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New Offset Act vs. offset crisis in Poland

13.06.2022

The new Offset Act entered into force on 30 July 2014. It changed the face of the Polish offset system. Now, the system is undergoing another transformation. How will the establishment of the Armament Agency affect offset in Poland and whether there is a chance to overcome the crisis?

New Offset Act vs. offset crisis in Poland

With the enactment of "new" Offset Act in 2014, the compensation system in Poland was adapted to the European regulations. This included, among other things, limiting offset only to direct offset, or directed only to defence sector, and resigning from its automatic application by making it dependent on whether the existence of the essential interests of state security was assessed positively.

In recent years, we can openly speak about the crisis of Polish offset. However, this mechanism still remains in the Polish legal order and, as such, deserves attention. Moreover, from January 2022, the offset and purchases for the Armed Forces were cantered around the Armament Agency.

Offset – definition

Offset (or compensation) is a structure used for several decades around the world, mainly in transactions of acquiring military equipment. The essence of offset is the compensation by a foreign supplier of expenses incurred by the state for the purchase of a given military system abroad.

In Poland, the legal basis for application of offset is laid down in the act of 2014 ("Offset Act")[1]. It is the second legal act of statutory rank regulating the offset. It replaced the old offset act of 1999[2].

In the European Union, the basis for application of offset mechanism is laid down in Art. 346 paragraph. 1 lit. b) TFEU[3], which gives each Member State the freedom to choose measures to protect fundamental security interests which relate to the production or trade in arms, munitions or war material, provided that such measures do not adversely affect the conditions of competition on the internal market with relation to products which are not intended for specifically military use.

Under the Offset Act, the Minister of National Defence is the minister competent for offset (under the old act of 1999 it was the Minister of Economy).  

Little-big (r)evolution

In recent months, the Polish system of acquiring military equipment has undergone major changes. The symbol of these changes was the "rebranding" of the Armament Inspectorate into the Armament Agency[4]. The new body brings together the existing competences of the Armament Inspectorate and other units of the Ministry of Defence in the field of preparation and implementation of purchases of military equipment and plays a leading role in the decision-making process related to offset.

Learn more: The Armament Agency – changes to military purchases system from  1 January 2022

The concentration of responsibilities related to the acquisition of military equipment and related offset should be assessed positively, because - at least in theory - this will allow for the acceleration of all procedures regarding purchase decisions, analysis of the essential interests of state security and the entire process of concluding and implementing the offset agreement.

The current structure may improve the decision-making process related to both the choice of procedure for purchasing military equipment (one of the procedures provided for in the Public Procurement Law (PPL) or the procedure resulting from Art. 346 TFEU), and the offset procedure itself, i.e. developing objectives for the offset offer, negotiating the offset agreement and supervision over its performance.

It is worth noting that before January 2022, the competences regarding the procurement of military equipment were divided between the Armament Inspectorate and other organizational units of the Ministry of National Defence, such as the Inspectorate for Implementation of Innovative Defence Technologies and the Offset Agreements Bureau.

Earlier, under the old offset act regime, the system was even more complex, because apart from the organizational units of the Ministry of Defence, the Ministry of Economy was also involved in the procedure, and in particular the Offset Programs Department, which was responsible for all activities related to the conclusion, performance and settlement of compensation agreements concluded with foreign suppliers.

The recent changes should be assessed positively, because at least in theory - assuming that the system will operate in accordance with the law makers’ intention - it will significantly simplify and accelerate the decision-making process related to retrofitting the Polish Armed Forces with foreign equipment (in recent years, mainly from the US).

Offset – justification required

In the 2014 Offset Act, the Polish law makers resigned from the previously binding rule, according to which the offset was applied somewhat automatically after exceeding the purchase volume threshold (EUR 5 million). According to the current regulations (Art. 7(4) of the Offset Act), the application of offset requires a justification.

The justification and the offset necessity assessment by the Ministry of National Defence based thereupon, prepared in accordance with the Regulation of the Council of Ministers of 1 December 2014[5], is the key moment in the procurement procedure. At this stage, a decision is made whether or not apply the derogatory clause contained in Art. 346 TFEU, enabling the acquisition of military equipment excluding procedures provided for in the PPL.

Pursuant to Art. 12 sec. 1 point 2 PPL[6], PPL provisions do not apply to contracts for military equipment specified in Art. 346 TFEU, if so required by the essential interests of state security.

The condition for applying derogation specified in Art. 346 TFEU is the absence of an adverse effect on the conditions of competition on the internal market with relation to products which are not intended for specifically military use.

Thus, the appropriate justification and assessment of the need to apply offset prepared by the Ministry of National Defence opens the way to a procurement process not subject to the PPL but based on the provisions of Decision 367 / MON[7].

The resignation from automatism, as well as concentration of all responsibilities related to military purchases in one institution, made the Polish offset system finally compliant with Art. 346 TFEU.

Only direct offset

Currently, under the 2014 Offset Act, the entire offset should be directed to defence sector. So indicates, for example, a definition of offset recipient in Art. 2 point 4) and definition of offset in Art. 2 point 14 of the Offset Act. Thus, using the wording of the old act, it is a “direct offset”.

Its objective is the cooperation necessary to maintain or establish in Poland the potential in terms of production, service, maintenance, repair and other capacities, necessary from the point of view of protection of the essential interests of state security. It is to ensure independence from a foreign supplier through transfer of technology and know-how along with transfer of economic copyrights or the use of a work (documentation).

The purpose of the offset is therefore clear and unquestionable - to provide the Polish defence industry with an "injection" in the form of new technologies, knowledge and competences enabling independent production, or at least maintenance, repair or modification of delivered items or its components. Based on the above, it is impossible not to express enthusiasm for the very idea of ​​offset and its legitimacy and usefulness.

Moreover, a successful offset may reduce the operating costs of military equipment throughout its life cycle. And those are considerable costs. Experts estimate that they constitute approx. 70% of total costs, while the price paid to a foreign supplier at purchase constitutes 30%. Building appropriate competences in the field of servicing, maintenance or modification may result in savings for the operator, and consequently for the State Treasury too, due to lack of need to send individual units of equipment abroad to carry out the necessary technical works.

For or against?

However, the offset has not, is not and will never be a gift from a foreign supplier to the State Treasury. There is no need to convince anyone that foreign arms corporations are not charitable institutions and it is not in their nature to transfer their knowledge or technology to foreign countries, even allied ones, for free. The offset is compensated by them with a correspondingly higher purchase price of a given weapon system.

The Ministry of National Defence, and thus the State Treasury, when requiring the offset, must take into account higher direct costs related to the supply contract.

The trick is to make a profit and loss account and weighing whether the possible benefits in the form of technology and new competences for the Polish armament industry are worth the higher purchase price and the obvious necessary costs associated with adaptation of Polish market operators, their plants, infrastructure and equipment to implement new capabilities.

Of course, the ideal scenario would be to acquire not only maintenance capacity, but also production (license) capacity for a given weapon system or at least its key components, and include it in the global supply chains of a foreign supplier. Ideals - as it happens in life - most often remain only in the sphere of dreams that are impossible to come true. In the case of offset, it happens because of disastrous negotiating mistakes of both tactical and strategic nature in recent years.

Offset in the Armament Agency – a forecasting attempt

The combination of purchasing and offset competences in one hand should be assessed positively. At last, the unit which makes decisions about purchases will also be competent in matters of offset, its scope, type and location. This gives a chance for a more professional and comprehensive approach to compensation of expenses incurred for the purchase of military equipment, as long as the entire transaction is planned and implemented from the beginning in such a way that the profit and loss account of the State Treasury and the Polish defence sector is positive.

It is easy to formulate spectacular offset obligations. Real professionalism is manifested in the ability to correctly define the goals we want to achieve, their profitability, usefulness from the point of view of the national defence potential and the ability to absorb offset by Polish market operators, which will not incur costs exceeding the expected profits.

Combining offset with acquisition of military equipment at the Armaments Agency gives a fair chance that such analyses will be carried out and will be carried out by the most competent people who know the needs and capabilities of the Polish arms industry.

Author:

Piotr Dudek,
Director of the New Technologies Department, Defence & Aerospace
TGC Corporate Lawyers

 

[1] Act of 26 June 2014 on certain contracts concluded in connection with the execution of orders of fundamental importance for state security (Dz.U.2021.1643)
[2] Act of 10 September 1999 on certain compensation agreements concluded in connection with supply agreements for the purposes of national defence and security (Dz.U.2013.716)
[3] Treaty on the Functioning of the European Union of 25 March 1957, including the changes introduced by the Treaty of Lisbon of 13 December 2007
[4] Decision No. 74/MON of the Minister of National Defence of 1 December 2021 (Official Journal of the Ministry of National Defence, item 252)
[5] Regulation of the Council of Ministers of 1 December 2014 on the rules and procedure of conduct in the field of justification and assessment of the need to apply an offset to protect the basic interests of state security (Dz.U. item 1819)
[6] The Public Procurement Law of 11 September 2019 (Dz.U.2021.1129)
[7] Decision No. 367/MON of the Minister of National Defence of 14 September  2015 on the rules and procedure for awarding contracts of primary importance to state security in the Ministry of National Defence (Dz.Urz. MON item. 265)

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