contractual provision, it is important to customize the clause to align with the specific context of the publishing arrangement and to tailor to the specific jurisdiction to ensure the clause is properly drafted and legally enforceable.