Indian Defence Review

The practice of countries demanding discharge of offset obligations as a prerequisite to foreign firms’ participation in major defense contracts is not new. While there is substantial divergence of views on the impact of offsets in achieving their stated goals, the fact remains that offset demands are increasing in all regions around the world.1 Over the years, as India’s private industry has developed its technical capacity and expertise, it has also scaled up its demands for reforming the defense procurement system, including an enhanced role for its indigenous industry, most notably through compulsory offset requirements to be met by foreign vendors.

This article focuses on certain aspects of defence offset contracts in India, and provides certain specific recommendations to further reform the legal and regulatory environment for better and more efficient offset contract administration.

Evolution of Indian Defence Offsets

Offsets were first implemented in India under the revised “Defense Procurement Procedure-2005” (DPP-05),2 effective July 1, 2005. The Services Capital Acquisition Plan (SCAP) Categorization Committee3 was authorized to recommend offsets up to 30 percent of the indicative cost in the RFPs where such cost was Rs. 300 crore (INR) or more, although changes could be suggested in the offset amount if necessary.4 Any cost incurred by the vendor in the infusion or providing of any technical or financial assistance was not permitted to form part of the offset offer.5

Notable changes in DPP-06 from previous versions related to the inclusion of private Indian defense industries as a vehicle for the discharge of offset obligations, and also the restatement of an inclusive range of services as options for discharge of offset obligations.

This minimalist regulatory framework was considerably modified in the revised “Defense Procurement Procedure-2006” (DPP-06), effective September 1, 2006,6 when the use of offsets was made applicable in the case of procurements categorized as “Buy (Global)”7 or “Buy and Make with Transfer of Technology (TOT).”8 The range of options for discharge of offset obligations was however considerably expanded.9 Notable changes in DPP-06 from previous versions related to the inclusion of private Indian defense industries as a vehicle for the discharge of offset obligations,10 and also the restatement of an inclusive range of services as options for discharge of offset obligations.11

The most significant development from a contract administration viewpoint was establishing the Defense Offsets Facilitation Agency (DOFA) as a specialized agency under the MoD (Ministry of Defence, Government of India) that was to function as a single window entity in assisting MoD in dealing with offset contracts.12 DOFA was to assist potential vendors in interfacing with the Indian defense industry for identifying potential offset products/projects, as well as provide requisite data and information for this purpose.13

DPP-06 was superseded by a new set of regulations—the “Defense Procurement Procedure-2008” (DPP-08)—effective September 1, 2008.14 Important changes made in the new regulations related to the waiver of offset liabilities on any procurement under “fast-track procedures;”15 broadening the list of private industries by removing the need for an industrial license for participating in offset programs16 and permitting credit banking in offset procedures.17

Also read: Defence Procurement Policy: A Positive Change – CII

The latest amendments to DPP-08 in the form of DPP-08 (Amendment 2009)18 made effective from November 1, 2009 permit the change of offset partners fixed initially under exceptional circumstances, where such change may be desirable to enable the vendor to fulfill its offset obligations.19 These amendments also specify that where offsets were not envisaged under the initial main contract, such provisions will also not be applicable when the government exercises its powers under the “options clause” of the main contract.20

Offset Contract Administration

Both DPP-06 and DPP-08 envisage an important role for DOFA in assisting the MOD in the formation and monitoring of offset contracts. DPP-06 assigned DOFA, inter alia, with the task of providing advisory clarifications on the policy and procedures (in consultation with the Acquisition Wing wherever necessary).21 DOFA was also to assist potential vendors in interfacing with the Indian industry in identifying potential offset products/projects.22 One of DOFA’s mandate was, and remains so even today, to assist the technical committee in evaluating offset proposals,23 and to advise the high-powered “Contract Negotiation Committee” whenever required.24

DOFA now has no specified role in assisting the concerned acquisition manager in monitoring the implementation,26 such responsibilities have now been taken over by the “Offset Monitoring Cell” in the MOD and by the MODs representative”¦

DOFA was also to assist the appropriate acquisition manager in monitoring the implementation of the offset contract.25 Interestingly, however, DOFA was not associated under DPP-06 with any re-phasing of offset obligations within or outside the time period of the main contract under “normal” or “force majeure” conditions.

Under the new DPP-08 as amended, DOFA now has no specified role in assisting the concerned acquisition manager in monitoring the implementation,26 such responsibilities have now been taken over by the “Offset Monitoring Cell” in the MOD and by the MOD’s representative,27 respectively. However, DOFA now assists the acquisition wing in the re-phasing of the offset obligations within and outside the period of the main contract under normal conditions,28 and in the re-phasing of offset obligations under exceptional or “force majeure” conditions.29

While the disassociation of DOFA with providing advisory clarifications on the policy and procedures could be justified on grounds of avoiding possible conflicts of interest since DOFA has membership from private industry associations;30 DOFA’s lack of association with the monitoring of offset contracts is worthy of serious re-consideration, in order that both the monitoring and re-phasing aspects of offset contract administration are vested in the same authority, resulting in more efficient administration of defence offset contracts.

Banking of Offset Credits

DPP-06 provided that only contracts for the export of defense products or services or investment made after the signing of the main contract would be reckoned for discharging offset obligations.31 This was perceived by the Indian industry to be unduly restrictive, and there had been an important demand for bringing in provisions to allow for the banking of offset credits to allow for greater flexibility in planning for the discharge of offset obligations by vendors.32 The origin of these demands lay in the fact that it is possible for a vendor to end up discharging offset obligations in excess of the legally required minimum. Further, having once established business relationships in the procuring country, a vendor may even voluntarily wish to continue exports or investments beyond the particular procurement contract to capitalize on economies of scale or to make use of attractive market opportunities33; and vendors may even wish to generate potential offset credits through programs undertaken prior to the award of the main contract to get an “early-mover” advantage.34

“¦having once established business relationships in the procuring country, a vendor may even voluntarily wish to continue exports or investments beyond the particular procurement contract”¦

DPP-08 now allows foreign vendors to create offset programs in anticipation of future obligations.35 Offset credits so acquired can be banked and discharged against future contracts, but they are not transferable except between the main contractor and its subcontractors within the same acquisition program.36 A vendor will therefore be able to discharge the banked offset credits for the RFPs, which are issued within the two financial years of the date of approval of the banked offset credits.37 However, this regulatory guidance is limited, since banking of offset credits immediately requires specific provisions to address a variety of contractual issues, including, inter-alia, the “competent authority” for certification; “valuation” and “timing” of certification; the handling of disputes regarding certified amount or date; tradability,38 and verifiability of a certified offset credit.39

DPP-08 presently grants recognition to offsets at the time of approval. Such recognition at the time of approval, as opposed to recognition at the time of offset activity, may create an incentive to a vendor to file a claim as late as possible; and it is entirely possible that the activity being certified may have little or no relevance from an offset standpoint, and may, in fact, merely constitute an ongoing business transaction. Considering that the essential purpose of offset agreements is to specifically motivate eligible offset activities,40 such an exercise may lose its purpose and may prove to be unfruitful and even counterproductive under certain conditions.41 This becomes especially relevant, considering that offset obligations in India are essentially indirect, allowing for a very wide scope of activities that may not always accrue intended benefits.42 For instance, India already has a robust and thriving software industry, and the inclusion of defense-related software in permitted offset activities may be lucrative to vendors while not being a very attractive proposition from a national interest viewpoint.43

These offset banking regulations are silent on the transferability of offset credits banked in anticipation of future contracts, as no subcontractors would exist at this point of time to which the credits could be transferred in case the vendor fails to get an award. At some point, therefore, the regulations may also need to open up the limitations to perhaps allow for the full tradability of offset credits generated either in anticipation of future contracts or generated through excess performance. If banking is allowed, trade in offsets could be the next step, as both are intrinsically and mutually contingent.44

Also read: Defence Industry Abroad

Since the regulations place a restriction on the parties eligible to receive banked offset credits (namely, subcontractors under the same acquisition program), mechanisms would need to be instituted to prevent unauthorized transfers from getting certified by mistake or otherwise. In fact, the introduction of a system of banking requires the setting up of a registry of banked offset credits that can verify—for the benefit of subcontractors—the value, time, and qualifications or easements, if any, of an offset held by a prime contractor that the prime may be offering to subcontractors in exchange of a consideration.

Such a registry would also help acquisition managers or other official agencies involved in the monitoring of the discharge of offset obligations to ensure that an otherwise “ineligible” offset credit does not get accounted for against a contractor’s performance or other contractual obligations. Some other issues that may require further regulatory guidance in the context of the banking of offset credits relate to issues such as the assignment by bidders of these credits to more than one RFP at a time; subsequent reassignment of assigned credits from one RFP to another at the option of the bidder; withdrawal of assigned credits by bidders from one RFP and re-banking them for reassignment at a later stage; and the legal status of credits once assigned by a bidder to an RFP that is subsequently cancelled (or in cases where the bidder is not the eventual contract awardee).

Conclusion

The use of offset agreements requires implementing a number of consequential, well-designed, and sharply-focused techniques for contract administration. The existing offset contract clauses may therefore be in need of some degree of refinement and detailing, more particularly with regard to provisions relating to the banking of offset credits by laying out the complete mechanisms for certification of offset credits in terms of value and time stamping, establishing a registry that allows private vendors and public officials to quickly verify claimed offset credits, and addressing issues regarding transfer of credits between connected or unconnected vendors.

In addition, the statutory role of DOFA in the contract administration process needs to be more clearly specified, especially vis-à-vis the Offset Monitoring Cell, since DOFA’s current role limited only to the contract formation process and re-phasing of the offset contract does not appear to be consistent with its broader mandate of being an important vehicle for the administration of offset contracts. The suggested changes may lead to increased bidder confidence by reducing their transaction costs with offset contracts; and the government could also benefit from such an exercise, as these changes should ultimately result in timely discharge of offset obligations by defense contractors.

Notes

1. US Department of Commerce, “Impact of Offsets in Defense Trade: An Annual Report to Congress,” Department of Commerce, Washington, D.C. (December 2007), at 4–8, accessed at www.bis.doc.gov/defenseindustrialbase programs/osies/offsets/final-12th-offset-report-2007.pdf.
2. The full text of DPP-05 is available at the MOD Web site at http://mod.nic.in/dpm/DPP%202005.pdf.
3. The SCAP Categorization Committee submits proposals to the Defense Acquisitions Council headed by the Raksha Mantri (Defense Minister) for approval. See MOD Web site, http://mod.nic.in /newadditions/procurement.htm, for more details on the organizational structure and committees relating to defense acquisitions in India.
4. DPP-05, 18, at 5.
5. Clause 2(f) of “Offset Schedule,” Appendix H to DPP-05, at 69.
6. The full text of DPP-06 is available at http://mod.nic.in/dpm/welcome.html.
7. DPP-06, 22 at 11. Buy Global contracts involve outright purchases from foreign/Indian vendors.
8. Ibid. Buy and Make with TOT contracts involve a purchase from a foreign vendor followed by licensed production. Both “Buy Global” and “Buy and Make with TOT” categories include contracts for warship construction. There are also two other categorizations: 1) Buy (Indian), which relates to contracting situations where only Indian vendors are allowed to participate (and must have a minimum 30 percent indigenous content of systems being integrated by an Indian vendor), and Buy & Make decisions, meaning a purchase from a foreign vendor followed by licensed production/indigenous manufacture in the country (see DPP-06, 4 at 7). Yet another categorization—Make Categorization — relates to indigenous research, design, development, and production of systems, which, while being favored, requires its benefits to be put to careful evaluation since it leads to denial of offset opportunities to the defense industry
   (see DPP-06, 23(b) at 144).
9. Clause 2.1 of “Procedure for Implementing Offset Provisions,” Appendix D to DPP-06, at 35 (see also corresponding current provisions at clause 2.1 of “Procedure for Implementing Offset Provisions,” Appendix D to DPP-08, at 43).
10. Ibid.
11. Ibid.
12. DPP-06, 3 at 36. In addition, under DPP-06, DOFA was to assist the acquisition manager in the acquisition wing of MOD in the implementation of the offset contract (DPP-06, 10.1, at 39). This assistance function has now been shifted to an “Offset Monitoring Cell” in MOD under the new 2008 regulations (DPP-08, 10.1, at 47), although sub-clause (c) continues to remain on board without any modifications, clause (h) has been completely deleted in the latest revisions to the procurement procedures, indicating perhaps the thinking that policy-based issues are best dealt within a more formal environment, such as within the Ministry itself.
13. DPP-06, 3.2 at 36. The latest regulations are silent on the composition of DOFA, or whether any changes have been made in a departure from the explicit position under DPP-06.
14. DPP-08 are available at MoD website at http://mod. nic.in/dpm/welcome.html. DPP-08 was in supersession of DPP-06. There are, however, cases that would be under various stages of processing in accordance with provisions of DPP-05 and DPP-06 at the time of the commencement of DPP-2008. As per the DPP-08, the processing of these cases carried out under the earlier procedures will be deemed to be valid; and only those cases in which an RFP is issued after September 1, 2008, will be processed as per DPP-08 (see DPP-08, 77 at 22).
15. Fast-track procedures (FTPs) are for meeting urgent operational requirements and were first promulgated via MOD ID No: 800/SS (A)/2001, September 28, 2001. Their objectives are to ensure expeditious procurement for urgent operational requirements foreseen as imminent or for a situation in which a crisis emerges without prior warning. Procurement proposals in which user trials are envisaged are not under the purview of FTPs. Revised FTP procedures have come into effect July 13, 2006, and these “FTP-2006” procedures are available at Chapter IV of DPP-08, at 191. Further, Clause 1.6 of “Procedure for Implementing Offset Provisions” (Annexure D to DPP-08, at 43) now exempts FTP procurements from offset obligations.
16. Ernst & Young, supra note 2, at 2.
17. DPP-08, 2.1(d), at 44.
18. DPP-08 (Amendment 2009), available on MoD website at http://www.mod.nic.in/dpm/welcome.html.
19. DPP-08 (Amendment 2009), 6.3, Appendix D, Chapter I as amended.
20. DPP-08 (Amendment 2009), 1.3, Appendix D, Chapter I as amended.
21. DPP-06, 3.1(h), at 36. This role has now been removed from DOFA’s charter of responsibilities under the new DPP-08.
22. DPP-06, 3.2, at 36.
23. See DPP-06, 3.1(b), at 36; and DPP-08, 3.1(c), at 44.
24. See DPP-06, 8.2, at 38; and DPP-08, 8.2, at 6.
25. DPP-06, 10.1, at 39.
26. See DPP-08, 10.1, at 47.
27. DPP-08 does not contain sufficient guidance on which particular official should be designated “the MOD’s representative.”
28. DPP-08, 10.3, at 47.
29. See Clause 6 of “Offset Contract,” Annexure IV to DPP-08, at 52.
30. “DOFA will function under the supervision of a designated Joint Secretary of the Dept. of Defense Production, and will have representatives from the Service Headquarters, Headquarter Integrated Defense Staff, the Defense Research and Development Organization, DPSUs, OFB, as well as from three industry associations.” (DPP-06, 3.2, at 36). This paragraph about the composition of DOFA, or anything similar, no longer exists under the revised DPP-08. Apparently, however, DOFA’s composition has not undergone any changes.
31. DPP-06, 6.4, at 38.
32. See, e.g., US–India Business Council, “Objectives for 2007–08,” accessed at www.usibc.com/usibc/advocacy/objectives.htm (last visited December 6, 2008); and “Interview with Lt Gen SS Mehta, Director General, CII,” India Defense Review (March 24, 2008, Vol. 23.1), accessed at https://www.indiandefencereview.com/ (last visited December 6, 2008).
33. Suman, supra note 53.
34. Ibid.
35. DPP-08, 2.1(d), at 44, allows for the creation of offset programs in anticipation of future obligations only in the main text of the regulations. However, clauses 1 to 5 of the part titled, “Banking of Offset Credits” (Annexure VII to Appendix D of DPP-08, at 55), contain provisions to the effect that a vendor could also create extra credits by exceeding its obligations under the main procurement contract.
36. DPP-08, 2.1(d), at 44; Clause 3 of “Banking of Offset Credits,” Annexure VII to Appendix D of DPP-08, at 55.
37. Clauses 4 and 5 of “Banking of Offset Credits,” Annexure VII to Appendix D of DPP-08, at 55. The cutoff date would be April 1 and October 1 of the financial year. To illustrate, offset credits that have been banked on or after April 1, 2009, would be valid for discharge against RFPs issued up to September 30, 2011. Similarly, offset credits banked on or after October 1, 2009, would be valid for discharge against RFPs issued up to March 31, 2012. Further, if a vendor is able to create more offsets than its obligations under a particular contract, the surplus offset credits can be banked and would remain valid for the period of two financial years after the conclusion of the contract. The surplus offset credits would be valid for discharge against the new RFPs, which would be floated within this period.
38. Suman, supra note 53. See also Thomas Mathew, “Getting the Defense Offset Policy Right,” The Economic Times (December 5, 2008), accessed at http://economictimes.indiatimes.com/articleshow/3794199.cms.
39. A senior official in MOD at the rank of Joint Secretary to Government of India has been notified as the competent authority to certify under Public Notice No. 1/0MC/08 (F.No.14 (1)/2008/D(S-III)/OMC) dated September 17, 2008. The same communication also notifies a senior officer at the rank of Director in the Department of Defense Production, MOD, as the officer-in-charge of the Offset Monitoring Cell. The notice can be viewed by first clicking on the link “New Additions,” and then subsequently on the link “Offset Banking Procedure” at MOD’s Web site at http://mod. nic.in/.
40. Richard J. Russin, “Offsets in International Military Procurement,” 24 Public Contracting Law Journal 65, 69 (1994).
41. Suman, supra note 53.
42. Ibid.
43. Ibid.
44. Ibid. On the other hand, a recent study conducted in 2007 recommends that trading of offsets should not be permitted (CII-RELIGÃRE, “Study on Offset Policy for Enhancing Industry Participation in Defense Production” (2007)).