The Discomfort of 'Letter of Comfort' in Rafale Deal
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Issue Net Edition | Date : 07 Dec , 2018

The ongoing case on a petition filed by Mr. Yashwant Sinha, Arun Shourie and Prashant Bhushan centres around the major question as to why a letter of comfort has been taken from the French Government in the Rafale deal in lieu of a sovereign guarantee. This has raised concerns about the proper enforceability of the contract, should M/s. Rafale default in execution of the main contract. Apart from the main contract, the offset contract that underpins would also have a porous liability.

Rationale for IGA

As per Para 104 (IGA) of the Defence Procurement Procedure (2006), there are three eventualities to deviate from a competitive tendering process and enter into an IGA, viz. when an equipment of proven technology and capacity available from a friendly country. Such comfort is drawn after joint exercises has been made by the defence services of the two countries. Further, if state of art of equipment is available in a friendly country at a cost lower than the Original Equipment Manufacturer, IGA can be opted for. Lastly, if there is a ban on state of art equipment, IGA can be resorted to. While defence procurement in India should ideally be done on a competitive tender basis, it is noticed of late that almost 70% of the defence deals are being concluded by India following the IGA route (Government to Government). This includes Foreign Military Sales from the USA Government. As of now, USA accounts for 55% of these G2G procurement, Russia 36% and Israel 9%. But in all these cases, sovereign guarantee is insisted upon.

Letter of Comfort and Sovereign Guarantee

During the hearing, the Attorney General mentioned that the letter of comfort is almost analogous to a letter guarantee. This contention was not accepted by the Ministry of Law when the IGA proposal was routed through them. They had strongly disapproved of letter of comfort and insisted upon sovereign guarantee from the French government. It would be relevant to understand the nuances of letter of comfort in legal and sovereign guarantee terms. A Letter of comfort is given by a parent organisation to acknowledge that the subsidiary has entered into a contract. It assumes that the principal will not severe its legal relationship till the contractual terms are satisfied by the subsidiary. Most importantly, a statement of comfort will indicate how far the parent company will go to support the subsidiary in fulfilling its contractual terms. It is more in the nature of a moral obligation than a legal one. In countries like Canada, there are two levels of letter of comfort; one in which it is just a statement of intent, while in the second form there is an intention to support the subsidiary. In contrast, in US they are against ‘letter of comfort’, as its legal enforceability is suspect.

On the contrary sovereign guarantee is given by the government; based on which in the event of a default by the contracting party, the government honours such commitment. Typically when MoD enters into a contract with a foreign OEM; a bank guarantee is insisted upon for making an advance payment to the OEMs. BGB also taken for performance upto completion of the warranty period. In case of Russia, the Cabinet had given a dispensation to Rosoboron Export limited not to give BGB but provide sovereign guarantee of the Soviet Union because of Indo-Soviet Strategic Treaty. However, such dispensation has not been extended either to Israel, USA or France with whom we have many defence deals.

As per Article 292 of our Constitution, sovereign guarantee is given by the Government of India for internal and external borrowings upon the security of the Consolidated Fund of India. In the USA, the Sovereign guarantee is given in the name of USA government. Further, in the FRBM Act 2003, it has been stipulated that 0.5% of the GDP should be earmarked as a contingent liability on the Consolidated Fund of India, in order to honour internal and external debt by the Government of India.

It would be interesting to note that in the Mirage 2000 aircraft deal concluded by Government of India in the 1980s, a sovereign guarantee was taken from the French government. Similar guarantees have been taken in the past for Jaguar aircraft deal from the UK, Su-30 deal from Russia. All G2G contracts through the USA provide for a sovereign guarantee. Therefore, it is quite baffling why the government has given such unusual a lee way to the French Government by agreeing to a letter of comfort.

Sri Sudhanshu Mohanty, who was Financial Advisor, Defence Services (2015-16) in an interview to Manu Pubby in the Economic Times on 15th October has mentioned that “a letter of comfort is definitely not at par with a sovereign guarantee. It may be morally binding but not legally enforceable; somewhat more akin to a sagai in a marriage which can be broken with impunity”.

Need for Skipping Competitive Tendering?

When the MMRCA deal was concluded, two vendors were found to be technically qualified viz. Eurofighter Typhoon and Rafale. The Rafale was selected on the basis of lower life cycle cost. It is still not clear why the government did not ask both these two technically qualified vendors to quote their best price bid, when they changed the goal post from Make-in-India to Buy from abroad. The attempt by the government not to disclose price under the ‘secrecy’ provision of IGA, is because of its attempt to scuttle competition in the guise of IGA. Our credibility as a transparent global buyer has certainly taken a dip!

Change of Conditions for Discharging Offsets

The policy of offset was introduced in 2005, based on international experience of countries like Brazil, who had leveraged their big buy of F-16s to develop an “Embraer Aircraft”, by getting technology from the USA as an offset. The offset provision helps a country to get high-end technology, FDI, export orders and outsourcing of orders from the OEMs. The MMRCA mega deal was perceived as a wonderful opportunity to get high end technology like AESR (Active Electronically Scanned Radar), Propulsion Systems, Seeker Technology.

As per the extant orders the OEM is free to select its offset partner. The foreign supplier and not the offset partner is responsible for discharging the offset obligation, which could be for getting export order, FDI, technology transfer etc. as alluded to above. However, there is a detailed procedure to verify the capability of the IOP (Indian Offset Partner) to discharge 50% offset obligation. The technically viability is evaluated by the Technical Manager in the Acquisition wing, which followed by a commercial evaluation committee headed by the Acquisition Manager. In several cases, there is a tendency on the part of the IOP is to overstate its technical capability and inflate the value of offsets to meet the 50% obligation. In the Rafale case, the basic examination of the technical viability and commercial claim of IOP viz. Reliance Defence Industry has been completely glossed over. There are also genuine concerns that the IOP does not have the capability to discharge these offset commitment unlike M/s HAL or Tatas and L&T who are actively involved with the defence projects.

Concluding Thoughts

Mr. Manohar Parrikar, the Defence Minister, in the forward to DPP 2016 has observed “I would like to emphasize on the importance of two key aspects viz. probity and trust”. The foregoing would clearly reveal that both these aspects have been overlooked. There are clear loopholes in regard to legal enforceability the basic contract and offset commitment with a letter of comfort. They go against the basic principles of transparency & accountability in contracts. The French government must be persuaded to give a sovereign guarantee, as does every other government including the Soviet Union, with whom we have a defence strategic partnership. Expediency cannot be at the cost of enforceability of contracts! The Rafale contract must not go the way of the Mirage contract where the relationship between India and France is that of buyer and seller and not as long partners for bolstering India’s indigenous manufacturing capability in critical defence subsystem. Make-in-India must remain true in spirit and letter and not a mere rhetoric!

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The views expressed are of the author and do not necessarily represent the opinions or policies of the Indian Defence Review.

About the Author

Prof (Dr) SN Misra

was previously Joint Secretary (Aerospace), Ministry of Defence, Government of India.

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