09 January 2009
The arm's length principle (ALP) 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". It is used specifically in contract law to arrange an equitable agreement that will stand up to legal scrutiny, even though the parties may have shared interests (e.g., employer-employee) or are too closely related to be seen as completely independent (e.g., the parties have familial ties).
A simple example is the sale of real property from parents to children. The parents might wish to sell the property to their children at a price below market value, but such a transaction might later be classified by a court as a gift rather than a bona fide sale, which could have tax and other legal consequences. To avoid such a classification, the parties need to show that the transaction was conducted no differently than it would have been for an arbitrary third party. This can be done, for example, by hiring a disinterested third party such as an appraiser or broker, who can offer a professional opinion that the sale price is appropriate and reflects the true value of the property.
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