"Famous Last Words"

Sales Statements Action (February 2007)

Dear Jim:

I am in the process of putting together a contract for game music, and the payment is mostly in the form of getting a straight percentage of sales.

How does one normally go about verifying those sales? I am wanting to include something which sounds like this:

"Supplier will have access to sales figures in the form of <something>".

I mean, I don't really want to say that they have to give me access to all their financial records, but neither do I want to simply take this guy's word for it. (Had enough of that in the music biz, and that was with publicly-traded companies) How does one normally check sales figures for payment, just by asking for a quarterly or semi-yearly sales statement?

Composer Not Accountant

Dear Composer:

Every agreement that provides for some future or contingent compensation based on sales or revenue generated from work product should contain both an accounting clause and audit rights language.

In the games industry, accountings are generally provided between 30 to 60 days after the end of each calendar quarter.

An accounting should provide sufficiently detailed information so that you can determine the amount of royalties that are owed.

You should determine what that information is based on the nature of your deal.

For example, if you are paid a percentage of net sales (and be sure that “net sales” is defined clearly in your agreement), you will want to know the number of unit sales, the average selling price, and the amount and description of each deduction that is taken from invoiced amount to arrive at “net sales.”

If the game is being distributed in countries outside the United States, a separate calculation should be provided for each country.

Some companies are now delaying payment of royalties by asking that the developer invoice the publisher after receiving the royalty statement. The publisher pays the invoice on a net 30 or net 60 basis. This practice delays payment further and should be resisted.

Your agreement should also provide for audit rights so you can verify that the calculations provided in your royalty statements are correct.

Generally, companies will complicate audit clauses in ways that make it more difficult and expensive to exercise these rights.

For example, typical first contract draft limitations provide that a royalty statement must be audited within one year or else the right is lost. Contracts can restrict audit access to a Certified Public Accountant, give the publisher the right to approve the auditor, not permit an auditor then engaged in another audit of publisher's books and records on behalf of another client to conduct the audit on your behalf, forbid any audit by an auditor working on a contingent fee basis, require all audit work to be completed in a short time (I have seen agreements that limit it to five working days), not permit an auditor to make any copies of any records (only hand written extracts!), and require any auditor to sign an NDA prepared by publisher. Some NDAs are so restrictive that no one would sign them.

In negotiating all these issues, some compromises may be reached. Your goal should be to come up with a process that permits you to verify the accuracy of statements and payments as quickly, efficiently and accurately as possible while not being unduly burdensome on either you or your publisher.

For example, I regard one year after receipt of a statement as an inadequate period in which to conduct an audit. One year may not be enough time in which to determine whether you believe there are errors in statements. Sometimes, apparent errors can only emerge from watching trends in royalty statements. It is typical that multiple statements will be audited at one time. The cost of auditing two or three years results may not be materially greater than auditing one or two statements. Sample data taken from several years experience may help verify the accuracy (or reveal areas on which the audit must focus). No time restriction (called a “statute of limitations”) is preferable. Three years is workable. Frequently, publishers will settle on two.

And remember, that while a contractual statute of limitations may end the general availability of older statements, a claim of fraud in litigation over underpayment may make those older records available.

Not all auditors are CPAs. In the UK, the title may not exist (I recall they are “Chartered Accountants” – UK readers can confirm or correct me here). Your goal should be first and foremost to find a qualified professional to do the job. That professional may or may not have achieved the status of CPA. Hiring a CPA may be more costly than an otherwise qualified royalty auditor. For these reasons, I recommend substituting the word “auditor” for CPA whenever it appears in an audit clause.

This should not be taken to suggest that anyone can conduct a royalty audit. Royalty accounting, particularly at the major publishers, is enormously complicated. Contracts generally only give you the right to audit a statement one time. It is critical that it be done thoroughly and professionally. You will only get one bite at the apple – so it is important that you engage a qualified experienced royalty auditor, whether that person is a CPA or not.

One final concern here – your question says you are providing the music, and payment is mostly in the form of contingent compensation. Have you considered retaining the copyright in your work rather than turning over rights on work-for-hire basis?

We will discuss that issue next month...