The Royalty Statements Do Not Add Up: Audits, Underpayment Claims, and Deadlines in California

Last updated: November 2026. Reviewed by Pavel Kolmogorov, California business litigation attorney (State Bar No. 321018).

When a licensee's royalty statements do not match its sales, start with the license's audit clause. Read it for which records may be inspected, how often, and who pays for the audit. A proven shortfall is a claim for breach of a written contract, which California allows four years to bring. (Code Civ. Proc., § 337, subd. (a).) A license may shorten that with a clause that makes each statement final unless it is challenged in time. Kolmogorov Law, P.C. represents licensors pursuing a shortfall and licensees answering an audit.

Call (909) 235-6116 or contact us online to discuss a royalty shortfall or an audit notice.

Start with the audit clause

The right to audit comes from the contract, so its limits do too. Before a notice goes out, read the clause for six things.

Notice: how much, and in what form.
Frequency: how often an audit may be held.
Lookback: how many past periods may be examined.
The auditor: whether an independent accountant is required, and whether a contingent fee is allowed.
Records: which books are open, and whether sublicensee and affiliate records are included.
Cost and interest: who pays for the audit, and whether that shifts when the shortfall passes a stated threshold.

A license with no audit clause may leave the records to an accounting claim or to discovery in a lawsuit. Our page on the accounting cause of action explains when that claim is available.

What an audit tests

An audit compares what was reported with what the contract required, and the questions fall under a few headings.

Deductions. Were returns, discounts, freight, taxes, and allowances taken as the net sales definition permits?
Bundles. How was the price divided when the licensed product was sold together with others?
Affiliates and sublicensees. Were sales to related companies reported at the price the contract requires, and was sublicense income shared?
Unreported channels. Were online marketplaces, new territories, and later product versions included?
Timing and currency. Were reserves, late reports, and exchange rates handled as written?
Minimums and advances. Were guaranteed minimums paid, and advances recouped correctly?

An auditor's report is evidence, not a judgment, and each finding still has to be tied to a contract term.

The four-year period runs payment by payment

A royalty obligation recurs. Under the continuous accrual doctrine, each breach of a recurring obligation is independently actionable and has its own limitations period. (Gilkyson v. Disney Enterprises, Inc. (2016) 244 Cal.App.4th 1336, 1341.) Applying that rule to periodic royalties, the Court of Appeal held that each failure to pay was separately actionable. The older breaches were time-barred, but the claim was timely for breaches within the four years before the lawsuit.

For a licensor the arithmetic is plain: each reporting period of delay can move the oldest period out of reach. Our page on the statute of limitations for breach of contract has the general rules.

An incontestability clause can shorten the time

A license may make each statement conclusive unless the licensor objects in writing within a set time. The Court of Appeal has upheld such a clause on its face. It required a specific written objection within 24 months after a statement was sent, and a lawsuit within six months after that. The court held that period was not unreasonable between represented parties of equal bargaining strength. By agreeing to a fixed accrual date, it added, the participants had waived the discovery rule. (Wind Dancer Production Group v. Walt Disney Pictures (2017) 10 Cal.App.5th 56, 76.)

The paying party did not win outright, because the same court found triable issues of waiver and estoppel. The evidence included oral tolling agreements, past failures to enforce the clause, and long waits before audits were allowed to begin. So what each side does during an audit matters.

Between sophisticated parties with counsel, a clause that fixes when a claim accrues can displace the discovery rule. A second Court of Appeal decision enforced one in a negotiated commercial contract where no misrepresentation was claimed. The rule has limits. An earlier decision reversed a summary judgment that had rested on a one-year objection clause. The royalty statements themselves were alleged to be misleading, and the court held that an unused audit right did not automatically defeat delayed discovery. The result under any clause depends on its wording, the parties, and the facts.

Three habits follow. Calendar the objection date for every statement, and send specific written objections before that date even if the audit is unfinished. Put any extension in writing, as our page on tolling agreements explains.

If you are the licensor

Compare the statements with what can be seen from outside: public filings, marketplace listings, and customer reports.
Give audit notice in the form the clause requires.
Protect the open periods with written objections.
After the audit, send a demand that ties each finding to a contract term and a dollar amount.

The claims that follow are breach of the license and, where the numbers are still hidden, an accounting. Interest is covered on our page on prejudgment interest. Termination for underpayment may have its own notice and cure steps, and use beyond the license can be infringement. Our page on license disputes covers both.

If you are the licensee facing an audit

An audit notice is a contract demand, and the contract limits it.

Hold the auditor to the clause: the periods open to review, the records listed, and the frequency allowed.
Ask for a confidentiality agreement before any records are handed over.
Check whether older statements have become final under an incontestability clause.
Answer the report item by item, with the definition that supports each deduction.

Refusing an audit that the clause allows can be a breach of its own, and an overpayment found along the way belongs in the same response.

What to bring to the first meeting

The license, every amendment, and any side letters.
The royalty statements and payment records for the periods in question.
Audit notices, auditor reports, and the correspondence about them.
Whatever shows the gap: sales data, public filings, listings, or customer reports.
Any written objection or tolling agreement already exchanged.

Frequently asked questions

Our licensee's royalty statements do not match their public sales. How do we audit them and recover the shortfall?

Use the audit clause in the license. Give the notice it requires, examine the records it lists, and send written objections to open statements. A shortfall is recovered as breach of a written contract, which California allows four years to bring under Code of Civil Procedure section 337, counted separately for each underpaid period. Check the license for a shorter objection deadline.

What is a royalty audit?

It is an examination of a licensee's books, by an accountant or other auditor, to test whether the royalties reported and paid match what the license requires. The right comes from the audit clause in the contract. In a California dispute, the audit report becomes evidence for a breach of contract claim or for the defense to one.

How far back can a royalty audit go?

As far as the audit clause allows, which may be a stated number of years. Separately, a California claim on a written license generally must be filed within four years of each underpayment, and a clause making statements final after a reasonable set period can shorten that. Check both limits before choosing the audit period.

We never audited our licensee and just learned it has underpaid for years. Have we lost the older royalties?

Possibly some of them. In California each underpaid royalty period is a separate breach, so periods within four years before suit remain open and older ones may be barred. A clause that makes statements conclusive after a set time can bar more. Court of Appeal decisions differ on whether delayed discovery survives such a clause. One allowed it where the statements themselves were allegedly misleading.

Can a licensee refuse a royalty audit?

Generally only on grounds the contract provides. A licensee may hold the licensor to the notice, frequency, scope, and confidentiality terms of the audit clause, and may object to periods the license treats as closed. Refusing an audit the clause permits can be a breach of the license in California, and it leaves the records to be obtained in litigation.

Talk to a California license dispute attorney

If royalty statements do not reconcile, or an audit notice has arrived, call (909) 235-6116 or contact us online. Kolmogorov Law, P.C. is located in Irvine, California. See also our intellectual property litigation page.

This page provides general information about California law and is not legal advice. Outcomes depend on the license, the records, the facts, and the court.