Audit Rights on Reported Sales

Because percentage rent depends on data the landlord cannot observe, essentially every retail lease with a percentage clause includes a right to audit reported sales.

What the clause should say

Scope. What records the tenant must produce — point-of-sale data, tax filings, general ledger detail, bank deposits. A right to audit with no defined scope invites an argument about what “books and records” means.

Frequency and lookback. Typically one audit per lease year, covering the two or three most recent years. A lookback that is too short lets a persistent understatement go unrecovered.

Notice. How much warning the tenant gets, commonly ten to thirty days.

Location. Where records are produced. Remote production is now standard and worth stating.

Cost allocation. This is the operative provision.

The threshold provision

The standard formulation: if the audit finds an understatement exceeding some percentage — commonly 2% or 3% — the tenant pays the audit cost. Below that, the landlord pays.

The threshold does real work. Without it, the landlord bears the cost of every audit, which makes auditing uneconomic for anything but large tenants. With it, the tenant carries the risk of material misreporting.

Some leases add a second tier: an understatement above a larger threshold — say 5% — triggers a default or gives the landlord termination rights. That is aggressive and usually negotiated out, but it does appear.

Interest on the underpayment should also be specified. Recovering the principal three years late without interest is an incomplete remedy.

When to exercise it

An audit is a significant step in a landlord-tenant relationship. Reserve it for genuine anomalies:

• Reported sales that diverge sharply from observable foot traffic
• A sudden drop with no operational explanation — no renovation, no competitor opening, no category-wide decline
• Reported figures that conflict with a tenant own public reporting, where the tenant is public
• Sales that sit suspiciously just below the breakpoint year after year

That last pattern is the classic signal. A tenant whose sales land at 98% of breakpoint for four consecutive years is either remarkably consistent or managing the number.

What audits typically find

Rarely outright fraud. Usually definitional disagreements:

• Online orders fulfilled elsewhere but placed in-store, excluded when the lease includes them
• Gift card revenue recognized at issuance rather than redemption, or vice versa
• Returns from other locations netted against this store sales
• Employee and promotional discounts excluded beyond what the lease permits
• Sales tax treatment inconsistent with the definition

Most of these are honest readings of an ambiguous clause. Which is an argument for drafting the gross sales definition carefully rather than for auditing aggressively.

The cheaper alternative

Most of what an audit would catch is preventable through better reporting hygiene: a clear gross sales definition, a required certification on the annual statement, and a consistent submission process that creates a record of what was reported and when.

A tenant who submits through a portal, sees the definition each time, and certifies annually reports more carefully than one who emails a figure once a year. That is considerably cheaper than an audit and does not cost anything relationally.

See how sales submission retains the per-period record an audit right depends on.