The “Defense Package” is about to be agreed upon by the European Parliament and the Council. As a consequence, the defense industry will face a completely revised legal framework. The proposal aims to open the European internal market for defense equipment and to implement EU-wide transparency and competitive rules for the trade and procurement of arms. The package consists of: 

  • A Communication outlining the Commission’s vision for the European defense equipment market (COM 2007 (764) final) 
  • A Directive on intra-EU transfers of defense products (COM 2007 (765) final) 
  • A Directive on defense procurement (COM 2007 (766) final)

The package will enhance competition in the European defense markets. At the same time, companies will benefit from less bureaucracy and possibly from the prevention of “offsets” (i.e. demand for countertrade in order to obtain a contract). Finally, the proposal not only concerns European suppliers, but will materially affect the business of companies from third countries (non European Union Countries) because it might lead to a “Buy European” policy. 

  1. Background

Today, the European defense market is characterized by clear divisions between individual Member States. As a result, the market is still fragmented.

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, time-consuming and expensive legal framework. Currently, there is no distinction between licenses for exports to Member States and to third countries. Hence, companies have to face lengthy administrative proceedings when they want to export defense goods within the EU or even in case they plan to temporarily transfer arms in need of repair to other Member States.

Moreover, defense contracts are not subject to EU procurement rules but may be awarded largely at the Member States authorities’ discretion. Thus, it is hardly surprising that Member States spend almost 85 percent of their equipment budget domestically. National governments not only want to promote their own national defense industries, but they also want to ensure their independence from foreign suppliers and the security of sensitive information.

The EC Treaty established a separate legal scheme regarding the transfer and procurement of defense products. According to Article 296 EC, “any Member State may take such measures as it considers necessary for the protection of the essential interests of its security which are connected with the production of or trade in arms, munitions and war material“. Member States make extensive use of Article 296 to award defense contracts to their own defense industries. From a legal perspective, it is only required that a Member State “considers the measures to be necessary”. Therefore, the European Commission has only a few means of control. 

  1. European Initiatives

In the course of implementing a European Security and Defence Policy (ESDP), Member States began to coordinate developing their military capabilities, improving the efficiency of defense spending and enhancing the defense industry’s competitiveness at a European level. The European Defense Agency (EDA) in Brussels was founded in 2004 for this purpose.

The same year, the European Commission published a Green Paper on defense procurement (COM 2004 (608) final). The European Commission stated that the strict separation of national markets, substantial structural differences between defense procurement and other public sectors, and the complex regulatory background create a serious challenge for a working internal defense product market.

As a consequence of the Green Paper, the European Commission presented the Defense Package in December 2007. The Directorate-General (DG) Internal Market (as regards the transfer Directive) and the DG Industry (as regards the procurement Directive) are in charge of the proposal. The two rapporteurs of the European Parliament’s Internal Market Committee, the German MEP’s Heide Rühle (Green Party – transfer Directive) and Alexander Graf Lambsdorff (ALDE / Free Democratic Party – procurement Directive) presented their reports, which largely support the European Commission’s proposal, prior to the Parliament’s summer break. At present, the vote in the plenary session is scheduled for November 2008.

In addition, the Member States have to agree on the proposal in the Council. The European defense secretaries are scheduled to meet in October and November shortly before the decisive vote in Parliament. The French presidency seeks to pass the Defense Package in 2008 in order to bring it into effect as soon as possible. After the Defense Package has passed the European Parliament and the Council, the Member States have to implement the directives into national law.

  1. The Directive on intra-EU transfers

The Directive on intra-EU transfers is expected to facilitate 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.

In the future, exports of defense products to Member States will be distinguished from exports to third countries. Intra-EU transfers will be facilitated by eliminating paperwork which in turn will significantly reduce the financial burden on companies. A study provided by the European Commission estimates the costs for licence applications incurred due to the current legal situation to be more than €3 billion per year.

The transfer Directive’s linchpin is the implementation 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. The new, simplified approach requires Member States to have greater mutual confidence in the respective licensing bodies of the other EU Member States. Therefore, the Directive provides a standardized regime setting forth the appropriate reliability criteria for companies. Recipients of defense-related goods need to complete a certification process before they are allowed to receive military equipment. 

  1. The Directive on defense procurement

The Directive on defense procurement aims to limit the use of Article 296 EC, according to which Member States are allowed to exempt defense contracts from general EU procurement rules and to award contracts directly to companies without competition. Therefore, the Directive allows contracting parties to make use of the negotiation procedure (with prior publication of a contract notice) as the applicable procurement procedure.

The scope of the Directive comprises all public works and service contracts for the supply of arms, munitions and war material. However, the Directive does not only refer to defenserelated products, but also to works, supplies and services that are necessary for the security of the EU and its Member States. Thus, the EU takes into account the new dangers arising from the threat of terrorism that might affect the procurement of certain sensitive non-military goods. At present, the broadening of the scope of EU procurement rules to cover such items is intensely discussed in all Member States, and in particular is opposed by the UK.

The European Commission’s proposal does not include the defense procurement Directive in the remedies Directive according to which the Member States are obliged to implement effective review procedures concerning the awarding of public contracts. Therefore, the Parliament’s rapporteur suggested amending the proposal so that in the future companies would have the opportunity to appeal decisions taken by the contracting parties. The French presidency generally backs this amendment which is favorable to the defense industry, although its own proposal provides wide exemptions for procurement decisions that are essential to its national security interests.

Finally, the Commission intends to minimize the use of countertrade (offsets) because of its market-distorting effects. Countries with a highly specialized defense industry and many exporters often face demand for an offset in order to obtain a contract. Therefore, the proposal provides a recital (recital 23) according to which no conditions of the procurement decision “may pertain to requirements other than those relating to the performance of the contract itself”. Several Member States and MEPs oppose this idea and seek a withdrawal of the recital, which would increase companies’ chances to take legal actions against offsets before the European Court of Justice. However, the rapporteur in charge of the Directive favors expressly referring to the problem of offsets.

  1. Impact of the Defense Package on the defense industry

The Defense Package for the first time will create a European level playing field for an industry that has previously been totally dominated by the interests of the respective Member States. Hence, this will create attractive new business opportunities for companies in other Member States. At the same time however, companies will still need to prevail in their home markets, which will also be opened to competition. In times of tight budgets, it is doubtful whether Member States will continue to automatically award domestic companies.

Stakeholders outside the EU should also consider the changes in the regulatory environment of the European defense markets. After the Pentagon decided to delay the US$35 billion air tanker procurement, which became a battle between European supplier EADS and the U.S. competitor Boeing, the Foreign Affairs Committee of the European Parliament voted in favor of a “Buy European” and “reciprocity clause”. If the plenary session in November confirms this clause, companies from outside the EU could be excluded from supply contracts because the EU considers the procurement rules in their respective home markets to adversely affect the European defense industry. Moreover, third countries, in particular NATO members outside the EU, would not benefit from the system of general and global licenses provided for by the Directive on transfers. Thus, the Defense Package would widen the gap between market conditions for European suppliers and their competitors from third countries.

Finally, the defense industry could benefit from the abolishment of offsets. In particular, companies from countries with a highly specialized defense industry often incur losses because of claims for countertrade. Although European law generally prohibits offsets, neither the European Commission nor the European Court of Justice has yet taken legal action. It also remains unclear whether in particular Germany, which strongly opposes offsets, can prevail in the Council. Therefore, it would be beneficial for the defense industry if the European Parliament decided not to abolish recital 23 of the Directive on procurement in November