Offset and Polonization in view of the European Union Law

PUBLISHED AT: Tuesday, 15 March 2016, 12:58
Jarosław Kruk

Reluctance of the European Commission towards offset practices applied by the Member States has been known for years. It represents one of the main sources of problems for free use of offset in Poland the consequence of which is looking for alternative offset-unrelated ways to promote Polish defense industry (e.g. polonization), and entry into force of a new offset act of 2014. Given the relevance of this “reluctance” for the Polish defense industry and the recent entry into force of the new legislation touching upon this issue, it would be worthwhile to cast some light on it.

The negative approach of the European Commission to the problem of offset should be no surprise since it directly results from the nature of offset and the functions performed by the European Commission. On the one hand, a constitutive feature of offset practices - regardless of how they are approached - is to impose additional obligations on foreign suppliers the aim of which is to strengthen the national defense industry. On the other hand, the main task of the European Commission is to ensure proper application of EU legislation by the Member States, including the provisions relating to freedoms of movement of goods and services which form a basis for the proper functioning of the internal market. Thus, discriminatory treatment of business operators from other Member States – because they are foreign entities - in order to strengthen one’s own defense industry, is naturally objectionable. Consequently, the European Commission has repeatedly indicated that offset practices are contrary to fundamental principles of the EU primary law.

This does not mean, however, that the case is already lost, and the Member States cannot apply offset at all, because the European Commission itself concurrently suggests that it is admissible for the Member States to apply offset practices. A mesure to use offset, which is essentially contrary to the EU law, is to apply a standard which allows to take measures incompatible with the EU law. This standard is based on Article 346 (1)(b) of the Treaty on the Functioning of the European Union, according to which the provisions of the Treaties shall not preclude the application of a rule according to which any Member State may take such measures as it considers necessary for the protection of the essential interests of its security which are connected with the production of or trade in arms, munitions and war material; such measures shall not adversely affect the conditions of competition in the internal market regarding products which are not intended for specifically military purposes.

This provision refers to the measures undertaken by the Member States in general terms. In order to adjust its content  to offset conditions, one should refer to the case-law of the Court of Justice of the EU and the guidelines presented by the European Commission in all sorts of legally non-binding acts (i.e. soft law). Providing such guidance the European Commission has a difficult role. On the one hand, it wants to limit the application of exclusion under Article 346 (1)(b) TFEU to prevent the Member States from abusing the opportunities offered by this provision. On the other hand, the exclusion was established in the primary EU law (the Treaty), and by this very fact the actions of the European Commission – also operating on the basis of the primary law - cannot, in this regard, freely restrict the use of this "safety valve" for the Member States without itself risking violating the EU law. Therefore, the European Commission is very cautious in giving those hints.

Reading through the statements of the European Commission, one can identify a number of principles which condition the use of offset on the basis of Article 346 (1)(b) TFEU. Firstly, it must be emphasized that this provision is exceptional, and because of its exceptionality it cannot be abused in practice by the Member States. Therefore, use of offset may only be justified by essential security interests of the state, whereas economic considerations exclude its use. When the Member States has already identified a specific aim corresponding to the conditions of essential interests of national security, the specific offset used by that state must be proportionate to the aim pursued. To put it otherwise, the required offset obligations may not exceed the minimum required to achieve a desired and legitimate aim. In addition, it is prohibited to use offset automatically on the basis of general and abstract grounds, which means that any need for using offset must be assessed on an individual basis (case-by-case assessment). This precludes the use of offset only for this reason that the legislator assumed in advance that in some category of cases offset is legally required. Finally, the Member States must bear in mind that the burden of proving a need for specific offset is upon the state which applies it. Though, the above catalogue of conditions is non-exclusive, it allows to understand criticism of offset applied in practice.

Given the above principles, many contradictions of the former offset act of 1999 come to light in respect of the conditions enabling the use of Article 346 (1)(b) TFEU. There is probably no need for too much debate over non-military offset (statutorily referred to as indirect) not applied in practice in Poland for years now - though literally permitted till the end of the former offset act being in force.  This offset was flagrantly contrary to the principle of exceptional possibility of using offset because of the fundamental interest of national security and to the content of Article 346 (1)(b) TFEU, according to which applied measures must not adversely affect the conditions of competition in the internal market regarding products which are not exclusively  intended for  military purposes.

Examples of indirect offset used in Poland may easily be indentified on the Internet, just to cite offset obligations involving the launch of a new passenger car production along with spare parts production. Automatism of offset use is much more interesting and important. In effect of an analysis of the former offset act we will come to a conclusion that in the case of purchase of weapons or military equipment indicated in the list covered by the Regulation for the amount exceeding EUR5,000,000.00 – unless there were exceptions provided for by law - offset had to be applied. But this is not the end, because in such cases offset not only was necessary; in addition, the value of an offset agreement could not be lesser than the value of a supply agreement (using the so-called "offset multipliers").

Formally, therefore, it was not about what and for what purpose we were to achieve through the use of offset, but it was more about filling in the "offset bag" so that the equation could make sense - and what this bag was filled in with, was of lesser importance. This approach was, therefore, contrary not only to the prohibition of the automatic use of offset, but also to the principle of proportionality requiring  the use of offset only to the necessary (minimum) extent.

The practice of using offset on the basis of the previously binding offset act, despite the absence of a fundamental change in the content of the act itself, however, attempted to follow the EU guidelines, applying the pro-EU interpretation of the offset act. In fact in some cases, though it requires a lot  of effort, on the one hand, it is possible to formally satisfy requirements of the former offset act, on the other, properly apply the exclusion under Article 346 (1)(b) TFEU. However, the new offset act was undoubtedly necessary. Without going into details of offset application on the basis of the new law, it should be indicated that the legislator has adopted a smart way to ensure compliance of offset practices under this law with Article 346 (1)(b) of  TFEU.

In oversimplified terms, it was simply repeated several times in the text of the act that offset is used when such compliance occurs. So it is the bodies applying this act that are burdened with ensuring proper use of offset without substantial suggestions on the part of the legislature. Actually, it is a very sensible approach because, as it is often the case in the legal context, the interpretation of Article 346 (1)(b) TFEU may change over time in the absence of binding guidelines on how to understand this provision. Furthermore, identification of all cases in advance that justify the use of offset (if possible) per se could violate the above guidelines for the application of Article  346 (1)(b) TFEU - the principle of exceptional use and a ban on automatism.

Finally, as is stated in the title, it is worth explaining some question related to the so-called polonization. Well, reluctance of the European Commission towards our using offset sometimes made our decision-makers, who wish to strengthen our defense industry, try to circumvent the problems associated with offset. In this regard, the so-called polonization has gained many supporters, which is not the product of legislative acts but more of practice, an approach towards procurement in the armament industry – i.e. arrangement of the conditions of tender in such a way to make a foreign supplier use "Polish" factors (e.g. using  Polish subcontractors, service centers located in Poland) . Let me omit here the benefits from circumvention of the offset procedures as such for the party placing an order, in particular on the basis of the former offset act when purchase formally took place at the Ministry of National Defense, whereas offset was negotiated in the Ministry of Economy.

From the point of view of the EU law, and more specifically Article 346 (1)(b) TFEU, the beneficial power of naming such practices polonization is obviously none. Reluctance of the European Commission towards the use of offset practices, of course, is not inspired by use of the word “offset”, but by combating practices restricting freedoms of the internal market - mainly discrimination against foreign companies. Naming similar practices in a different way cannot have a greater effect especially that, given the statements of the European Commission, we see that it does not use an unambiguous definition of offset, but by offset it means also some practices which fall within the ambit of our use of the word polonization. The European Commission indicates that offset practices differ across the Member States.

Regardless of whether offset has a military or civil character, whether it is direct or indirect and whether these are measures restricting the functioning of the internal market. Without application of Article 346 (1)(b) TFEU, one cannot require purchase of goods or services from contractors which are based in a particular Member State (the same applies to subcontracting) or making investment in a particular Member State. In the case of polonization violating rules of free market, one should, therefore, also rely on Article 346 (1)(b) TFEU and justify every manifestation of polonization in the same way as the need for use of a specific offset. The use of such polonization must also be objectively justified by a need for essential security interests of the state and not purely by economic support of the Polish arms industry. This does not mean, of course, that the term polonization must entail a practice contrary to the principles of the internal market, because this is a very broad concept. But, undoubtedly, the use of polonization solely in order to circumvent the requirements for offsets should prove fruitless.

Authors:

Stanisław Michałowski, Attorney at Law

working towards his PhD at the Faculty of Law and Administration of the University of Warsaw

Kruk & Partners Law Firm

Jarosław Kruk, Legal Advisor, Managing Partner

Kruk & Partners Law Firm

Jarosław Kruk
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