Disputes in regard to royalties and fees can arise in any situation in which one party owes payments to another party based on a pre-determined agreement or formula. These disputes inherently involve financial results, accounting records, calculations and in some cases fraud. As a result, forensic accountants are often retained to ensure proper compliance with the applicable agreements and to substantiate or refute disputable claims of incorrect royalty calculations or payments.

Royalty disputes will often involve the following parties:

  • Franchisees and franchisors
  • Licensees and licensors
  • Authors and publishers
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Franchisee-Franchisor Disputes

Franchisee-Franchisor Disputes

The relationship between a franchisee and franchisor can become strained and often hostile due to disagreements about royalties or other fees owed. Disputes of this nature may lead to the financial and reputational damage of the litigants. Furthermore, if a franchisee becomes suspicious that another franchisee is underpaying royalties or not contributing their fair share of other fees – such as fees that are pooled for the benefit of franchisees as a whole – they may become more inclined to underpay their own royalties and fees to the franchisor.

Incorrect royalty payments can be caused by:

  • Intentional under-reporting of key amounts (such as sales)
  • Misinterpretations or disagreements involving definitions, calculations or the established terms of the franchisee – franchisor agreement
  • Mathematical or formula errors in underlying spreadsheets or working papers

By conducting royalty audits, franchisors can not only ensure that they are receiving the royalties to which they are entitled, but they can also avoid the distraction, cost and brand damage that could occur as a result of an ongoing royalty dispute or a loss of trust among one or more franchisees.

In order for a franchisor to protect themselves with an effective royalty audit, they should ensure that their franchise agreements have ‘due diligence’ or’ right to audit’ clauses which stipulate that an independent auditor may obtain a franchisee’s financial records, and which will also allow the auditor to scrutinize the amounts that have been calculated and reported by franchisees.

Royalty audits in the context of franchisee-franchisor relationships can be conducted on a recurring or periodic basis, and can either be company-wide or take the form of a targeted audit of a specific franchisee.

Recurring Company-Wide Royalty Audits – These are typically higher-level reviews that involve comparing amounts that were reported by a particular franchisee to the amounts that were reported by other franchisees or to relevant benchmarks. In these cases, the royalty audit is performed in order to assess its reason ability and to identify any anomalies.

Targeted Royalty Audits and Investigations–A targeted audit of a particular franchisee becomes necessary when a recurring, system-wide royalty audit has identified glaring or obscure in consistencies in royalty payments, when specific red flags are recognized or when allegations of wrongdoing surface with respect to this franchisee.

Whether the situation calls for a system-wide or a targeted royalty audit, nagel + associates approach royalty disputes with a skeptical outlook and an acute attention to detail. We identify existing irregularities within the franchisor-franchisee dynamic, and expertly mitigate the potential adverse impact that these irregularities may cause. We can assist by:

  • Reviewing and assessing the results reported by franchisees
  • Comparing royalty calculations to the applicable franchise agreements
  • Performing royalty audits, including ‘surprise audits’ to identify issues or to confirm suspicions
  • Conducting interviews with employees, customers, suppliers or other key parties
  • Preparing expert reports, schedules and document briefs
  • Critiquing reports prepared by other auditors
  • Providing expert testimony in court

At nagel + associates, our professionals specialize and excel at investigating fraud and assisting in the resolution of disputes. If you are a franchisor and you suspect non-compliance by your franchisees – whether due to fraud or error – contact us so that we can discuss how we can help you to mitigate the potential financial and reputational damage that can occur as a result of royalty disputes.

Licensee-Licensor Disputes

Licensee-Licensor Disputes

Similar to the relationship between a franchisee and franchisor, the relationship between a licensee and licensor (whereby a licensee pays royalties to a licensor for the right to use their intellectual property) can deteriorate due to disputes that involve royalty fees.

In theory, the licensee-licensor relationship is a mutually beneficial one since it allows the licensee to benefit from – and the licensor to realize the value of – the creations and discoveries of the licensor, which are often the product of considerable expense and effort. However, since royalty payments are often based on the representations, calculations and interpretations of the licensee, they may either knowingly or unknowingly under report and underpay the licensor the amount to which they are entitled.

Frequent causes of under reported or underpaid royalties include:

  • Misunderstandings or differing interpretations of the agreements between the licensee and licensor
  • Excessively aggressive interpretations of the agreements between the licensee and licensor
  • Deliberate and fraudulent acts of deception or misrepresentation
  • Intentional or unintentional errors can result in the following: certain products being excluded when calculating royalties, the application of incorrect royalty rates or using the wrong formulas when determining royalty payments
  • An incorrect usage of the adjustments for related-party transactions, discounts, rebates or deductions

A royalty audit performed by an independent and qualified forensic accountant can help to ensure that the licensee complies with the applicable license agreements entered into with the licensor. This will ensure that all royalties owed to the licensor are correctly paid. Moreover, a royalty audit will create an overall aura of accountability that encourages ongoing compliance by the licensees that are associated with the licensor.

Royalty audits can be performed on a recurring or rotational basis to ensure blanket coverage of all license agreements that a licensor has in place. However, if these recurring or rotational audits identify discrepancies or information suggesting non-compliance by a specific licensee to an agreement entered into with the licensor, then the licensor may opt to undertake a targeted and detailed royalty audit of the specific licensee.

In order to enable effective royalty audits, licensors should ensure that their license agreements have ‘due diligence’ or ‘right to audit’ clauses that permit an independent auditor to obtain a licensee’s financial records and to scrutinize the amounts calculated and reported by licensees.

Since non-compliance with license agreements can often lead to contentious disputes and protracted litigation, royalty audits should be performed by an experienced forensic accountant. This is particularly true if the issue involves allegations of fraud or the intentional under-reporting of royalties.

At nagel + associates, we apply our extensive knowledge and experience with investigating fraud and resolving disputes to consistently secure favourable results and judgements for our clients. If you are a licensor and you suspect non-compliance by your licensees – whether due to fraud or error – contact us

Author-Publisher Disputes

Author-Publisher Disputes

Similar to the relationship between a franchisee and a franchisor, or a licensee and a licensor, the relationship between a publisher and author (whereby a publisher pays royalties to an author based on the sales of the author’s works) can be strained by disputes over royalty payments.

While the publishing royalty payment process seems straightforward, an author may be unsure if he or she is receiving the full entitlement of royalties. The author may be confused because of the following factors:

  • Royalty calculations are often complicated and may involve varying royalty rates and numerous deductions and adjustments
  • Publishing agreements may be lengthy, and as a result, not always read in full or comprehended by the author
  • Authors may be reluctant to question the amounts reported and paid to them by their publishers
  • Royalty statements provided to authors likely do not contain all of the data needed for authors to verify the completeness and accuracy of their royalty payments

In order to enable effective royalty audits, an author should ensure that their publishing agreements contain’ due diligence’ or ‘right to audit’ clauses which will permit an independent auditor to obtain the publisher’s financial records and to scrutinize the amounts calculated and reported by the publisher.

If an author believes that he or she is being underpaid by their publisher, or if they simply do not know and want to find out, hiring a qualified forensic accountant to conduct a royalty audit will assist in alleviating this concern. The forensic accountant that is retained to perform the royalty audit must be well-versed in performing investigations, offering expert testimony and providing litigation support to the author. The decision as to which forensic accountant the author decides to retain should be undertaken with an abundance of caution, since the suspected underpayment amount may be substantial, and could possibly be the result of ill-intent, manipulation and fraud.

At nagel + associates, investigating fraud and assisting in resolving disputes is our focus. If you are an author and you suspect that you are not receiving the full value of the royalties that you are entitled to – whether due to fraud or error – contact us

Red Flags:

  • Lack of franchises
  • Public reviews and feedback are consistently negative
  • Prior bankruptcy
  • Ongoing franchise fees are excessive when compared to that of the competitors
  • Little or no territory protection
  • Lack of financial performance representation
  • High franchise turnover, indicating a consistent level of franchisee dissatisfaction

Mr. Harvey recently retired and decided to put his savings into ‘ABC Burgers’, a popular fast food franchise with over 150 locations across the country. Mr. Harvey paid $100,000 for the franchise which was operational within 2 months of purchase.

Almost immediately, Mr. Harvey noticed some irregularities. Although he purchased his ingredients directly from the franchisor as per the franchise agreement, different companies were responsible for delivering the meat, buns and potatoes. Also, he observed that the quality of the product varied from week to week. After some investigation Mr. Harvey discovered that the franchisor was purchasing lower quality products and passing them off as organically-made, with 100% beef and no pesticides.

Mr. Harvey spoke with the other franchisees to share his findings. As it turns out, each franchisee had their own misgivings and questionable experiences about their dealings with the franchisor. There were also several pending litigations that had yet to be resolved between franchises and the franchisor.

After much thought and discussion, the franchisees decided to retain a forensic accountant to conduct a thorough investigation into the franchisor and the legality of his questionable practices. The forensic accountant produced an investigative report and testified in court to share their findings.

Relevant Evidence:

  • Contracts
  • Financials
  • Electronic evidence
  • Interviews

To determine whether your organization may be susceptible to fraud, take the following brief survey: