The concept of ‘recourse’
is key to understanding risk allocation in intercompany agreements.
It’s also key to
implementing transfer pricing policies in a way which is consistent with the
approach set out in the OECD TP Guidelines: the fundamental idea of delineating
transactions between associated entities, and then allowing the risk allocation
inherent in that delineation to ‘play out’ or 'materialise'.
‘Recourse’ refers to the ability of one party to
make a contractual claim against another. It encompasses both the subject
matter of the claim and its quantum.
One way of looking at contractual recourse is to
ask three questions:
1. In what circumstances would a claim arise?
For example, a breach of a duty to deliver goods corresponding to an agreed
standard. Or a contractual indemnity which applies if one party suffers a third
party product liability claim.
2. How would any claim be calculated? For
example, a potential claim may include loss of profits. Or a dollar-for-dollar
payment to ‘make whole’ the party being indemnified.
3. What exclusions or limitations would apply to
the claim? For example, there may be a contractual cap on the total amount of
claims in a period.
The archetypal example of this approach is
insurance policies - underwriters are masters of defining and assessing risk.
And of course the policy terms and inextricably linked to the pricing of
premiums.
As with any other aspect of intercompany
agreements, the objective here generally not to replicate the form of
contractual arrangements which exist between unconnected third parties.
The objective is to implement the relevant
transaction in legal reality in a way which:
* approximates an arm’s length result for the
parties;
* aligns with operational reality; and
* also aligns with the financial capacity of the
relevant parties to bear risk.
