The need for investment in defence capability and capacity is growing everywhere in the world. The new global political situation has also led to the realisation of a great need for strengthening the industrial capacity of the Danish defence. Foreign suppliers wishing to export to the Danish military are met with an offset requirement from the Danish state.

You cannot say Danish defence purchases without also saying offset rules. Offset is - when the rules so allows - a condition when foreign suppliers of military equipment do trade with the Danish state.

The state imposes an obligation on suppliers to invest in Danish industrial production capacity and technological competence. For example, a supplier of cannons to the Danish defence may be obligated to invest in projects with the Danish defence industry relevant for cannon systems over a period. The offset may be as high as equal to the purchase price.

The offset rules

The offset approach is based on an exemption from Article 346 of the EU Treaty, which states that exemptions from the prohibition against preferences for a country's own industry require the existence of an essential security interest.

The Danish offset system has several times triggered objections from the European Commission, which has sent letters of formal notice of treaty infringement. The objections have included the fact that offset requirements were made almost without exception and without demonstrating any concrete security interest.

There is no doubt that suppliers 'demand a premium' for accepting an offset requirement. The over the market price paid for the product constitutes the funding of the offset offered to Danish industry. This was the reason why the Commission considered this system to challenge the strict rules on state aid. Furthermore, the Commission found it difficult to accept that the offset obligation could be settled without a close link between the investment project and the service provided.

After years of negotiation, the letter of formal notice was shelved in 2018 when Denmark drafted a detailed set of rules on the legal conditions for both the requirements for and the discharge of offset obligations.

The advantage for Denmark is that, through the projects, the state will have a system that can provide the industry with knowledge about the latest technology or production capacity in an otherwise inaccessible market.

ICC agreements

Industrial Corporation Contracts are discharge agreements that the supplier concludes with the Danish Business Authority regarding the investment project with a Danish company. The Danish Business Authority must thus approve the project that the foreign supplier enters with a Danish company. The decisive factor is how much value the agreement has for Denmark.

The foreign supplier must be able to discharge its obligation to the Danish state, but it is based on an agreement with the Danish company, which must be profitable and beneficial to both parties.

An ICC agreement is based on the basic agreement with the Danish company, and this complex of agreements must be transformed into an ICC agreement between the Danish state and the foreign supplier.

The offset discharge rules

If a supplier of helmets buys straps for helmets from a Danish company for DKK 100 million, the supplier's obligation is reduced by a 1:1 factor.
If, on the other hand, the foreign supplier enters into an agreement on a research project to improve, optimise and develop new products, the obligation is written down by factor 1:5. Even better, if the supplier provides a Danish company with ownership of technology assets or rights to commercialise the product itself, you can reduce the obligation by a factor 1:7.

Technology transfer may mean that you can get out of your offset obligation cheaper than the premium, so that it yields a profit. The explanation is that the Danish state wants the capacity here in Denmark in order to have the technology available in Denmark for subsequent export.

Export control may be an obstacle

Export of defence equipment is subject to a wide range of international obligations, which, among other things, are intended to prevent weapons from being exported to conflict-ridden countries and areas. These control measures are commonly referred to as "export control", which means that there are restrictions on the types of weapons and military equipment that may be exported and to which countries they may be exported.

There are control mechanisms and control regimes which all companies need to pay strict attention to, not only in the EU, but especially in the USA. The US ITAR legislation applies to everything that incorporates a US product. This means that a company may be affected by US ITAR legislation if it manufactures sophisticated calibration equipment that may be used for measuring bombing accuracy, with a US ingredient or simply with US assistance. There are severe penalties for exporting to blacklisted countries.

Challenges for foreign suppliers

Many foreign suppliers find it difficult to find projects that qualify for the settlement of the offset obligation. But the challenge also applies to the tendering process, which the suppliers need to be familiar with. The contract places high demands on the understanding of, among other things, discharge rules, as the consequences of a poor contract are high.

It is a major challenge to discharge obligations within the time frame and the milestones that have been set and must be met. If the terms are not met, the offset obligation is converted into a cash payment claim, as it is a penalty-based system. There is a need for counseling in conflict situations if the companies have not settled the obligation in the cadence stipulated in the contract, which will cause problems.

The systems have become regulated more precisely and more transparent than before the EU Commission intervention in 2014. The Danish system is, however, still more bureaucratic and negotiable than elsewhere in Europe. When concluding the purchase agreement companies are faced with requirements that tie them to Denmark for a considerable time period and the complexity typically calls for legal as well as technical advice.

Facts

The Danish state imposes an obligation on suppliers of services to the Danish defence to invest in Danish industrial production capacity and technological competence when entering into an agreement on the purchase of military products.

According to Article 346 of the EU Treaty, there must be a close link between the investment project and the service that was provided with a counter-purchase obligation.

he obligation may be written down by a factor of up to seven depending on the nature of the consideration. The highest factor is achieved for projects that involve the transfer of technological competence and capacity to a Danish company.

Points of attention for foreign suppliers:

  • The tendering process, including negotiation of offset requirements
  • Possible use of the appeal system
  • Conclusion of agreements with Danish companies on projects for the discharge of the offset obligation
  • Conclusion of the ICC agreement.

Industrial Corporation Contracts (the ICC agreement) are discharge agreements that foreign suppliers conclude with the Danish Business Authority regarding the investment project with a Danish company. The ICC agreement is based on the basic agreement with the Danish company, and this complex of agreements must be transformed into an ICC agreement between the Danish state and the foreign supplier.

Contacts

Poul Hvilsted

Attorney (H)

Andreas Christensen

Partner (H)

Jakob Krag Nielsen

Partner

Jonas Eigil Nielsen

Junior Partner

Timmi Smed O'Brien

Attorney