THE FEINGOLD AMENDMENT May 25, 2001

AND INTERNATIONAL OFFSET

THE FEINGOLD AMENDMENT AND INTERNATIONAL OFFSET

A BRIEF INTRODUCTION

The Feingold Amendment, 22 U.S.C. § 2779a, prohibits U.S. defense contractors from making incentive payments to United States persons (as defined below) in order to induce such United States persons to purchase foreign products and services so that the U.S. defense contractor can satisfy its foreign offset obligations. This paper briefly describes the restrictions imposed by the Feingold Amendment on offsets in international defense sales.

I. The Feingold Amendment

In 1994, the Congress enacted the so-called “Feingold Amendment” as part of the Foreign Relations Authorization Act for 1994 and 1995. The Feingold Amendment was introduced by Senator Russell Feingold, a Democrat from Wisconsin, and is designed to prohibit certain practices used by U.S. defense contractors in satisfying offset obligations imposed by foreign governments.

Specifically, the Feingold Amendment prohibits U.S. defense contractors (or their employees, agents or subcontractors) from making incentive payments to United States persons for the purpose of causing such United States persons to purchase foreign-made goods in order to satisfy, in whole or in part, the defense contractor’s offset obligations.

A. To Whom the Feingold Amendment Applies

The Feingold Amendment applies to companies based in the United States that manufacture or sell defense products or services. It also applies to their employees, agents and subcontractors. Note that there is no requirement under the Feingold Amendment that the employees, agents or subcontractors themselves be U.S. persons. A U.S. defense contractor cannot circumvent the Feingold Amendment by having a foreign subcontractor make an incentive payment that would otherwise be prohibited under the Feingold Amendment if the U.S. defense contractor itself made the payment.

B. DEFINITION OF “UNITED STATES PERSON”

The Feingold Amendment prohibits a defense contractor from making incentive payments to any “United States person.” The term includes U.S. nationals and permanent resident aliens and corporations, partnerships, or other legal entities organized under U.S. laws. The term also includes foreign companies owned or controlled in fact by U.S. nationals or by U.S. companies. Although there is no definition of “control” in the Feingold Amendment, control is generally understood to exist where a person or company has the right or ability to direct the affairs of another company.

The Feingold Amendment does not prohibit incentive payments to foreign persons or foreign companies that are not owned or controlled in fact by U.S. companies. A U.S. defense contractor may therefore make incentive payments to a foreign company to induce that foreign company to purchase goods from a country where the U.S. defense contractor has offset obligations. However, U.S. defense contractors and their subcontractors must be careful to conduct some basic due diligence before making an incentive payment to a foreign company to ensure that the foreign company is not controlled by United States persons.

C. WHAT IS AN INCENTIVE PAYMENT?

The Feingold Amendment defines an “incentive payment” as “direct monetary compensation” paid to a United States person to induce or persuade that person to purchase “goods or services produced, manufactured, grown, or extracted, in whole or in part” in a foreign country to which the U.S. defense contractor has an offset obligation.

It is clear that this language applies to cash payments. It is also clear from the legislative history of the Feingold Amendment that it also prohibits the following:

(i) Payments made by checks;

(ii) The extension of credit; and

(iii) Persuading or causing a bank to extend credit to a United States person at a below-market interest rate.

The Feingold Amendment does not explicitly address giving other things of value to United States persons, such as goods or services. The prevailing view is that U.S. defense contractors should avoid giving anything with direct economic value to United States persons as an inducement for such United States persons to purchase foreign goods or services. For example, the following transactions (and related variations) should be considered to run afoul of the Feingold Amendment when undertaken to induce a United States person to purchase foreign goods or services:

(i) Providing technical assistance free of charge to a United States person;

(ii) Making office space, equipment, and secretarial assistance to a United States person; and

(iii) Providing training.

In light of the potential diversity of such transactions, U.S. defense contractors should carefully review any proposed transaction where goods and in-kind services may be furnished to United States persons in order to earn offset credit.

D. THE ISSUE OF U.S. COMPETITION

The Feingold Amendment does not require that there be any showing of U.S. competition or require that a U.S. company be potentially or actually affected by an incentive payment. Thus, an incentive payment that induces a United States person to purchase foreign goods will violate the Feingold Amendment even if there is no U.S. source for the goods in questions.

II. Government monitoring

Under the Arms Export Control Act, the President is required to report to Congress regarding certain international sales of U.S. defense products. In 1999, Congress enacted the Defense Offsets Disclosure Act in 1999 (the “Disclosure Act”). The Disclosure Act amended the Arms Export Control Act to require the President to report on offset agreements that have been proposed in connection with the export of certain U.S. defense products. Moreover, the Disclosure Act allows the House Committee on Foreign Affairs to request information about offset obligations from defense contractors in connection with any proposed export of major defense equipment.

In addition, the Disclosure Act established the National Commission on the Use of Offsets in Defense Trade (also known as the Presidential Offsets Commission) to study and address all aspects of the use of offsets in international defense trade. The eleven-member Commission, consisting of representatives from both the public and private sectors, is responsible for reviewing and reporting on: (i) current practices by foreign governments in requiring offsets in purchasing agreements, (ii) the nature of offsets offered by U.S. and foreign defense industry contractors, (iii) the impact of the use of offsets on defense subcontractors and non-defense industrial sectors affected by indirect offsets; and (iv) the role of offsets, both direct and indirect, on domestic industry stability, U.S. trade competitiveness, and national security.

In 2000, President Clinton created a parallel President's Council on the Use of Offsets in Commercial Trade (“Council”). Both the Commission and Council consist of the same members, share similar duties (as described in the preceding paragraph) and are funded and administered by the U.S. Department of Defense.

Recently, the Council and the Commission began to collect information from U.S. defense contractors about offsets and how they are satisfied. The amendments to the Arms Export Control Act and the creation of these new organizations demonstrates that the use of offsets in international defense sales has become a high-visibility issue, and will be increasingly subject to official scrutiny.

III. enforcement

The Secretary of State is authorized to enforce the Feingold Amendment, and may impose civil penalties for violations. Each violation of the Feingold Amendment is punishable by a civil fine that may not exceed the greater of (i) $50,000 or (ii) an amount equal to five times the prohibited incentive payment.

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