Implications of offset agreements.

• Author: Basaran, Halil Rahman

1. INTRODUCTION

   What do offset agreements tell us about international law? This question is the primary focus of this article. The question may appear challenging in that doubts may arise as to the feasibility of interpreting international law based on a single type of contract. Moreover, the opacity and the complexity of offset agreements and defense offsets may not permit a complete analysis. Still, there are threefold answers to such doubts.

   First, international agreements--treaties or international commercial contracts--are the foremost sources of international law. However, it must be stated that treaties are not as popular as they were in the 20th century. At present, new kinds of international law-making have, to a certain extent, replaced treaties. In coarse terms, it is known as "informal international law-making." (1) Informal international law-making has begun to challenge classical treaty-based law-making. Indeed, due to their idiosyncrasies, certain special agreements, such as offset agreements, may offer a certain type of law-making which challenges the classical parameters of international law and international economic law. (2) Thus offset agreements are evidence of certain trends in international law and if a certain type of agreement is in vogue, this is an occasion to reinterpret and re-identify international law. In this regard, the concept of "informal international law" will be expanded upon and elaborated in this article.

   Second, the stakeholders of an international contract can tell us much about the current state of international law. The parties to offset agreements are governments and corporations. Governments are the foremost subjects of international law, whereas corporations are its ascending and putative subjects. The way these two form contracts is crucial. It gives signals to both governments and corporations with a view to acceptable standards in contracting. A precise international contract law and its concomitant practice take root, a phenomenon and process to which international law cannot remain indifferent.

   Third, the subject-matter of a contract can be of utmost importance for the development and interpretation of international law. If the contract's subject-matter involves a dominant theme with which international law is involved and is attempting to resolve, that theme emerges in the clothes of international law. Indeed, there are two dominant themes of the offset agreement: one is essential security interests, whilst the other is the defense industry. Both shall be explored in this article in due course.

   The argument of this article is that an offset agreement cannot be merely reduced to a contract ancillary to the defense industry's main acquisition contracts. Rather, an offset agreement reflects a larger dimension of international law in that, first, it makes clear the role of governments in the international transactions of defense companies, and, second, an offset agreement represents a challenge to international law regarding the concepts of state secrets, trade secrets, treaty, contract and national public policy. This article posits international arbitration as the mechanism to settle disputes with regards to those concepts. Hence, the offset agreement provides an important toolkit for understanding and interpreting international law. Arguably, offset agreements have become a prominent feature of international law, largely seen as instruments which offer a boost to industrial economies worldwide. (3) Their popularity seems set only to increase.

   To clarify, this article starts by defining the offset agreement. The concept of "state secret" is then developed, following which national public policy's dominance over international public order is explored. The latter will explain how national security and its corollaries are favored over international peace and security, the prime objective--allegedly--of the United Nations. The fifth section will analyze the exceptionality of the defense industry, after which the sixth section will discuss "informal international law" in relation to offset agreements and will elaborate the theoretical framework of offset agreements. The following section will then deal with the concepts of treaty and contract, after which the eighth section will posit international arbitration as the most suitable method for dispute settlement regarding offset agreements. The article will conclude by reasserting the above argument with a view to the significance of offset agreements.

2. DEFINING THE OFFSET AGREEMENT

   Basically, an offset agreement is the contract to offset the advantages given to the contractor by the main contract (the acquisition contract). The main contract is a sort of privilege for the supplying company and the second contract (offset contract) offsets that privilege. In fact, the purchasing government is leveraging its purchasing power through the offset agreement. The defense contractor submits to this leveraging due to his wish to enter the buyer government's market. The buyer exerts real power and defense contractors, in competition with each other, submit to the conclusion of offset agreements. The power of the buyer governments (most of whom are developing countries) comes from the fact that western defense companies have seen their domestic markets shrink (4) and are now trying to penetrate developing countries' markets.

   While on the one hand, the offset agreement helps to mask the financial liabilities of companies, on the other, governments may present advantages granted by offsets as a success, although the price of the acquisition contract (the main contract) may have increased due to the offset agreement. That is, the price of the offset agreement is tacitly added to the value of the acquisition contract. Offsets could give some export advantages to the purchasing government, which in turn may sell such exports as a stand-alone success of the government, seeing as it does not have a connection with the increase in price of the acquisition contract. Hence, there is an important political economy dimension of the offset agreement. Indeed, it may even be interpreted as a contribution by developing countries to international contracting and international law.

   The properties of the market are important for the ability of the purchasing government to impose its offset terms on the contractor: the acquisition contract should involve large sums. High-tech products often constitute the subject-matter of the contract, products whose infrastructure and maintenance require considerable investment and expenditure. Such products or services may be civilian (e.g., commercial airlines) or military in nature. This article looks at the latter, for which there are important reasons.

   Firstly, offset agreements have come into vogue through defense procurement. The post-World War II era has seen the increasing emergence of offset agreements in arms deals. Arguably, offset practices began with the deal between the United States of America and West Germany in the 1950s, whereby West Germany was required to buy American military equipment and services to "offset" the expenses America incurred in stationing of troops in West Germany. (5) Defense offsets have now become common practice, arguably, to the point of becoming customary law. Just like many other customs, (6) the offset "practice" started at the behest of a powerful country, namely, the United States of America, and has now grown to become accepted practice in around 120 countries. (7)

   Second, the most widespread offsets are still likely to take place in the defense industry. The highly dynamic defense procurement market has adopted and developed the offset practice and, notwithstanding its discontents, this trend seems to have continued. The competition between supplying defense companies leads them to offer special and attractive offsets to buyer governments.

   Third, considering international law, the defense industry presents an idiosyncratic case. It is a 'sensitive' sector, in which regulation is not easy. Although national laws try to tackle the defense industry to ensure a level of transparency, accountability and the rule of law, national law per se is not the subject of this article. Rather, this article focuses on the international legal dimension. In gross terms, under the term "essential security interests", international law has procured a certain 'exceptionality' for the defense industry. That is, international (trade) law has concurred that the defense industry is an exceptional political matter rather than a purely economic sector that is to be regulated, even though it does possess market-distorting and anti-competitive effects. Still, this does not mean that the defense industry and its now well-established component--defense offset--are wholly outside international law. This article aims to clarify this 'predicament'.

   Arguably, the defense contract is not directly relevant to the public--viz., the tax-payer--in terms of benefits. Defense expenditure is often regarded as a reallocation of funds that could be (better) spent on social and economic facilities that directly serve the interests of the citizens, such as health, social security, education, transport and environment. Hence defense offsets serve to compensate the purchasing country's economy through investing either in its national defense industry or in these other sectors which are directly beneficial to the public. Rather than one single agreement, there exist two (or more) interdependent agreements--the acquisition agreement and the offset agreement--that constitute a common framework.

   In commercial life, it is possible to see interrelated agreements constituting a commercial relationship. In particular, in the event of a sustainable partnership among contracting parties, it is more natural that a series of contracts exists. These contracts may be mutually influential and supportive, and...