Download the ebook

Mergers & Acquisitions December 2010

United Arab Emirates Offset

Program Bureau Adopts

New Policy Guidelines

In June of 2010, the Offset Program Bureau (“OPB”) of the United Arab Emirates (“UAE”) If you have questions or comments about

announced new policy guidelines for the UAE’s Offset Program for international defense this Alert, please contact one of the

contractors (the “New Guidelines”). While, at least for the time being, the complete lawyers listed below:

guidelines are confidential and not available to the public, the OPB has issued a summary Neal Grenley

highlighting the key terms of the New Guidelines, as well as the main differences from the Partner, New York

guidelines previously in effect. According to the OPB, the New Guidelines are the result of a + 1 212 819 8890

more than two-year initiative, including surveys conducted with major defense contractors [email protected]

and a review of offset programs in other countries, designed to make the UAE’s offset

Philip J. Power

program more flexible and transparent and to improve the options for defense contractors to

Partner, Abu Dhabi

satisfy their offset obligations, while at the same time catering to the economic and

+ 971 2 495 0134

commercial needs of the UAE by creating strategic and sustainable projects in the country. [email protected]

Key Objectives of the New Guidelines Richard Burke

Counsel, Washington, DC

Many of the features of the New Guidelines will be familiar to defense contractors + 1 202 626 3687

acquainted with the UAE’s former offset policy (or, indeed, with similar offset programs in [email protected]

any of the approximately 122 countries around the world that maintain such programs).

Deema Ghosheh

Broadly speaking, the key objectives of the New Guidelines are:

Counsel, Abu Dhabi

■■ Maximizing program fulfillment by incentivizing defense contractors to fulfill their + 971 2 49 50 131

obligations through “high-multiplier” projects, such as partnering with the local [email protected]

private sector through joint ventures to create profitable and sustainable enterprises

in strategic sectors.

■■ Improving transparency by ensuring that offset requirements are communicated at an

early stage in the procurements process, and enabling contractors to have greater

visibility into the offsets program and more open dialogue with the OPB.

1155 Avenue of the Americas

New York, NY 10036

United States

+ 1 212 819 8200

Client Alert

Mergers & Acquisitions

Overview of the UAE Offset Program The UAE’s Offset Program is designed to further incentivize

defense contractors to fulfill their offset obligations in projects

The UAE’s Offset Program was established in 1992, after the and sectors that the UAE deems strategically or commercially

Gulf War highlighted the need for the UAE to develop its armed important, by applying various multipliers to offset credit values

forces by purchasing modern defense equipment and arms. earned for specific projects. Thus, under the New Guidelines,

The program applies to any defense procurement contract having “input-based” projects, such as equity contributions and

a cumulative value exceeding US$10 million in any five-year period. technology transfers, carry a maximum multiplier of 2.0x, whereas

Under the New Guidelines, the procurement and offset processes “output-based” projects, such as joint ventures with UAE-based

proceed in parallel. Thus, a defense contractor will be informed commercial partners, carry multipliers of between 2.0x and 5.0x.

of the requirement to enter into an Offset Agreement during the The New Guidelines reflect the fact that Abu Dhabi is currently

bidding process, and the defense contract award will be linked focused on developing capabilities in supplier products and

with the signing of an Offset Agreement setting out the details services, such as advanced material parts, technical services,

of the contractor’s offset obligations. The basic obligation of the precision manufacturing and advanced electronics, as well as

Offset Program is that defense contractors who are awarded related end-user products, such as large- caliber tank guns, military

significant procurement contracts are required to earn Offset tanks, air/gas compressors, water desalination systems, vehicle

Program credits in an amount equal to at least 60 percent of the suspension systems, transportation and equipment, oil and gas

value of the defense contract award. In the New Guidelines, the separator systems and oil drilling rigs.

OPB indicated its belief that this 60 percent figure is at the lower

end of the spectrum, compared with contractor obligations under Milestones and Liquidated Damages

comparable offset programs in other countries.

Under the New Guidelines, contractors are generally required to

How Does a Defense Contractor Fulfill its fulfill their offset obligations over a seven-year period, in

accordance with the following milestones: 5 percent of the

Offset Obligations?

required offset credits must be earned in year 1, 10 percent in year

Contractors may earn credits to satisfy their offset obligations 2, 10 percent in year 3, 15 percent in year 4, 15 percent in year 5,

in a variety of ways, such as making direct investments in UAE 20 percent in year 6 and 25 percent in year 7 This represents a

commercial enterprises, transferring technology or know-how, change from the prior guidelines, under which offset obligations

providing export or marketing assistance to UAE entities, were generally required to be fulfilled over seven years on a

providing technical training to UAE nationals and partnering with straightline basis, and reflects the OPB’s greater focus on more

UAE entities to establish joint ventures and other commercial complex start-up ventures and R&D projects, for which the path to

enterprises in the UAE. These offset projects may or may not profitability and sustainability is frequently more back end-loaded.

be related to the subject matter of the underlying defense Another feature of the New Guidelines is that OPB may, in its

procurement contract. However, the New Guidelines draw a discretion, grant grace periods for the achievement of milestones

distinction between “input-based” projects, for which offset on a case-by-case basis, depending on the complexity of a

credits are awarded based upon the value of the contribution by particular project. The OPB assesses liquidated damages of

the contractor, and “output-based” projects, for which credits are 8.5 percent for a contractor’s non-performance of its offset

awarded based upon the “value” created for the UAE economy, obligations, which are imposed on the unfulfilled portion of the

which may be measured by the net profits, export sales and/or obligation as of each milestone. Payment of the liquidated

number of UAE nationals employed by the project entity. damages fulfills 50 percent of the obligation due. The remaining

The New Guidelines provide that no more than 30 percent of a portion is carried forward to a separate account to be fulfilled after

contractor’s offset obligations may be satisfied through “input fulfillment of the last milestone. Accumulated liquidated damages

based” projects, and the balance (at least 70 percent) must be are repaid to the contractor upon conclusion of the program and

satisfied through “output-based” projects. The rule that at least fulfillment of all milestones.

70 percent of a contractor’s offset obligations be fulfilled through

“output-based” projects is technically a new requirement, since Offset Committee and Defense

the former Offset Program guidelines did not specify a minimum Contractors Council

percentage, although in practice the OPB has always expressed a

preference for offset projects that create profitable and sustainable The New Guidelines provide for the establishment of an “Offset

commercial enterprises in the UAE and thereby contribute to Committee” to serve as a liaison between the OPB and the UAE

the development of the UAE’s economy and the employment Armed Forces General Headquarters. The Offset Committee is

of UAE nationals. comprised of three OPB officials—the CEO, Director of the Offset

Unit and Offset Program Manager, and three officials from the

White & Case 2

Client Alert

Mergers & Acquisitions

General Headquarters—the Chief of Logistics, Director of project to attain such value may in fact be substantially lower than

Purchasing Department and Director of Contracts Finance. the value amount. Thus, defense contractors seeking to maximize

The New Guidelines also provide for the creation of a “Defense their offset credits through minimum cash outlay would do well

Contractors Council” comprised of representatives of the OPB, to consider partnering with UAE-based commercial enterprises

significant defense contractors and others. The stated purpose through joint ventures and co-investments.

of the Defense Contractors Council is to ensure “more open

dialogue” between defense contractors and the OPB, improve Joint Venturing in the UAE

the offset program and “strengthen transparency” .

Under the UAE Companies Law, in order for a foreign company

to establish a limited liability company in the UAE, it must enter

Illustrative Example into a joint venture with a UAE national or a company wholly

To illustrate how the UAE offset program would apply in a typical owned by UAE nationals whereby the UAE party’s ownership in

case, take the example of a US$1 billion contract for the the company constitutes a minimum of 51 percent of the share

supply of fighter aircraft. This creates an offset obligation of the capital. Notwithstanding the requirement of majority UAE

seller in the amount of US$600 million, which might be ownership, quite frequently foreign entities seeking to do business

satisfied as follows: with a UAE local partner will reach an understanding that the local

partner will essentially act as a “silent” partner with no active

involvement in the operations of the venture. In addition, it is

relatively common for profits and losses of the venture to be

Offset Project Actual Value Multiplier Credit Value

contractually allocated among the joint venture parties on a basis

Foreign direct US$75 million 1.0x US$75 million

other than proportionate share ownership (e.g. through “total

investment

return swaps” and similar devices). However, because the main

Export US$30 million 1.5X US$45 million

purpose of the UAE Offset Program is to contribute to the

assistance/

marketing development of the economy of the UAE and the employment and

training of UAE nationals, it is unlikely that such arrangements

Total US$135 million US$180 million

“Input- would be favored by the OPB or result in any meaningful credits

Based” toward the satisfaction of a contractor’s offset obligations. One of

Joint venture US$30 million 4.0x US$120 million the clear implications of the New Guidelines is that the value of an

with UAE “output-based” project such as a joint venture, for purposes of

company to awarding offset obligation credits, will be measured in terms of

provide aircraft the venture’s commercial viability, profits generation and

maintenance

contribution to the UAE economy over time, and that objective is

Joint venture US$60 million 5.0x US$300 million

likely to be satisfied only by ventures in which the UAE local

partner has a meaningful economic stake and plays a significant

develop airport role in management and operations.

Total US$90 million US$420 million

At the same time, because the long-term viability and profitability

“Output-

Based” of the venture is crucial to determining whether the contractor will

ultimately receive offset credits for its participation, it is essential

GRAND US$225 million US$600 million

TOTAL: that the contractor has sufficient protections as a minority

shareholder to ensure that the venture is being managed with a

As the foregoing example illustrates, defense contractors have a view towards enhancing profitability (at least during the period

strong incentive under the New Guidelines to earn their offset while the offset obligations remain outstanding), and that

credits through “output-based” projects, as the higher multiplier management is properly incentivized to achieve that result.

attached to such projects allows the contractor to earn a greater The UAE Companies Law provides for certain minimum minority

value in offset credits in exchange for a lesser amount of cash shareholder protections, such as requiring supermajority

outlay, as compared with “input-based” projects. In this respect, shareholder votes for the following actions:

it is worth noting that, since the value of an output-based project ■■ Any increase or decrease in the share capital of an LLC

(before the multiplier is applied) is measured based on factors (at least 75 percent).

such as net profits, export sales or number of UAE nationals

employed, the actual cash outlay by the contractor to enable the ■■ Any amendment to the articles of association of an LLC

(at least 75 percent).

White & Case 3

Client Alert

Mergers & Acquisitions

■■ Any proposal to dissolve or wind up an LLC an “as-requested” basis as can be further detailed under the

(unanimous approval or otherwise any majority specified in the articles of association of the joint venture company or the

Articles of Association of the LLC). management agreement appointing the general manager.

We would recommend that the shareholders agreement or

■■ Any resolution to increase the liability of any shareholder of

other governing document for the joint venture clearly provide

an LLC (unanimous approval).

that the general manager, as well as other senior managing

■■ The merger or amalgamation of the share capital of an LLC officers, serve under the direction and supervision of the board

with any other person (the approval threshold required for an of directors, and be required to report regularly to the board on

amendment to the articles of association which may be any financial performance and other significant operational matters.

percentage between 75 percent and 100 percent). Contractors may wish to seek the right to approve of the hiring

of senior managers, as well as the right to fire senior managers

■■ The conclusion of any loan agreement for a period in excess

without the approval of their joint venture counter-party, and

of three years; the sale or mortgage of the real estate or place

of business of an LLC; absolving debtors of the LLC of their whether such right should apply only in “for-cause” scenarios or

liabilities; and an agreement to proceed with mediation/ for any reason whatsoever. In addition, the shareholders

conciliation or arbitration, unless such matters by their nature agreement should specify significant actions or decisions that

form a part of the LLC’s objects or are permitted to be require approval at the board and/or shareholder level, and may

undertaken by the board of directors in the Articles of not be taken by the general manager acting alone.

Association of the LLC (at least 50 percent).

Veto Rights. While the ability of a contractor, as a minority

The foregoing minority protections represent a statutory shareholder, to negotiate significant veto rights will depend on

minimum, and joint venture parties in the UAE are free to contract the relative size of its stake in the venture, we would recommend

in the relevant shareholder agreement or other joint venture that, at least during the period when the contractor’s offset

governing documents for additional minority investor protections. obligations remain outstanding, the shareholders agreement

In addition, depending on the nature of the venture and the should provide the contractor with veto rights with respect to

industry in which it operates, foreign contractors in an offset significant transactions that could materially impact the viability

program venture should consider the following: or profitability of the venture during the offset period. Examples of

such significant transactions would include acquisitions or

Board Representation. While directors of a UAE company are dispositions of substantial assets, mergers, consolidations

understood to serve the interests of the shareholders, and do or recapitalization transactions, and incurrence of substantial

have certain specific duties under the UAE Companies Law indebtedness, as well as substantial investments in R&D, capital

(such as approving the annual financial results prior to a distribution expenditures, hiring and compensation of key employees, and

of profits), as a general matter, the concept of director fiduciary material deviations from approved budgets.

duties is relatively undeveloped in the UAE. However, we are

aware of precedents in which persons serving as directors of a Transfer Restrictions. Given the importance of having the venture

company have been held personally liable to third parties for achieve profitability and sustainability within the seven-year offset

actions of the company. While board representation may impart period, it is important that the shareholders agreement or other

greater visibility into management and influence over operational governing documents for the venture contain a general prohibition

decisions, contractors should bear in mind that, under the UAE against the transfer of shares, whether by the contractor or the

Companies law, minority shareholders already enjoy substantial local partner, during the offset period. However, in practice it will

informational rights with respect to a UAE company. Depending be necessary for the agreement to permit exceptions to the

on the size of the contractor’s stake in the joint venture and the general prohibition. For example, it is fairly common for many of

functional role that the board is expected to play in the operation the privately held commercial enterprises in Abu Dhabi to have

of the venture, the contractor should consider whether board overlapping ownership which is ultimately traceable up to the

representation is desirable, or whether its interests are Government of Abu Dhabi (informally referred to as “ Abu Dhabi

adequately protected through its statutory and contractual rights Inc. ). Thus, the local venture partner, if it is an “

” Abu Dhabi Inc.

as a shareholder. entity, may want the ability to transfer its shares in the venture to

other “ Abu Dhabi Inc. entities, and for the most part this should

Contractually Defined Role of Management. It is relatively not be objectionable to the contractor, so long as the other venture

common in the UAE for a company’s day-to-day operations and shareholder(s) and the business of the joint venture company are

decision-making to be conducted largely by a general manager, not negatively affected by such a transfer.

who may report to the board of directors only sporadically or on

White & Case 4

Client Alert

Mergers & Acquisitions

Exit Transactions. Many contractors will want to provide in the US Export Controls

shareholders agreement or other governing documents for their

eventual exit from the venture upon fulfillment of their offset Contractors that engage in exports of hardware or transfers of

obligations, particularly if the venture is not central to the technology from the United States to satisfy offset obligations

contractor’s core business or strategy and was entered into may be subject to licensing or other requirements pursuant to

primarily for the purpose of satisfying an offset obligation. US export control laws and regulations. There are two principal

Traditional exit scenarios, such as an initial public offering of the US export control regimes that could be of relevance. The Bureau

venture company, a private sale of the company to a third party or of Industry and Security (“BIS”) of the Department of Commerce

a sale of the contractor’s minority interest in the company, would controls the export from the US and re-export from third countries

customarily require the consent of the local venture partner. of listed “dual-use” commercial products and technology of

Other potential exit events that should be considered include a US origin. Contractors may need to obtain license authorization

forced sale of the contractor’s interest in the company to the before transferring goods or technology to foreign parties,

local venture partner at a predetermined price. including the transfer of technology to foreign persons in the US

or to overseas persons electronically. For example, transfer from

Management Incentive Arrangements. In light of the the United States to the UAE of advanced computers or

importance to the contractor that the joint venture achieve semiconductor manufacturing equipment may require BIS

sustainable profitability within the seven-year offset period, licensing. These license requirements are subject to frequent

contractors would do well to consider at the outset of the venture change due to changing foreign policy and national security

how best to incentivize key managers and employees to maximize priorities. Changes may impair the ability of companies to export

profitability over the relevant time period. As a matter of habit and and substantial civil and criminal penalties may apply where these

custom, equity-based incentive arrangements are not nearly as controls are violated.

commonplace in the UAE as they have become in the US and

Europe even for relatively small companies (although cash The Department of State Directorate of Defense Trade Controls

bonuses for good management performance are fairly common). (“DDTC”) administers the International Traffic in Arms Regulations

However, there is no impediment under UAE law to implementing (“ITAR”). The ITAR imposes export controls on Munitions List

equity-based incentive plans at UAE companies, and contractors items, i.e. items primarily designed for military applications.

should consider using such plans, whether alone or in combination Export and re-export of any items or technology on the Munitions

with other management incentive arrangements, particularly if a List to all destinations except Canada are subject to licensing

public offering or third-party sale of the venture is a viable exit requirements for both US and non-US companies. For example,

scenario, in order to ensure that management and shareholder the transfer to the UAE of technology for the design or use of

interests are aligned during the offset period. military items will require an export license from DDTC. Transfers

of technology may be authorized through several mechanisms,

including licenses and Technical Assistance Agreements, which

authorize a number of identified parties to exchange covered

know-how or engage in technology transfers over the course of a

specified period of time.

White & Case 5

Client Alert

Mergers & Acquisitions

This Client Alert is provided for your

convenience and does not constitute

legal advice. It is prepared for the general

information of our clients and other

interested persons. This Client Alert

should not be acted upon in any specific

situation without appropriate legal advice

and it may include links to websites other

than the White & Case website.

White & Case has no responsibility for

any websites other than its own and

does not endorse the information,

content, presentation or accuracy, or

make any warranty, express or implied,

regarding any other website.

This Client Alert is protected by

copyright. Material appearing herein

may be reproduced or translated

with appropriate credit.

www.whitecase.com

In this alert, White & Case means the international legal practice comprising White & Case LLP, a New York State registered limited liability partnership, White & Case LLP,

a limited liability partnership incorporated under English law and all other affiliated partnerships, companies and entities.