Paris resists liability for Rafale, though it would reduce Dassault’s costs

By Ajai Shukla

Business Standard, 14th March 16

Around 2004, when the Indian Air Force (IAF) ordered some 40 additional Sukhoi-30MKI fighters from Russia, India’s cabinet exempted Moscow from providing bank guarantees to cover “performance and delivery liabilities” for the new aircraft. Russia had insisted on this exceptional waiver, given its strategic relationship with India and the Su-30MKI’s proven performance. In the years ahead, New Delhi was to regret not binding Moscow to specific liabilities, as the Su-30MKI consistently disappointed the IAF with availability rates of below 50 per cent.

Now, with New Delhi and Paris having inked an inter-governmental agreement (IGA) on January 25 for the purchase of 36 Rafale fighters, France, like Russia in 2004, is resisting sovereign liabilities that would make the government of France, not just Dassault alone, responsible for delivery or performance shortfalls in the Rafale.

India’s defence ministry, like weapons buyers everywhere, insists on writing “liabilities” into contracts for defence equipment. These are usually backed by bank guarantees that New Delhi can encash if the equipment’s delivery or performance is not according to the contract. On Monday, Indian Express reported that the Ministry of Law and Justice has insisted on sovereign guarantees.

But Paris, like Moscow earlier, wants to provide just a “letter of comfort”, the disparaging term for a written (but commercially un-enforceable) government undertaking to enforce the contract provisions.

Added to the already difficult negotiations over the Rafale’s cost, which the defence ministry considers exorbitant at Euro 11-12 billion, and wants to bring down to no more than Euro 9 billion, the disagreement over liability further complicates any early conclusion of the Rafale contract.

Knowledgeable insiders speculate that New Delhi might be attempting to help reduce Dassault’s cost by shifting liability to the French government. A bank guarantee would cost Dassault 3-4 per cent of its value, while a sovereign guarantee incurs no cost.

Paris and Dassault have even earlier backed away from incorporating liabilities into the Rafale contract. In long-drawn and eventually fruitless negotiations between 2012-15 for 126 Rafales, Dassault had declined to accept liability for 108 fighters that were to be built in India by Hindustan Aeronautics Ltd (HAL). This was one of the thorniest issues that led to a breakdown in negotiations.

“Usually, a written liability that binds the vendor company would prove adequate in a defence contract. However, since the French government has taken a leading role in pushing the Rafale contract, it should not back away from taking on liability”, says Amit Cowshish, a former financial advisor for defence ministry acquisitions.

According to the defence procurement procedure (DPP), an aerospace contract should involve a signing amount of no more than 15 per cent, another 70 per cent paid out in step with delivery milestones, and about 15 per cent retained for the warranty period to cover defects, if they arise.

Yet, the defence ministry has been paying as much as 20-25 per cent while signing the contract, and even paying out the 15 per cent warranty amount, satisfying itself with a bank guarantee for that amount.

“Arms vendors and supplier countries are notoriously reluctant to accept liabilities written into contracts. However, it is essential for our defence ministry to demand these, so as to have a mechanism for enforcing multi-billion dollar contracts”, says SN Misra, a former defence ministry aerospace contracting veteran.

Interestingly, Washington follows an entirely different system for Foreign Military Sales (FMS) contracts, in which the US Department of Defense (Pentagon) concludes contracts with US arms vendors on behalf of the purchasing country. For purchases like the C-130J and C-17 Globemaster III, India has been depositing 40 per cent of the contract value into an escrow account with the US Federal Reserve. This serves as a “termination guarantee”, in case the buyer government unilaterally terminates the contract. The “liability” is negotiated separately between the Pentagon and the vendor company.

Prime Minister Narendra Modi had requested French President Francois Hollande last April for 36 Rafale fighters on a “fast track” basis. In January, the two countries had signed an “inter-governmental agreement” during Hollande’s visit to India. Almost two months later, no contract is in sight.