Offset Agreements: A Practical Guide

Toby Duthie, Partner, Forensic Risk Alliance & Lukas Bartusevicius, Business Development Analyst, Forensic Risk Alliance.

Offset agreements have played a major role in global defense procurement over the past few decades. Global defense budgets are growing rapidly, leading to fierce competition among suppliers and ever-greater scrutiny of government spending. In order to offset the cost of defense procurement and to source the most cost-effective deals available, buyer countries often require defense vendors to make additional investments in the country, often worth 50 to 100% of the value of the main contract. Agreed offset packages are very complex and secretive, and often have little to do with the vendor’s operations; taken together, this presents major risks to the vendor.

The unique nature of offset packages makes them difficult to compare – valuation of the offset performance is therefore tricky. Offset obligation value is expressed as a percentage of the main contract’s value, which is then processed by a government formula. This is usually a function of the expectations of the performance of the vendor in the prescribed offset package, which is then used to establish performance requirements. Upon successful completion of such arbitrarily prescribed tasks, vendors earn offset credits; once the required amount of offset credits is acquired, the offset is deemed complete.

Due to often complex and evolving requirements in unknown markets, as well as potentially biased expectations and arbitrary measurement, offset discharge becomes a difficult issue to manage. The issue is exacerbated by the fact that offset obligations often are a secondary consideration to the main contract, which may lead to so-called offset-gaps. To deal with management issues and to protect the main contract, vendors often commit significant resources to offset ventures but not always before the main contract has been awarded. However, lack of oversight and compliance measures bring about high third-party risk.

Since 2007, many governments have been cracking down on international corruption. It is estimated that $2.6 trillion is lost annually due to fraud, bribery and other corrupt practices. Government procurement is the most corrupted practice on the international level – according to the OECD, between 1999 and 2014, 57% of all bribes were paid to secure government procurement contracts. International anti-corruption regulations are very flexible when it comes to jurisdiction. The main legal tools – the U.S’s Foreign Corrupt Practices Act, the UK’s Bribery Act and the obligations of the OECD’s Anti-Bribery Convention – cover the same corruption offences: bribery of a foreign official, commercial bribery, record-keeping and internal control violations, and failure of a commercial organization to prevent bribery. Each of these offences carry severe penalties, which is a significant factor as very often the guilty parties are not aware of the violations they are committing. Defense vendors therefore run a high risk of sanctions and fines, and prison sentences on individuals.

The offset industry is booming – which has both positive and negative effects. The highest risk for vendors is non-compliance, which can lead to both sanctions in multiple jurisdictions and the loss of the main contract. As offset deals are unique and non-comparable, strategic business development approach is commonly applied, and internal compliance departments based in home countries are often left outside of the loop. Companies should follow emerging best practice of strengthening its oversight of offset ventures during deal structuring (by thorough due diligence of the stakeholders involved, ensuring all transactions comply with all international regulations, and carrying out analysis of offset valuation); and during discharge (by auditing performance documentation, which is often in a foreign language and prepared in accordance with unknown accounting standards, monitoring credit claim procedures, and ensuring all internal controls, books and obligations are met). Furthermore, vendors should invest heavily in measures that pre-empt and prevent corruption, bribery, money laundering and fraud. Finally, and most importantly, it is vital to remember that in offsets, one size does not fit all – a flexible, tailored approach is of crucial importance.

Forensic Risk Alliance

image

Forensic Risk Alliance is an international firm of forensic investigators and accountants, data protection experts and eDiscovery specialists with offices in the US, UK, France and Switzerland. It helps businesses to resolve complex and high-risk financial, legal and regulatory challenges. Its people provide independent, conflict-free advice and litigation support services, often in the local language. FRA collects and analyzes data for use in legal disputes and investigations (often cross- border) in a number of areas, including litigation, fraud, bribery and corruption investigations. FRA is one of only ten companies in the world approved to carry out validation audits for the EITI (Extractive Industries Transparency) Initiative which evaluate how well a country’s government conforms to the EITI’s standards of transparency in reporting revenue received from the extraction of natural resources.

(808)

Share