Audit clauses – some useful guidance

17 Feb 2015
Audit clauses are common in various kinds of contract and are often insisted upon by, for example, banking or pharmaceutical clients, who may themselves be subject to strict regulation.

The drafting of audit clauses varies considerably from contract to contract but they are often drafted in a wide and intrusive way; including rights to access premises, IT systems and other sources of data and information, often at little or short notice.

The recent case of 118 Data Resource Ltd v IDS Data Services Ltd & Ors [2014] EWHC 3629 (Ch) provides some useful guidance for anyone drafting or negotiating audit clauses and also provides some comfort for suppliers who may be forced to accept onerous audit terms.

118 licenced certain rights to IDS and the licence granted 118 certain audit rights, one of which provided that 118 was entitled to enter IDS's premises where copies of the database were used "for the purpose of ascertaining that the provisions of [the] Agreement [were] being complied with". The clause contained nothing more and, importantly, contained no mechanism for how that audit right should be implemented.

When a dispute arose between the parties, 118 sought to rely on the audit clause and subsequently issued an interim application seeking access to IDS’s customer contacts, financial information and other confidential material. The judge at the interim application stage therefore had to determine whether 118 was entitled to rely on its audit clause for these purposes.

In summary, the judge (Deputy Judge Halpern QC) decided that 118 was not entitled to enforce the audit provisions owing to the fact that the clause contained no mechanism for how the inspection should be conducted, in addition to which the purpose of the audit was unclear. Because the clause lacked clarity, the judge considered the court was being asked to imply provisions which went far beyond the wording of the clause and, as such, he considered the Court was being asked to reword the audit clause. Consequently, the audit clause was not suitable for an order for specific performance and ii8’s application was rejected.

Helpfully, the judge went further and stated that even if the clause had been clearly drafted, it should not enable 118 to obtain unrestricted access to IDS’s information, including its customer information.

There was a subtext to 118’s application, namely that 118 appeared to be attempting to use the audit provisions to obtain access to information for the purposes of the litigation which was underway with IDS. Nevertheless the decision of District Judge Halpern is very useful in providing guidance in an area which is often ripe for debate and disagreement.

The take-away points from this case are essentially the same for those proposing audit clauses as they are for those potentially on the receiving end, namely that the audit clauses should: –

  1. Be clear in their terms and objectives.
  2. Be specific and tied to the legitimate rights and interests relevant to the contract.
  3. Contain a clear and well-structured mechanism for how the audit right will be exercised and when.

Failing to comply with these requirements means you may well have an audit clause which is unenforceable. That may be some comfort to suppliers who are forced into accepting unreasonable audit provisions but will give no comfort to anyone seeking to rely upon an audit provision, which will be of particular concern to heavily regulated companies, such as those in the banking and pharmaceutical sectors.

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