India is embarking on an ambitious defense and homeland security expansion plan, expecting to spend $30 billion over the next five years and upwards of $100 billion over the next decade. Considered one of the world’s fastest-growing defense markets, recently India was ranked as the world’s fastest-growing homeland security market. This growth presents tremendous opportunities for U.S. defense and technology companies in aerospace, government contracting, and homeland security. But to meaningfully participate in the India defense opportunity, one must understand and be prepared to navigate through some nuanced and complex terrains.
First, a prospective bidder needs to understand the different procurement categories. The defense procurement categories are established in the Defence Procurement Procedure (DPP), which governs procurement by the Indian Ministry of Defence (MOD). The DPP sets out the Government of India’s (GOI) policies for every step in the procurement process, from acquisition planning to preparing requests for proposal (RFPs). Compliance with the DPP is essential to competing effectively for Indian defense contracts.
Before it was revised in 2009, the DPP provided three categories of defense procurement:
- Buy: Outright purchase of defense equipment from foreign or Indian vendors. Programs where the purchase is made from an Indian integrator of foreign equipment must include at least 30 percent Indian content.
- Make: Purchase of equipment from Indian vendors using indigenous development and production.
- Buy & Make: Purchase from a foreign vendor with provisions for Indian co-production or licensed manufacturing.
In November 2009, the MOD amended the DPP and added an important fourth procurement category called “Buy & Make (Indian).” Under Buy & Make (Indian), the RFP will be issued only to Indian vendors, who in turn can decide what foreign suppliers to involve. This is intended to more effectively incentivize technology transfer and co-development in India.
Specifically, under Buy & Make (Indian), Indian firms must submit the project proposal, outline the development and production roadmap, either alone or in a production arrangement with a foreign partner, and provide details of the transfer of technology to the Indian partner. There must be at least 50 percent local content, and the Defence Production Board is responsible for monitoring implementation of the production arrangement, including absorption of technology by the Indian partner.
Buy & Make (Indian) is aimed at helping promote indigenous capabilities by driving technology transfer, joint ventures, licensed production and in-country manufacture. The MOD has not yet publicly indicated which projects will be designated Buy & Make (Indian), but for those which are so designated, Indian bidders will be in control of the process. Thus, non-Indian companies that wish to participate in this category of procurement should think ahead about identifying prospective Indian partners and crafting collaborative arrangements that can satisfy these requirements.
Complying with Agency Restrictions
There are a variety of reasons why agents may be necessary in defense and homeland security bidding. Bidders without an institutional presence in-country may believe it is particularly necessary to have third parties acting on their behalf. But one needs to proceed with caution under the Indian defense procurement rules on agency. The Indian government is particularly sensitive to the role of agents in defense procurement given prior controversies, most notably the Bofors scandal, which is considered “India’s Watergate.” As a result, there are a variety of restrictions governing the use of third party agents. Penalties for non-compliance can include disqualification from the procurement, cancellation of the contract, and debarment from future bidding.
Under the DPP 2005, parties bidding on procurements exceeding approximately $45 million are required to execute a “Pre-Contract Integrity Pact,” the express purpose of which is to ensure that, in competing for a defense contract, bidders take all measures necessary to “prevent corrupt practices, unfair means and illegal activities.” The Pre-Contract Integrity Pact requires bidders to agree to be bound by the “Agency Clause,” which provides:
Bidder confirms and declares that it… has not engaged any individual or firm, whether Indian or foreign whatsoever, to intercede, facilitate, or in any way to recommend to the Government of India or any of its functionaries, whether officially or unofficially, to the award of the Contract…
As indicated above, the Pre-Contract Integrity Pact essentially requires bidders to affirm that they have not engaged an agent. Although engaging an agent technically is not prohibited, it requires separate registration under rigorous requirements and the MOD reserves the right to reject any agent. As a result, no one has registered as an agent since the requirement was imposed in 2001. Thus, as a practical matter, for foreign companies interested in bidding for defense contracts in India, the prudent course is to ensure they do not engage any person or entity that performs any functions the nature of which require registration as an agent.
The exact meaning of the terms in the agency clause themselves are not entirely clear, and the Indian courts have not ruled on them. Nonetheless, there are some useful “do’s/dont’s” that may provide general guidance for foreign companies bidding on defense contracts in India. For example, rather than engage an entity to act as a consultant for any particular procurement program, consulting relationships should be for advice and assistance in connection with business opportunities in India generally.
Meeting Offset Requirements
Perhaps the most important issue in accessing Indian defense procurement opportunities is offsets, that is, the requirement to return to India a percentage of the value of the goods and services awarded in a defense procurement. Offsets are seen as a means to use foreign participation to foster and enhance an indigenous defense industrial base in India. It is important to know what offset requirement attaches to each procurement.
Under the DPP, procurements from foreign vendors over approximately $65 million must generally be offset by purchases or investments by the foreign vendor in Indian defense products, services, industries or research and development worth at least 30 percent of the procurement value. Offset requirements involve local purchasing, indigenous content, use of inputs, and co-production. This can be accomplished by (i) buying India defense items; (ii) buying India-defense related services; (iii) investing in an Indian defense joint venture; or (iv) investing in Indian defense research & development. Proposals are evaluated by the Defence Offset Facilitation Agency (DOFA).
Several policy issues are at the heart of the offsets discussion today. One concerns how closely offsets need to be related to the corresponding defense procurement. Currently, India’s system only credits “direct” offsets, i.e., those that are directly related to the product or service being sold. Some contend that India should also credit “indirect” offsets applied in industries outside defense, such as in commercial aerospace or homeland security. This approach would not only make it easier to meet offset requirements (and thus reduce the foreign bidder’s costs in India), but could also enable development in other areas of interest to India, such as infrastructure.
Another policy issue concerns the level of foreign direct investment, which currently is capped at 26%. Those who advocate foreign investment to at least 49% argue that providing foreign parties a greater ownership stake in Indian entities would stimulate offsets and collaboration. Specifically, in their view it would (i) incentivize foreign bidders to become more fully engaged in their India joint ventures and partnerships; (ii) spur investment as well as joint development and co-production; and (iii) motivate foreign bidders to locate strategic defense related R&D and manufacturing operations in India.
Other offset policy issues concern whether wholly-owned subsidiaries in India may qualify and whether transfer of technology can count. The India defense opportunity is not just a chance for foreign players to serve the Indian market, but is also an opportunity for Indian companies to become a key part of the global defense supply chain. So, as stakeholders focus on how to implement an effective framework for defense procurement and collaboration, both the GOI and domestic and foreign players are deliberating on what system of offsets can best serve the interests of both sides.
Finally, perhaps no issue appears more vexing than U.S. export controls. If not managed effectively, it can be a deal-stopper that prevents transfer of sought after technologies. Upon arriving in Washington for their State visit and tour of duty, respectively, both Prime Minister Singh and Ambassador Shankar expressly mentioned U.S. export controls in their first remarks, underscoring the significance of this issue to U.S.-India defense trade.
India’s push for technology transfer raises significant export control compliance issues both for U.S. companies and foreign companies involved with U.S.-origin goods, software, technology and services. Specifically, the International Traffic in Arms Regulations (ITAR) restricts the transfer from the U.S. to foreign persons of defense-related technology, such as combat aircraft technology. The Export Administration Regulations (EAR) restrict the transfer of dual-use technology, i.e., that considered military useful, such as that for certain airport baggage screening systems. The ITAR and EAR often require export licenses before U.S.-origin technology may be shared with foreign persons. Those licenses can also impose ongoing export reporting and technology transfer compliance requirements. Even having meetings or making sales presentations where technical information is exchanged may constitute technology subject to U.S. export controls and require prior government approval.
In July 2009, the U.S. and India reached a milestone by agreeing on uniform language for End-Use Monitoring (EUM) arrangements that permits the United States Government to inspect on-site certain U.S. defense articles transferred to India, as required by U.S. law. The EUM expands the permissible range of defense-related trade with India, but it does not remove ITAR and EAR licensing requirements. Rather, prospective U.S. and Indian bidders and partners in defense trade need to be thinking about issues such as, what technologies will require licensing; what technologies are likely to receive licenses; what procedural safeguards are likely to be imposed on technology exports; and how should programs be structured to avoid export control problems.
Because compliance with U.S. export controls is critical to the process, early assessment of these issues is recommended, e.g., when companies identify prospective partners for bids. Certainly, U.S. companies cannot proceed without assurances that export control requirements will be met. Also, Indian companies need export counsel to help their U.S. partners deliver on their technology transfer proposals. These issues are complicated but can be managed.
Need for Advance Planning
The U.S. and India are natural allies because they are the oldest and largest democracies, respectively, and share a legal system based on common law. Now, the shared experiences of 9/11 and 26/11 underscore the great potential of the emerging U.S.-India strategic partnership. There are many issues to sort through as India embarks on high-stakes, big-ticket defense procurement, most importantly sensitive national security issues for both countries. By anticipating and addressing these issues in advance, however, private defense bidders can position themselves to participate in this important opportunity.
Mohit Saraf is a senior partner of Luthra & Luthra Law Offices and can be contacted at email@example.com. Sanjay Mullick is a counsel in the International Trade practice of Pillsbury Winthrop Shaw Pittman LLP and can be contacted at firstname.lastname@example.org.
by Mohit Saraf and Sanjay Mullick