The pandemic brought the spotlight to the life science sector, which continues to see unprecedented growth and innovation. With developments in science and technology coupled with increasing capital infusion from various sources, the industry has attracted new attention.
With complex regulatory requirements around the world and a challenging international manufacturing and distribution ecosystem, entities holding certain rights to health technologies or drugs (licensors), look to larger international organizations to handle their manufacturing and distribution (licensees). Under such arrangements, the licensors receive either royalties or profit sharing along with periodic statements, showing the “waterfall” of the revenues and costs as per the license or distribution agreement.
A licensor receiving such statements and payments may want to consider the following risk factors as upon review of royalty statements.
POTENTIAL INCONSISTENCY BETWEEN THE STATEMENT AND THE AGREEMENT
Agreements may not be detailed enough to cover all possible scenarios and situations, which leaves room for interpretation by the licensee. When developing the template or algorithm of the initial royalty or profit-sharing statement, the licensee could be interpreting unclear or “grey” terms and conditions of the agreement subjectively, or more likely “in favor” of the licensee. This can potentially result in under-reporting of revenues or over-reporting of expenses.
To mitigate this risk, one should be familiar with the license or distribution agreement and see if any material differences between the statement and agreement.
UNUSUAL ENTRIES ON THE STATEMENT
The high volume of transactions and limited resources or time available to review underlying details by the licensee finance team could negatively impact the statement quality control. This could lead to increased errors on the royalty statement. Unusual entries, such as negative revenues or significant discounts or rebates, as well as unfamiliar expense accounts or other deductions, could indicate a risk of other errors on the statement.
COMPLEXITY OF THE AGREEMENT
Generally, the more complex a deal is, the higher the risk of error and omissions. This represents an inherent risk, which should be considered as part of one’s decision to ultimately conduct an audit of the statement.
INTERNATIONAL CONSIDERATIONS
Licensees depend on local distributors to handle sub-distribution on their behalf. Local distributors operate differently and may not be consistent with the licensee’s accounting methodology, systems, processes and local customs and practices. This can present various challenges for the licensee. Thus, information coming in from such local distributors may be misinterpreted or entered into the licensee’s accounting system incorrectly.
Furthermore, it is critical to ensure that the licensee has a compliance program to monitor any potential anti-corruption violations or red flags, as required by various applicable regulations.
OTHER FACTORS TO CONSIDER
There may be many other factors specific to a licensor’s circumstances, such as a dispute with the licensee, lack of transparency, product quality control, regulatory compliance matters or delays by the licensee in response to inquiries. Such factors may increase the potential risk of underreporting of royalties/profit sharing or present other challenges, such as legal or reputational issues.
If any of the above risks are present, one should consult with an auditor to further evaluate the possibility of performing an audit on their behalf.
If you have any questions about the above content, please reach out to a member of GHJ’s Royalty and Licensing Team.
