The OECD transfer pricing guidelines (22 July 2010) provide that when an existing contractual relationship is terminated or substantially renegotiated in the context of a group’s business restructuring, the restructured entity may suffer harm that may potentially give rise to a requirement for arm’s length indemnification.
In order to determine whether an indemnification would be at arm’s length, the OECD transfer pricing guidelines point out that the starting point is a review of the contractual terms (i.e., notice period, indemnification clause, etc.) set out in the terminated or renegotiated agreement.
When such contractual provisions do not exist, it is necessary to determine whether the applicable commercial law or case law provides a right to indemnification, in view of the nature of the terminated / renegotiated agreement.
French case law
French courts in two recent cases found that a sufficient notice period must be given when an agreement is terminated—particularly when such notice is considered necessary, given the commercial relationship at issue. Failure to provide such notice period can give rise to a compensation payment for unfair termination.
The cases are:
- Court of Appeal of Paris, 5th Chamber (Cour d'appel de Paris, 5ème Chambre) No. 08/19944 (20 September 2012)
- Supreme Court, Commercial Chamber (Cour de Cassation, Chambre de Commerce) No. 11-24.570 (6 November 2012)
The Paris Court of Appeal found that a contractually agreed notice period must be fully applied unless it can be shown that there are grounds for an exception, such as an inability to perform the contractual obligations.
The Supreme Court, Commercial Chamber, found that when there was no contractually agreed notice period, the seven-month notice period given to a distributor was not “fair” with respect to termination of a 15-year exclusive distribution agreement. In this case, the court concluded that the notice period must be determined in view of the commercial relationship (e.g., length of the contract and other circumstances) between the parties—in other words, the terminated party’s economic dependency must be measured, here by taking into account the portion of its turnover generated with respect to the terminated commercial agreement. On this basis, the Supreme Court held that a 20-month notice period was required to compensate for the harm sustained as a result of the unfair contract termination.
Tax professionals with FIDAL* observed that the Supreme Court case highlights that an appropriate notice period must take into account specific circumstances existing at the termination date. Of note, in determining whether the notice period was sufficient, the Supreme Court did not take into consideration the terminated party’s entering into a similar commercial agreement with a third party.
As has been observed, these judicial decisions—which are to be read in light of chapter IX of the OECD transfer pricing guidelines—are in line with the position of the French courts with respect to relationships between unrelated or affiliated entities. The cases serve as a reminder of the importance of a proper assessment of the notice period (according to either contractual terms or case law/commercial law), and the potential for compensation owed on termination of an existing commercial relationship, especially in a restructuring context.
For more information, contact a tax professional in the Global Transfer Pricing Services group (FIDAL*) in Paris:
+ 33 1 55 68 1615
+ 33 1 55 68 15 22
+ 33 1 55 68 16 57
Xavier Sotillos Jaime
+33 1 55 68 14 85
* FIDAL is an independent legal entity that is separate from KPMG International and its member firms.