COVID-19 may make incomplete contracts renegotiable

June 23, 2020

It is clear that many multinational companies’ international tax structures, as memorialized by intercompany agreements and transfer pricing policies, did not contemplate a disruptive event on the scale of the COVID-19 pandemic and related governmental actions.  As a result, left unaltered, the tax structure may result in non-arm’s-length outcomes and be subject to dispute by tax authorities. A legal analysis of the intercompany agreements may appear to bind the parties, even if there is a force majeure clause; however, an economic analysis of the contract may justify the ability to remedy the transfer pricing outcome to reflect arm’s-length behavior in the current economic environment. 
In this Law360 article, authors Robin Hart and Steven Schwartz draw on an extensive body of economic literature on incomplete contracts to explain how the contracting parties can resolve mutual obligations/terms and conditions as unaccounted for situations materialize.  The typical approach in the literature, and in practice, is for the parties to resolve the issues raised by an unanticipated issue through renegotiation. Hence, there may be an economic justification for controlled parties to a transaction to negotiate a temporary or permanent remediation (in the form of an adjustment to the terms of the agreement) to account for the unique business impacts that are unfolding due to the global pandemic.

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