Last week, the European Parliament and the Council passed the so-called Defense Package. With the package, which consists of two Directives, the EU introduces EU-wide transparency and competitive rules for the trade and procurement of arms.  

The package aims to enhance competition in the European defense markets. At the same time, companies can benefit from less bureaucracy. In particular, the complicated licensing scheme for cross-border transfers of military equipment will be simplified. Furthermore, a new review procedure requires that Member States undertake the measures necessary to ensure that decisions taken by the contracting authorities may be reviewed effectively. Finally, the procurement Directive encourages national governments to place more contracts with small and medium enterprises (SMEs).  

Member States shall adopt the laws, regulations and administrative provisions necessary to comply with this Directive at the latest two years after the entry into force of the package. Thus, the new rules will apply in the beginning of 2011. The defense industry should make the most of this period to prepare for the new European level playing field.  

  1. BACKGROUND  

The defense package intends to end the fragmentation of the European defense market. At present, EU internal market rules do not apply to the export of defense products to other Member States. Therefore, applications for export and re-import licenses are subject to a complicated legal framework. Companies face lengthy administrative proceedings when they want to export defense goods within the EU because there is no distinction between licenses for exports to Member States and to third countries.  

Furthermore, defense contracts are not subject to EU procurement rules but may be awarded largely at the Member States authorities’ discretion. Thus, Member States spend almost 85% of their equipment budget domestically. According to Article 296 of the EC Treaty, a separate legal scheme regarding the production and trade of defense products applies so that a Member State may protect its interests of security. However, at present it is hardly possible for the European Commission to control whether such interests of security are in fact given.

  1. THE DIRECTIVE ON INTRA-EU TRANSFERS

The Directive on intra-EU transfers of defense products (COM 2007 (765) final) facilitates cross-border transfers of military equipment by simplifying the framework of 27 different national licensing schemes. Producers established in one Member State will be authorized to supply all other Member States without restrictions. According to a study provided by the European Commission, this will save companies up to three billion Euro per year in costs for license applications.  

The transfer Directive implements a system of so-called general and global licenses in place of individual transfer licenses. These licenses permit defense product suppliers to perform several transfers of defense-related products to another Member State without the need for individual authorizations.  

Member States will publish general transfer licenses (Article 5). Such licenses directly allow all domestic companies, which comply with the conditions set out in the license, to transfer the covered defense-related products without individual prior authorization. The Directive provides that Member States shall publish general licenses at least in certain unproblematic cases, e.g. if the recipient is part of the armed forces of a Member State; if the good is transferred for the purpose of maintenance and repair to the originating supplier; or if the recipient is a company holding a certificate. To obtain such a certificate, recipients need to demonstrate their reliability, in particular as regards its capacity to observe export limitations of defense-related products. The Commission will set up a register of all certified recipients.  

Global transfer licenses (Article 6) authorize companies individually to transfer defense related products. Such licenses allow companies to cover a large number of a company’s products to one recipient or a certain category of recipients in one single administrative act. A global license shall be granted for a period of three years by the authority of the Member States in which the supplier is located or from where the supplier intends to ship the goods.  

Member States shall lay down rules on dissuasive penalties applicable to infringements of the new provisions, in particular in the event that they provide false or incomplete information regarding the end-use of defense related goods or export limitations.  

The new types of export licenses only apply to intra-EU transfers. Exports to third countries, regardless of whether NATO allies such as the USA, are not covered by general or global transfer licenses. Thus, companies need to assess thoroughly the scope of licenses granted by authorities. Other export control frameworks still may apply, e.g. the US ITAR regulations. Although the defense industry benefits from less bureaucracy, in the future companies have to bear more responsibility to comply with the requirements of the EU transfer Directive by setting up efficient internal compliance systems.  

  1. THE DIRECTIVE ON DEFESE PROCUREMENT

The Directive on defense procurement (COM 2007 (766) final) aims to enhance competition in the European defense markets. Member States will only be allowed to exempt defense contracts from general EU procurement rules in exceptional cases. In general, contracts shall be award in open proceedings. To ensure that Member States can protect classified information and legitimate interests of security of supply, contracting authorities may impose on companies respective requirements.

The scope of the Directive comprises all public works and service contracts for the supply of arms, munitions and war material. Moreover, the Directive refers to the general security sector (e.g. police, homeland security). As with general EU public procurement Directives, the new provisions apply to contracts which have a value exceeding € 412,000 for works and service contracts and € 5.15 million for construction contracts. Contracts with a value below these thresholds are rewarded pursuant to national law. However, Member States have to respect the principle of transparency as set out in the European Directive.  

For the first time, and due to the European Parliament’s amendments of the Commission’s initial proposal, the new Directive includes the defense sector in the remedies Directive according to which the Member States are obliged to implement effective review procedures concerning the awarding of public contracts. In the future companies have the opportunity to appeal decisions taken by the contracting parties. However, the Directive provides for provisions which shall guarantee that no classified information becomes disclosed.  

Finally, the defense industry benefits from a restriction of the use of countertrade (so-called offsets). The Directive aims to eliminate illegal offsets by providing detailed rules for subcontracts. Contracting authorities may ask the successful tenderer to subcontract to third parties a share of the contract (not exceeding 30% of the value of the contract). This allows small and medium enterprises (SMEs) to take part in public tenders which would be too large for a stand-alone bid. The European Defense Agency (EDA) published more detailed, nonbinding guidance on offsets for Member States in a Code of Conduct at the end of 2008.  

Companies from third countries such as the USA still may bid for contracts in Europe in the future. The Parliament rejected proposals to exclude companies from outside the EU from supply contracts because the EU considers the procurement rules in their respective home markets to adversely affect the European defense industry.  

  1. IMPACT OF THE DEFENSE PACKAGE ON THE DEFENSE INDUSTRY

The defense industry should make the most of the two year period during which Member States implement the Directive into national law to prepare for the new European level playing field. Member States will not continue to automatically award domestic companies due to the new provisions.  

As first step, companies should ensure that they comply with the certification requirements set out in the Directive on intra-EU transfers in order to benefit from the new system of general licenses. They need to demonstrate proven experience in defense activities, appoint a senior executive as the officer personally responsible for transfers and exports, and implement an internal compliance program. Such a program is of particular importance because Member States are obliged to impose sanctions on infringements of the new provisions. Thus, companies have to be aware of severe penalties if they provide false or incomplete information regarding the end-use of defense related goods or export limitations.  

Regarding public procurement of defense related goods, new market opportunities for companies in other Member States arise. However, it remains to be seen whether Member States will make use of certain exemptions in the Directive as loopholes to award contracts directly to domestic companies. This is why it is even more important that the procurement Directive includes the defense sector in the remedies Directive so that companies may appeal decisions taken by contracting authorities. This requires companies to prepare professionally for such review procedures because Member States may implement short time limits for applying for review of only 10 days.  

Finally, small and medium enterprises may benefit from the provisions on subcontracting since they may take part in tenders which until now were only available for large companies. Successful tenderers should carefully pay attention to subcontracting requirements imposed by Member States. Otherwise it would be possible that subcontracting becomes a new form of offsets by giving preference to domestic subcontractors.