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What Is The Arm’s Length Principle?

What Is The Arm’s Length Principle?

Impartiality and objectivity are key traits of the law. The arm's length principle helps preserve this. Read more about this principle here.

6th August 2019
Reading Time: 3 minutes

The law is full of principles that govern how parties ought to interact with one another. One of these examples is the arm’s length principle. This principle is the condition or the fact that the parties to a transaction are independent and on an equal footing. Such a transaction is known as an arm’s length transaction. Its main function is to test whether an agreement will withstand legal scrutiny. This may be so even though the parties may have shared interests. Despite those shared interests, ensuring that either party to a transaction is separate enough not to bring about any conflicts of interest is crucial. This principle exists in a number of different types of law. Accordingly, we have explored these for you below.

Contract law

The arm’s length principle is quite common in contract law. Its purpose is to ensure that parties to a contract are separate enough an entity to be able to engage in such a contract without jeopardising impartiality and fairness. It is important to determine the independence of parties. For example, familial ties in commercial relationships and alike. So long as the arm’s length principle is satisfied, the contract continues. In any contractual negotiations, seeking the advice of a contract lawyer is always a good idea.

Property law

Following on from contract law, and usually running alongside it, is property law. The arm’s length principle might emerge where lawyers or a court may need to determine whether parents selling property to their children was in fact a bona fide sale and not a gift. The difference being that there are a number of tax implications and other legal consequences between the two. This is just one example, but may apply in other ways.

Employment law

The arm’s length principle would also apply to Employment Agreements in the contractual process between parties which might have familial ties. It is not uncommon for families to work together so when parents hire their children, this principle comes to the fore. It may also exist in spousal relationships. You should consult an employment lawyer if you are concerned about conflicts of interest in your work place.

Tax law

There are also functions for this principle in respect of tax law. This serves to ensure that transfer prices between companies of multinational enterprises are fair. Its aim is to guarantee these transfer prices are based on an actual market value, and not manipulated. In this context, the principle means that prices should be the same as they would have been, had the parties to the transaction not been related to each other. The Australian Taxation Office website provides guidelines on how this works.

The threshold for what constitutes an arm’s length will vary largely based on the specific situation. In any event, the main moral of the story is that this principle exists to prevent impropriety and ensure fairness across commercial transactions and alike. Maintaining independent impartiality is integral to fair transactions and good faith. A common part of commercial transactions can involve leverage, but it should never undermine fairness. If you are concerned about whether you would satisfy this principle in your own situation, it may be worthwhile seeking the advice of a lawyer.

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Paul Taylor

Paul is an intern at Lawpath, and is currently studying a combined Arts/Laws degree with a major in criminology at Macquarie University. Paul has an interest in legal tech, which complements his broader interest in cyber crime/security and the way in which it is changing the world.