No Mention of Offsets in the US Government Communications
LOO and LOA between the US Government and the FMS customer and the contract associated with that LOA (between the US Government and the contractor) do not include any of the terms of the offset agreement (such as the delivery schedule, acceptance criteria, etc.) even though the LOA and the contract may include costs associated with the offset. Any offset contract signed between the FMS customer and the contractor remains distinct and independent of the LOA and the main contract.
Non-Revelation of Offset Costs
While preparing LOO and LOA, the US Government obtains estimated offset costs from the contractor and includes in the line item price for the required contracted item. They are never reflected separately. Thus a customer can never find out whether any offset costs are being charged to him. The US Government is of the view that the exact quantum of offset costs should never be disclosed as most foreign governments do not want offset costs isolated/highlighted. On the other hand, the US contractors fear that foreign governments may refuse to pay for them.
The US companies exporting defence equipment through the DCS route have to participate in competitive bidding with offset proposals as per the buyer countrys procedures.
The line item containing the offset costs is usually the first major fixed-price type line item in the LOA for the primary defence system being procured. This holds true for the resultant contract as well. In a contract document, offset costs should be accumulated, priced, and paid against a single Contract Line Item Number for the FMS customer’s deliverable item.
If a customer seeks additional information concerning FMS contract prices, the Government, after consultations with the contractor, should provide sufficient information to demonstrate the reasonableness of the price. This may include tailored responses, top level pricing summaries and historical prices.
Enforcement of Offset Obligations
The FMS customer is responsible for administering and enforcing the offset agreement. If the contractor does not perform the offset requirement in accordance with the terms of the offset agreement, it is for the FMS customer to enforce it. The US Government, through a DFARS memorandum, has clarified that it would assume no obligation to satisfy or administer the offset requirement or to bear any of the associated costs. It does not get involved at all.
Limited Government Oversight
In cases of sole source procurement, the Government reviews the offset agreement to evaluate the allowability, allocability, and reasonableness of proposed offset costs.
The contractor must provide a detailed cost estimate for the offset costs for which it wants to be paid. If the contractor is unwilling or unable to document the offset costs, then the Government does not allow the offset costs to be charged to the contract.
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After the LOA is signed and prior to the contract signature, the Government must determine whether the proposed offset costs are allowable and allocable.
Offsets in Cases of Systems Integration
There are cases where the US Government acts as a systems integrator for an FMS sale. In such cases more than one contractor would be involved as in the cases of aircraft and ships. Different contractors would need to sell the basic platform, weapons package, sensors and other sub-systems under separate FMS contracts. If the customer Government demands a written single offset agreement, the contractor selling the basic platform should act as the prime contractor and sign it. Suppliers of other add-on packages should sign internal contracts with the prime contractor undertaking to fulfill their share of offset obligations.
Offsets in Sales through Foreign Military Financing (FMF)
The US Government spends three to four billion dollars every year as Foreign Military Financing (FMF) grants. These are used by the recipient nations to purchase defence equipment from the US industry. There is no foreign competition in such deals. FMF consists of non-repayable and payable components. Non-repayable FMF funds should not be used to pay offsets as it is considered grossly unfair.
As regards repayable FMF sales, US defence contractors are permitted to recover all costs incurred on offset obligations. As per the orders issued by the DFAR in 1999, such cases are treated at par with deals financed wholly with customer’s cash.
Conclusion
India has carried out wide-ranging reforms in its procurement organisation and procedures. The new procurement procedure ensures transparency, fair play and open competition. Offsets have been made mandatory for all deals over USD 68 million. India allows discharge of offset obligations through direct purchase of defence products and services provided by Indian defence industries; or Foreign Direct Investment (FDI) in Indian defence industries; or FDI in Indian organisations engaged in research in defence R&D. It is for the vendor to select methodology and an Indian partner for the fulfillment of offset obligations.
On the other hand, despite its stated opposition to the concept of offsets in international trade, the US Government has accepted the fact that the US companies will suffer if offsets are not offered by them. It has, however, put in place an elaborate monitoring mechanism to minimise its adverse effects on the US economy. All firms with more than USD 5 million offset liability are required to report to the Secretary of Commerce.
The US companies exporting defence equipment through the DCS route have to participate in competitive bidding with offset proposals as per the buyer country’s procedures. However, in the case of FMS deals, the US Government adopts a ‘hands off’ approach. It lets the seller company charge offset costs but does not become a party to any offset agreement, which has to be signed directly between the buyer country and the contractor.
The Indian Government must acquaint itself thoroughly with all facets of the US policy while demanding offsets with FMS contracts. As the US Government assumes no responsibility for ensuring fulfilment of the offset agreement, it is imperative that foolproof and enforceable safeguards are incorporated in the offset contract.
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