Multinational Enterprises (“MNE”) that are looking to mitigate their exposure to market changes provoked by crisis may find themselves considering the termination or suspension of intercompany agreements with non-performing parties. Terminating an existing intercompany agreement can very well be a key step that an MNE undertakes to protect its business; however, MNEs should also be aware that terminating arrangements could lead to unintended transfer pricing and tax consequences and may ultimately impact the structure of the group.
There are different approaches that an MNE can take regarding termination of agreements, each of which should be considered on a case-by-case basis.
If a specific agreement contains a negotiated force majeure or hardship provision, or its governing law recognizes the existence of force majeure as a matter of law (as is the case with many civil law jurisdictions), the parties to the agreement may be able to suspend or terminate their legal relationship without penalties, allowing for a one time reallocation of profit or loss. MNEs that invoke force majeure or hardship should be aware of how unrelated parties have approached this analysis in their jurisdiction and should adequately document the reasons why each provision applies to their particular circumstances. Generally, citing to declining market conditions may not be sufficient on its own to clear this hurdle and a tailored approach to transfer pricing documentation may be required as limited third-party data may be available.
If an intercompany agreement does not contain a force majeure provision, or such provision does not apply, then MNEs should undertake a detailed review of the particular consequences that may arise from suspending or terminating the agreement, as non-performance may constitute a breach of contract that entitles the affected party to seek damages or other contractual remedies. In this regard, “liquidated damages” provisions or penalty clauses can be helpful in limiting the economic impact for a related party to the extent such clauses are accepted in the jurisdiction of concern. However, MNEs should be diligent in documenting the specific legal grounds for non-performance, specifically where limited damages will be paid, and consider unanticipated consequences that may arise from a change in legal relationships (for example, if a “business restructuring” has occurred).
As a final alternative, MNEs that wish to terminate or suspend an intercompany agreement should also consider whether such agreement meets the legal and tax requirements to be rescinded. Contract rescission generally allows a company to unwind a transaction restoring the parties original status with no penalties or lingering legal effects and thus may be the easiest way for an MNE to mitigate the effects of contractual non-performance. However, MNEs should be aware that tax authorities have allowed rescinding valid transactions, in part or in whole, in very limited circumstances and should be prepared to defend this position against a potential audit.