The European market for defence and security products is worth more than €90 billion (US$117 billion). But less than 15 percent of that value is awarded through public tenders. Around 85 percent of the defence spending of national governments within the European Union goes to domestic suppliers.  

In January, in an effort to open the European defence equipment market to greater international competition, the European Parliament voted to approve the EU Directive on Defence and Sensitive Security Procurement. This measure forms a part of the “European Defence Package” published by the European Commission.  

When transposed into national law, the new rules promise to provide suppliers with improved market access by extending the use of the existing EU public procurement procedures to a broad range of defence and security programs. Significantly for U.S. companies previously shut out of domestic markets by national preference, the measure will, for the first time, introduce a procedure for bid protests for defence contracts.  

Background  

Within the European Union, there is currently no body of government contract regulation for defence procurement analogous to the U.S. Federal Acquisition Regulations. The founding treaty of the European Union expressly excludes defence procurement from the scope of Community law. Article 296 of the EU Treaty expressly reserves to each EU member state the right to “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.” Article 296 is relied upon widely by national governments to avoid the use of the tendering rules of the EU-wide public procurement code for contracts involving a wide range of defence and security items—from boots to bullets.  

The differing export control regimes in each member state also restrict the cross-border movement of defence and security items across national borders, further inhibiting international competition. While European law permits the free movement of dual-use items within the EU, the national export control rules governing defence articles remain inconsistent and cumbersome, requiring manufacturers with plants in different countries to deal with multiple licensing regimes for the movement of their products and components, as well as technology transfers. The European Commission estimates that the direct administrative cost of intra-community transfers of defence articles is €413 million (US$ 538 million).  

The European Commission’s response to these obstacles to greater competition is the European Defence Package, which has three elements: the Directive on Defence and Sensitive Security Procurement, a separate Directive on Intra- Community Transfers, and Commission Communication regarding the proper interpretation of the national security exemption in Article 296.  

Directive on Defence and Sensitive Security Procurement

Current EU public procurement rules require that, with limited exceptions, qualifying contracts be awarded through a public tender process or other competitive procedure open to domestic and international suppliers. In most cases, the proposed contract award must first be advertised by the contracting authority inviting expressions of interest. The authority is then required to adopt one of four different types of tender procedures that include both an open tender process and, for some categories of contract, a “negotiated procedure.” The negotiated procedure allows the contracting authority to select one or more prospective suppliers, and to establish the contractual terms through direct negotiation. Currently, the negotiated procedure may only be used in limited circumstances; for instance, where the product or service is only available from a small number of sources or single source.  

The Directive on Defence and Sensitive Security Procurement will extend features of the current EU-wide public procurement code to certain types of defence and security contracts. It recognizes that, given their complexity and sensitivity, conventional open tender procedures are not an appropriate method for the award of contracts for defence and security items. Instead, the Directive will permit contracting authorities to use the negotiated procedure as the contract award process, without having to provide justification.  

The Directive will govern all contracts for the supply of military equipment, certain sensitive security equipment, works and services for specifically military purposes, and sensitive works and sensitive services that have a value of €412,000 (US$536,000) for supply and service contracts, and €5,150,000 (US$6.7 million) for works contracts. In the non-military security field (including homeland security), the Directive will apply to public contracts meeting these value thresholds possessing characteristics similar to defence contracts, such as procurements related to the protection of borders, police activities and crisis management operations.  

The Directive covers both defence and security contracts, but its application for contracts involving intelligence will be limited. It will not apply to contracts involving sensitive information that, if revealed, would threaten essential security interests, or that support intelligence gathering activities.  

The National Security Exemption

The new Directive does not remove the right of national governments under Article 296 to exclude a particular contract from the mandatory procurement procedures on grounds of national security. It will, however, limit use of the exemption to cases where the authority can show that the tender processes contained in the procurement Directive are not sufficient to safeguard essential security interests.  

In an attempt to clarify the scope of the exemption, as a part of the European Defence Package, the European Commission has published an Interpretative Communication providing its interpretation of Article 296. This guidance document provides that application of Article 296 to defence procurement is subject to the following conditions: (1) the exemption must be necessary for the protection of member states’ essential security interests, (2) only the protection of essential security interests justifies an exemption, and other interests such as economic and industrial interests, are by themselves not sufficient, and (3) the security interests at stake must be “essential,” which implies that the exemption is only available for defence procurement contracts that are of highest importance for member state’s military capabilities.  

It will be for the contracting authority to make an assessment of whether the Article 296 exemption is available on a case-by-case basis. The European Commission, however, may ask a member state to furnish evidence for the justification of the use of the exemption for a particular contract. It can also challenge that use in the European Court of Justice if it considers that a member state is making improper use of Article 296. It will then be for the contracting authority to prove that the use of the exemption is necessary for the protection of its essential security interests.  

Directive on Intra-EU Transfers of Defense Products

The European Defence Package includes a further Directive designed to simplify the current national licensing systems for cross-border transfers of military equipment, and technology transfers within the European Union. The new measure will permit suppliers established in one member state to move products and technology across borders within the Community under a single licensing scheme. The Directive will introduce a system of “general” and “global” licences in place of individual export licences.  

A general licence issued by that national authority will permit all businesses in that member state that meet specific licence conditions to transfer defence items and technology without individual prior authorization. General licences will be available, for instance, for shipments made to a member of the armed forces of that member state, and for parts required for maintenance and repair to an existing customer.  

Global transfer licences will permit companies to make multiple transfers of defence articles to a named consignee or category of consignees; specifically, transfers to armed forces of others EU member states, transfers to companies of components in the context of industrial cooperation, transfers of products necessary for cooperative programs between participating member states. A global licence will be granted for a period of three years.

The transfer Directive should improve security of supply and reduce the administrative burden and uncertainty of routine exports within the European Union. A greater compliance burden will, however, be placed on the contractor in terms of ensuring continued compliance with the applicable licence conditions.  

Bid Protests

In contrast to the position in the United States, challenges by aggrieved bidders of defence contract awards are very rare in Europe. This is, in part, because of the nature of the relationship between national defence ministries and their favored suppliers, the reluctance of contractors to sue their largest customer, and the absence of a judicial review procedure tailored to the defence sector. The procurement Directive introduces a potentially important change—both for domestic contractors and prospective suppliers from other countries.

Contracts awarded under the new Directive’s procedures will be subject to the review procedures established by the EU Remedies Directive (which came into force in 2008). This measure requires the awarding authority to wait for a specified number of days following contract award before signing the contract. This “standstill period” gives rejected bidders the opportunity to commence a review procedure in the national courts of that authority.

The Directive also requires member states to establish clear and effective procedures to enable an aggrieved bidder to seek redress in cases where contracts have been unfairly awarded. Local courts are empowered to set aside contracts where the mandated tender procedures have not been followed, and to require retendering.

The procurement Directive provides for specific procedures for the safeguard of sensitive and classified information.  

Offsets  

Many EU-governments require offsets as a condition of granting contracts in the defence industry to non-domestic suppliers. Offsets can take various forms, but often involve a condition that subcontracts of a specific value be awarded to domestic companies. Indirect offsets can require suppliers to procure the placement of contracts for unrelated (non-military) goods with domestic suppliers.  

Offsets, by their very nature, are discriminatory and are inconsistent with the open market principles enshrined in the EU Treaty. In the context of large defence contracts, they are often a political necessity for a government wishing to place an order with a non-domestic supplier.  

The procurement Directive is neutral with regard to offsets. Instead of regulating them in the context of the procurement Directive, the European Commission has decided to leave it up to the individual member states to decide whether a particular offset requirement complies with competition rules and the EU Treaty.  

Impact  

It remains to be seen whether the European Defence Package will succeed in breaking down the long-standing and cosy relationships between national governments and their favored domestic suppliers that currently characterize the European defence market. The success of the new measures in achieving greater transparency and greater competition is going to depend upon the willingness of both the European Commission and individual bidders to challenge the continued reliance by contracting authorities on the Article 296 national security exemption.  

In the future, a bidder excluded from a contract opportunity limited to domestic suppliers on grounds of national security will have a clear legal basis for challenging that decision and any subsequent contract award. The contracting authority can be put to the burden of proving that the use of the negotiated procedures mandated by the procurement Directive are not sufficient to safeguard essential security interests.  

But perhaps the most significant impact of the package will be the imposition of the European Commission’s oversight over national defence procurement decisions. A defence minister’s discretion regarding procurement awards will now become subject to continual review and possible challenge from Brussels. The threat of such intervention may be sufficient incentive to open more large procurements to international competition.