Tariff Impacts Spill Over Onto Intercompany and Licensing Agreements, Law Firm Says

These types of examinations were just one of many suggestions offered by the law firm during a June 25 webinar on legal and business considerations related to U.S. tariffs.

“I have to stress intercompany agreements really need to be the starting and ending point of everything when it comes to transfer pricing and responding to tariffs. If no intercompany agreement is in place, which unfortunately is a case of quite a few companies, we would strongly recommend getting one,” Baker McKenzie partner Philip Thomson said.

An intercompany agreement is one way a company can build in flexibility so that it can be more nimble in handling evolving scenarios, according to Thomson.

“If one does have intercompany agreements in place, then really examine how the risks to the parties are allocated and what the pricing parameters are so that you can consider amendments to provide greater flexibility if benchmark profit ranges are used to support intercompany pricing policies and they don't support the outcomes under a higher tariff,” Thomson said.

Companies can model potential transfer pricing outcomes across various tariff scenarios, he said. This type of analysis is particularly useful for situations where companies use the same price for customs and transfer pricing purposes, as it can help them understand whether their current transfer pricing policies will be violated with an additional tariff burden, Thomson continued.

“For example, let's assume that a U.S. distributor imports goods from a foreign affiliate, and its transfer pricing policy is such that the distributor will earn a 3% operating margin on the distribution of those goods. To what extent will an increased tariff affect the policy?” Thomson said. “Perhaps an easy response would be to simply reduce the transfer price to allow the company to earn their 3% margin -- essentially, place the burden of the tariff on the foreign party. That’s what many companies do, but it's not always the best approach.”

A company finding itself in that situation may consider a reconciliation program to account for post-importation pricing adjustments with a single entry, or it should seek to separate the non-dutiable elements of the transaction, he said.

When considering how to navigate changes in U.S. tariffs and trade policies, companies have multiple options that will enable them to react proactively instead of reactively, according to the webinar participants.

For starters, companies should consider auditing their existing contracts to understand their exposure to tariff rate changes, according to Baker McKenzie international commercial law lawyer Peter George, who said his work with clients has involved focusing on the delivery terms of key contract provisions and how they relate to liability for duties. This also might include “future-proofing” contracts for potential tariff changes, he said.

“We're looking at understanding how and what flexibility clients have under their current and existing contracts to adjust pricing, to change forecasting, to change volume commitments, to change delivery terms, and [we’re] also assessing the impact that specific change adjustment terms might have on their commercial agreements, including material adverse change clauses and force majeure provisions,” George said.

Companies should also consider the impact that tariff rate changes have on licensing agreements, George continued.

To determine how and where companies should be nimble, Mark Bloom, North America chair for the law firm’s global restructuring and insolvency practice, said companies should adopt a “three ways approach” consisting of looking inward within company operations and keeping an eye on the company’s cash and liquidity position, and then looking outwardly “in both directions,” from up the supply chain to down the distribution chain.

This examination is important so that a company may know what rights it has available if a key supplier, distributor or customer becomes involved in a bankruptcy or restructuring proceeding, he said.

“One interesting phenomenon that we're seeing is that, initially, lenders mostly have shown patience as their affected borrowers adjust and work through the issues posed by the tariff concerns. But there are signs, however, that this passive approach has begun to wane, at least in distress situations,” Bloom said, citing scenarios in which companies file Chapter 11 bankruptcy. The lenders who provided the initial financing for bankruptcy and the exit financing also have included “an escape hatch in their loan commitments for certain tariff events” to maintain flexibility on the lender side to renegotiate or pull back from commitments, he said.

“The flood of restructuring and insolvency work that many have predicted based on the tariff uncertainty and volatility has not occurred, but we're definitely moving, as I said, from a trickle to a flow,” Bloom said.

Meanwhile, Rod Rosenstein, Baker McKenzie’s national security practice chair, outlined a laundry list of potential strategies that companies should pursue:

(1) consider the impact of tariffs on supply contracts and other agreements, particularly the impact of potential non-performance or breach, the need for price reopeners or adjustment clauses in contracts to account for the potential for changes in tariffs, and the importance of including that as a risk factor to consider in your contract decisions;

(2) consider contract risks, including handling any negotiations or disputes that may result from contract disputes;

(3) assess supply chain and third-party risks, including potential liability of suppliers, customs brokers, freight forwarders, and others who might engage in purposeful fraud, as well as due diligence obligations for vetting suppliers and intermediaries;

(4) investigate alleged tariff circumvention, such as country of origin fraud;

(5) conduct crisis planning and develop contingency plans as “in this Trump administration, what I tell people is to expect the unexpected and be confident that you do not know where the administration may go next;” and

(6) be aware of the potential legal challenges to the impositions of tariffs, such as those in the U.S. courts and in international forums.

The uncertainties over U.S. trade policy are also creating an environment that discourages mergers and acquisitions, according to Kathryn Strong, a Baker McKenzie partner involved in M&A. She said her firm is seeing a decrease in the average purchase price for acquisition deals in China and longer time frames to close deals as buyers and shareholders are wary of purchasing assets and operating in China.

Many multinational companies are also exploring ways to diversify away from China and Mexico as part of a strategic move to diversify supply chains and reduce single or primary source vulnerability, Strong continued. Industries seeking to diversify sourcing include technology, automotive and consumer goods, with Vietnam, India, Thailand, Malaysia, Indonesia, the Philippines and Mexico being considered as alternative manufacturing sites, she said.

Still other strategies to pursue are taking advantage of various Customs procedures, such as foreign-trade zones, duty drawbacks and bonded warehouses, according to Eunkyung Kim Shin, international trade partner. Companies might also consider different valuation methodologies to optimize duty position, she said.

“It has been more critical than ever for businesses to reassess the way we classify our goods and determine whether there's a code that could apply to the goods that could result in a duty position that's more favorable to the company,” Shin said.

For instance, companies should consider whether there are any duty savings between shipping a final good and a semi-finished good, she said.

Regardless of the strategies companies pursue amid U.S. trade uncertainties, businesses should be aware that the increased emphasis on preventing white-collar crime is expected to continue, even as various federal agencies have seen staff reductions, Baker McKenzie experts said.

“What we're experiencing is that your day-to-day questions, like licensing processes or customs clearance and things of that sort, are maybe delayed, but we're not seeing a meaningful reduction in the enforcement activities,” Shin said. “Even with the reduced staff, it remains a high priority within the government, and in fact, that is what we see on the ground as well.”