The Indian Defence
Procurement Procedure (DPP) has been under evolution since its first iteration
in 2005 and can be best witnessed through the evolution of offsets. The DPP
clearly establishes offsets as the desired path to eventually reduce India’s
reliance on international vendors and the international political interference
which usually accompanies strategic procurement. There are some legal issues, which are
creating challenges for the industry and need to be examined.
The evolution of offsets
The 2005 DPP required a vendor to either
directly purchase, or provide market access or create new markets for products,
components and services from any Defence Public Sector Undertaking (DPSU) or
the Ordnance Factory Board (OFB) as its offset obligation. It is notable that
the term services remained unexplained. The 2005 DPP also allowed foreign
direct investment in an Indian PSU for defence industrial infrastructure
through equity participation.
The 2006 iteration was a significant
step forward which removed the ambiguous concepts of providing market access
and creation of new markets and instead provided for vendors to directly
purchase or execute export orders for products, components or services from
either a DPSU, OFB or any private defence enterprise operating under an
industrial license. It also clarified the scope of services to include
maintenance, overhaul, up-gradation, life extension, engineering, design,
testing, defence related software or quality assurance services; permitted FDI
in private Indian defence industries and in organisations engaged in defence
research & development and established the Defence Offset Facilitation
Agency as a regulator and facilitator for foreign vendors.
The 2008 DPP was a further step forward
which introduced the concept of banking of offset credits. The 2011 DPP showed
sensitivity to vendor concerns and expanded the list of eligible products to
include the categories of homeland security and civil aerospace products. The
inclusion was welcome, in light of the continued international concerns with
respect to the qualitative aspects of products being manufactured by the Indian
industry and the ability of the Indian industry to absorb technology.
Subsequently the Ministry of Defence
(MoD) also issued the Offset Revision Guidelines on 1 August 2012. The
Guidelines refined certain concepts and were a clear intent of how the Indian
MoD wanted to proceed for acquiring key technologies.
The biggest conceptual change which the
Guidelines introduced were the introduction of investment in kind. Paragarph
3.1 (c) of the Guidelines explains investment in kind as documentation,
training and consultancy required for full transfer of technology (ToT). The
Guidelines also explained that investment in kind could also be made by
providing machinery and equipment.
The Guidelines were formally
incorporated under the DPP with its 2013 iteration. The 2013 DPP took another
significant step forward by introducing the concept of multipliers for
investments/ purchases from Micro Small Medium Enterprises (MSMEs) and transfer
of technology to Defence Research & Development Organization (DRDO).
Subsequently, MoD issued a notification in May 2013 suspending the services
component of offset contracts.
The evolution of the philosophy of
offset has been closely watched by the world community and while the forward
strides in expanding the scope of achieving offset obligations have been
welcome, there are significant issues which need to be addressed to make
offsets successful. The following section of the article attempts to articulate
some of these issues which have both legal and commercial implications for
vendors.
Legal challenges affecting the success
of the scheme
The present FDI norms only permit
investment up to 26%. The restriction has been universally criticized as it
gives OEMs restricted operational rights and a disproportionate amount of
control to Indian offset partners. The limited equity participation raises
significant issues from the OEM perspective on aspects pertaining to quality
control, protection of OEMs intellectual property and management issues. While
the issue has been actively discussed at various governmental levels, the
stasis in implementation continues to be a major stumbling block for OEMs
looking to invest in critical technologies.
The discontinuation of investment in the
services sector has been a significant backward step. The restriction on services would hit
most OEMs who are required to provide simulators, training services and
maintenance as part of their contracted obligations. Though no formal rationale
for taking the step has been extended by the MoD, the probable reason may have
been the abuse of the services route, in which case the emphasis should have been
on instilling checks and balances and not an indefinite suspension of the
option. Alternatively, the MoD, through Defence Offsets Facilitation Agency
(DOFA), could evaluate each investment in services on a case to case basis.
The present regime imposes an obligation
on the vendor to adhere to timelines for fulfilling its obligation without
imposing responsibilities on the DPSUs to respect the timelines. In the event the delays are caused due
to the scope apportioned to the DPSU, the only recourse which would remain with
the OEM would be limited to seeking liquidated damages from the DPSU which
assuming it agrees to pay, may or may not be sufficient to compensate the OEM
for the punitive damages it may be liable to pay under the offset scheme Further, in the event the vendor seeks
to enforce damages through courts, the process may derail the entire
transaction and cause substantial losses to the OEM’s program.
The issues around transfer of technology
are multiple and complex. The DPP places considerable emphasis on
transfer of technology. In such a scenario, the valuation of the technology
becomes a critical issue. The DPP provides detailed guidelines of the
qualitative parameters which constitute transfer of technology, but does not
provide any process for valuation of the technology or weightage for how
sophisticated it might be.
An argument in favour of MoD’s position,
would be that the price at which the goods may be purchased would include the
value of technology and hence the same should not be given additional
weightage. The authors believe that this is a myopic view. The DPP covers
complex multi-year procurements with emphasis on the transfer of core
technologies and therefore a weightage needs to be given to the technology a
vendor may be willing to transfer. This may also prove to be an incentive to
OEMs to bring the latest bleeding edge products to the table.
The present mechanism of technology
transfer provides negligible protection to the intellectual property of a
vendor. For example, technologies transferred to
DRDO can be used by DRDO to build products and freely export them. In case DRDO
collaborates with another international defence research & development
organization for further refining of the technology, it would result in a
vendor losing commercial opportunities in other countries along with the
ownership of its intellectual property. This may also lead to a situation where
an Indian DPSU may be able to offer the same product to another country cheaper
than what the OEM may be able to offer.
In conclusion, it may be submitted that
though the policy intention behind offsets remains progressive, there is a need
to review it to iron out the various legal concerns and issues. A clear policy and implementation
mechanism would help in removing the regulatory and commercial ambiguities and
also help the forces to upgrade on schedule. Further, India could also take a leaf
from the international practices being followed in other countries such as
Australia and South Korea which have significantly gained from offsets by
setting up transparent systems and an investor friendly climate. A dithering
policy and legal regime would not only increase the procurement cost but would
also result in considerable delays and possibilities of disputes in investing in
the Indian defence sector.
Editor’s note: The authors represent
Khaitan & Co law firm in Defence Practice. Their views may be in line with
those of their clients.
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