Implications of new rules in the US for India’s Defence Management

Controversies with defence procurement in India can usually be traced to imperfections within its Defence Procurement Procedure (DPP). For instance, despite “indigenisation” being an important policy objective in defence procurement, and despite minimum “indigenous content” requirements being mandatory for various categories of acquisition cases for decades altogether, the DPP till recently lacked a mechanism for computing indigenous content in defence acquisitions. Certain DPP provisions for commercial bids evaluation “kind of” equated foreign-origin parts paid for in domestic currency as “domestic content”—a formulation that was both incorrect and misleading. This deficiency was substantially corrected during the last round of reforms as part of DPP-2013 by incorporating a definition of indigenous content in line with international best practices, clearly recognising that manufacturing state-of-the-art defence equipment requires professionally-worded rules and regulations in the first place to support the acquisition process.

Just as an unambiguous definition of domestic content is a minimum pre-requisite for developing indigenous manufacturing capabilities, the ability to identify the ultimate source of each component that goes into defence weapons and platforms is equally important from contracting as well as strategic perspectives. The former perspective enables establishment of clear contractual liabilities for defects and accidents, while the latter enables blocking of undesirable “sleeper-agent” components from defence supply chains—components that can stop working when needed in war, or components that store and transmit tactical intelligence without user knowledge or consent.1 With this background, this short note traces recent US regulatory developments on detection and avoidance of counterfeit components in defence procurement as a potentially useful trigger for undertaking similar reforms in India.

Early last month, the United States issued a DFARS (Defence Federal Acquisition Regulation Supplement) revision2 governing detection and avoidance of counterfeit electronic parts in defence acquisition programmes of its Department of Defence (DoD). The revision applies to all Cost Accounting Standards (CAS)-covered prime contractors engaged by DoD, and obligates pass through of responsibility and liability provisions to all subcontractors at all tiers, both domestic and foreign, irrespective of whether the items supplied under such sub-contracts are COTS (Commercial Off-The Shelf) or non-COTS items. These new US developments will impact Indian suppliers acting in any sub-contracting capacity; and could also perhaps inform Indian Ministry of Defence (MoD)’s efforts for streamlining its own Defence Procurement Procedure (DPP), which presently lacks similar guidance on detection, reporting and liabilities in respect of counterfeit parts in defence purchases.

In a recent accident involving a foreign-sourced aircraft of the Indian Air Force (IAF), it appears that certain equipment was handed back to the supplier for fault-identification; and given any rational supplier’s interests in protecting its own interests first and foremost, it was hardly surprising that effectively a “no-defect, no-problem with supplies” report was received from the supplier, even as a (confidential) Court of Enquiry has apparently now been ordered by the IAF. The Indian practice clearly contrasts with the new DFARS revision, the latter being the result of open Senate hearings on counterfeit parts3 that were started as recently as in November 2011, quickly followed by the 2012 and 2013 National Defence Authorisation Acts, then followed by proposed revisions published in May last year: all of which have now culminated in the latest revision. These attempts in the US for handling problems with counterfeit parts have been open, transparent, consultative and rather efficient, all at the same time; and the US experience could therefore contain valuable lessons for other countries interested in implementing equally open, efficient and well-articulated defence procurement reforms.

Inter alia, the DFARS revision in the US: (i) obligates covered contractors and all their sub-contractors to establish and maintain an acceptable Counterfeit Electronic Part Detection and Avoidance System (CEPDAS)—where failure to implement such a system can result in disapproval of the purchasing system (apparently of the prime contractor alone) and withholding of payments (which could impact Indian sub-contractors at various tiers); and (ii) states upfront that the cost of such counterfeit parts, including costs of rework or corrective action that may be required to remedy the use of such parts, would be unallowable, subject to a narrow set of exceptions—once again, a provision that could impact Indian sub-contractors at various tiers. The CEPDAS is required to be implemented by all primes and their sub-contractors, and is required to include risk-based policies and procedures for sourcing from responsible and reliable suppliers, training of personal, inspection and testing of electronic parts, processes to ensure traceability and abolish proliferation, reporting and quarantining systems and control of obsolete electronic parts.4

Of late, the Indian industry has increasingly found an important place in global supply chains for defence equipment; and implications of the new DFARS revision on Indian defence industry’s growth prospects could therefore be both immediate and significant. Given the cost-implications of non-compliance, as well as risks of being rendered ineligible as sub-contractors for compliance failures, the Indian industry may need to move quickly and implement suitable systems fulfilling the new DFARS mandate, while also ensuing that its own sub-contracts placed with domestic or foreign suppliers necessarily include contractual clauses that have been outlined in the DFARS revision.

Intermittently, MoD contracts with US Government (USG) under Government-to-Government (G2G) agreements in the form of Foreign Military Sales (FMS) contracts, which have hitherto generally been construed as fixed-price contracts by procurement officials in India. However, it may now become necessary for MoD to re-examine if any of its FMS contracts—based on a LOR-LOA (Letter of Request-Letter of Acceptance) system of bilateral exchanges—could in fact include provisions for amendment or reimbursement of certain costs to USG; and therefore whether resultant sub-contracts awarded by USG in turn are therefore CAS-covered in any form—under either full or modified CAS-coverage. If it is indeed so, then MoD may need to fully protect its interests by including suitable cost-recovery and cost-ineligibility provisions in its G2G contracts mirroring USG’s contractual rights—essentially, a pass-through of USG’s benefits to India’s MoD under FMS contracts where the resultant sub-contract is CAS-covered and therefore covered by the new DFARS revision.

In addition, given that the DPP does not presently contain a clear or complete framework articulating risks, liabilities and costs for MoD’s contractors for aspects such as design defects, latent defects, post-acceptance testing warranties, damages to government-furnished property, or for resultant liabilities and cost-apportionment. The new DFARS revision in the US could therefore also provide additional leads to India’s MoD to further deepen its own reforms process and refine the existing liability framework under the DPP as well.

The author is a civil servant. Views contained in this article are purely personal and do not reflect the official position or policy of the Government of India or any of her departments or agencies.

• 1. See, for instance, research work being undertaken by the Cyber & Information Security Research Group?and the Center for Trustworthy Embedded Systems (official website http://www.ioc.ornl.gov/index.html).
• 2. Office of the Federal Register, DARS Rule for Detection and Avoidance of Counterfeit Parts: Notice dated May 6, 2014 (DFARS Case 2012-D055), available online http://1.usa.gov/1tuswpk.
• 3. Committee on Armed Services United States Senate (2012), Inquiry into Counterfeit Electronic Parts in the Department of Defence Supply Chain, available online http://1.usa.gov/T5JPSP.
• 4. Ibid.