How to interpret an IP royalty audit clause?
Paddington Bear may be well known as a warm, amiable character thanks to the recent movies and Buckingham Palace appearances, but a dispute over merchandising revenue has revealed some tensions behind the franchise.
These tensions were evident in a November 2022 IPEC judgment by Her Honour Judge Melissa Clarke (Pixdene Ltd v Paddington and Company Ltd), in which she had to interpret a number of issues arising from a single clause of a short agreement between the parties. As the judge wrote: “The reason for [the number of issues raised] is that the parties do not trust each other.” They asked the Court to provide guidance on their obligations and entitlements “without leaving anything to the common-sense of the parties to sort out between them, since, they believe, they will not”.
Paddington and Company owns the IP rights in and arising out of Paddington Bear. Under the agreement between the parties, Pixdene is entitled to 10% of the final share of the net Paddington Bear worldwide merchandising income.
The single clause of the agreement that is in dispute reads:
“During the term of this Agreement a third party auditor may, upon prior written notice to Paddington and not more than once per every two year period, inspect the agreements and any other business records of Paddington with respect to the relevant records or associated matters during normal working hours to verify Paddington's compliance with this Agreement."
In 2019 Pixdene appointed an auditor to carry out the annual audit, but the parties disagreed over issues including which documents must be provided to the auditor, who can carry out the inspection, what period the audit covers and whether documents can be redacted. These were among the issues for the Court to resolve.
The judge set out the law on contractual construction and the implication of terms in a contract, and noted that the only evidence of the intention of the parties at the time of the agreement was the agreement itself.
Paddington argued that Pixdene was asking the court to construe the clause in a way that gives rise to additional rights and obligations to the plain meaning of the words. It said the clause should be constructed with the context in mind, including (i) the agreement was drafted professionally between two legally represented parties, (ii) it expressly says it is intended to “formalise” the parties’ rights and obligations; and (iii) in the absence of ambiguity, the words should be given their natural meaning.
HHJ Clarke said she accepted points (ii) and (iii) and in relation to point (i) she accepted that Pixdene was legally represented even though there was no direct evidence on this point. But she added that part of the context is that “clause 5 is drafted for Pixdene’s benefit. Without this audit right, Pixdene would have no way of verifying whether Paddington had complied with its obligation to pay Pixdene royalties under clause 1 of the [agreement].”
She went on to resolve all the issues in dispute between the parties. Her declarations included:
Pixdene must give at least 10 business days’ notice of an audit;
The inspection must take place at a venue within Paddington’s control and within normal working hours;
Paddington should make copies of the inspected documents as requested by the auditor, and allow the auditor to make copies themselves, but such copies must be kept confidential;
Pixdene cannot inspect documents or be provided with copies and the auditor can only disclose information to Pixdene that is necessary; and
Paddington can only redact documents to the extent that they are legally privileged.
What does this mean?
The judge has done an admirable job in resolving the issues between the parties clearly and logically, particularly given that there was no live evidence in the one-day hearing. Hopefully the relationship between them which has clearly been strained will be improved by the Court’s intervention.
The lesson for the future: it would surely have been in the interests of everyone for the agreement to have stated clearly and comprehensively the obligations on both sides. That should have removed any mistrust and avoided this lengthy and expensive litigation.
Parties entering into such agreements are advised to seek legal advice to ensure that all relevant issues are discussed and clarified when signing, to try to avoid disputes such as this erupting in the future. Please contact us for more information on how we can help.