Leasing Holds Promise for Vendors and Services

Leasing can undoubtedly be a cost-effective tool for augmenting military capabilities but may not be suitable in all cases. Leasing as a mode of procurement only aims at striking a balance between the operational requirement of the Services and the commercial interest of the A&D industry in the face of growing financial constraints and delay in normal acquisitions.

One of the highlights of the Defence Acquisition Procedure 2020(DAP-2020), promulgated by the Ministry of Defence (MoD) on September 30,is mainstreaming of leasing as a mode of acquiring military assets from the Indian and foreign vendors, which was earlier resorted to only by way of an exception. There is a full-fledged chapter in the DAP-2020 detailing the procedure and documents related to leasing of unused and previously used assets.

Leasing has been categorized in the DAP-2020 as a procurement category, with two sub-categories to distinguish between the source of acquisition: Lease (Indian) and Lease (Global). This category is in addition to various existing variants of the ‘Buy’ and ‘Make’ categories. However, what makes leasing unique is that while all other procurement categories result in ownership of the asset by the MoD/Services, leasing provides them the option to either own, or to return, the asset after the lease period is over.

In relaxation of the general principle of dealing directly with the Original Equipment Manufacturers (OEMs)followed in normal acquisition cases, MoD will also be willing to make lease arrangements with the government of the OEM’s country or even the third-party financiers of the Lessors. Consequently, the lease agreement/contract will require coordination between a leasing firm, its financiers, OEM and/or the government of the OEM’s country. This may add to the challenges faced by those responsible for finalizing such agreements, but these are not insurmountable.

Leasing is not new and considerable expertise already exists in the MoD/Indian Navy (IN) which had leased a Charlie-I class nuclear attack (SSN) submarine in 1988 for three years from the erstwhile Soviet Union and commissioned it as INS Chakra. More than a decade later in 2011, it again leased a submarine -this time an Akula-class SSN submarine- from Russia. This submarine, also christened as INS Chakra, was commissioned in the IN on April 4,2012. Its ten-year lease expires in 2022, but it may possibly be extended at least till the second Akula-class submarine is delivered in 2025, for which a $3 billion Inter-governmental Agreement (IGA) was signed with Russia in March 2020.

In the face of persistent shortage of funds for capital acquisitions, leasing can reduce the pressure on the capital outlay, but it may necessitate higher allocations under the revenue segment of the defence budget if the lease rentals are to be treated as revenue expenditure. The DAP-2020 does not seem to be very clear on this count, but it is an important issue that must be clarified quickly. That said, irrespective of whether the rentals are paid from the revenue or the capital budget, the initial (first payment) may not be as insubstantial as seems to be the general impression.

This is because the DAP-2020 provides for payment of a ‘commitment fee’ by the lessee (MoD/Services) to the lessor (the vendor) as a consideration for taking the asset off the market to make it available for lease. This fee may have to be paid by way of an advance payment (up to 15%), in which case it may entail a substantial cash outgo at the initial stage also, but it can also be paid by way of increased rate of initial payments or as per the mutually agreed terms. The initial cost may also go up on account of modifications/de-modifications in the asset to make it useful for the Services. These tricky issues will need to be carefully handled while establishing cost-effectiveness of acquiring the assets on lease, soliciting offers and later during commercial negotiation.

Leasing can undoubtedly be a cost-effective tool for augmenting military capabilities but may not be suitable in all cases. The DAP-2020 mentions the following situations in which leasing may be preferred:

  • Where procurement is not feasible due to time constraint.
  • Where the asset/capability is needed for a specific time or would be under utilised if procured.
  • Where smaller numbers of assets are needed, and administrative/maintenance infrastructure expenditure would be high.
  • When service life lease rentals are a better option compared to a one-time acquisition cost.
  • To gain experience for operational exploitation of equipment.
  • Due to operational necessity.

Leasing will help the Services in augmenting military capabilities and open new business opportunities not only for the Aerospace & Defence (A&D) industry but also the financiers. It will, however, be naïve to expect that procedurally leasing would be easier and quicker than the normal acquisition cycle. As per the DAP-2020, proposals for leasing of assets will have to go through the following stages which are almost the same as for the normal acquisition proposals:

(a)Request for Information (RFI).

(b) Identification of Equipment and Operational Demonstration to identify the equipment that best meets the capability sought.

(c) Preparation of Leasing Operational Requirements (LOR).

(d) Obtaining of Acceptance of Necessity (AoN).

(e) Solicitation of offers (by issuing Request for Proposal).

(f) technical Evaluation Committee (TEC).

(g) Contract Negotiation Committee (CNC).

(h) Approval by Competent Financial Authority (CFA).

(j) Signing of Lease agreement.

(k) Post lease management.

While firming up the proposal, the Services will also need to decide whether to go in for Operating Lease or Finance Lease. An Operating Lease enables the lessee (MoD/Services) to use the asset for a specific period -typically less than its useful life, though the DAP-2020 does not specifically say so- without having to own it or to acquire its ownership at a pre-determined price at the end of the lease period. It could be a Dry lease in which only the asset is leased, or a Wet lease in which the lessor provides the asset, crew, maintenance and insurance to the Lessee.

The most recent example of a wet operating lease is the acquisition of two non-weaponized General Atomics Aeronautical Systems MQ-9 Sea Guardian unmanned aerial vehicles (UAVs) by the IN in November 2020 from the US for one year, though it is not very clear if this lease agreement has been signed under the DAP-2020.

These drones will augment the IN’s surveillance capabilities and could also be used to monitor developments along the Line of Actual Control (LAC). Maintenance and other technical support for these drones will be provided by General Atomics, but the IN will have full control over their operational deployment and the information gathered by them.

Operational lease is distinct from the Finance Lease which too is allowed by the DAP-2020. Under a Finance lease agreement, the Lessee pays the entire value of the asset over the term of the lease -typically covering the entire or the major part of its useful life, though this too is not specifically mentioned in the DAP-2020- and acquire its ownership at the end of the lease period for a nominal predetermined payment -also known as the balloon amount- or return it to the Lessor,

Realizing its potential, the IN and the Indian Air Force (IAF) seem to be  exploring the feasibility of  leasing UAVs, Surveillance Aircraft, Operational Support and Auxiliary Vessels, Mine-Sweepers, Light Utility Helicopters, Training Aircraft, Light Utility Helicopters (LUH), and Mid-air Refuelling Aircraft, for which the Request for Information also seems to be have been issued to the prospective vendors to make the platform available on wet/ dry lease. The Indian Army (IA) also needs to follow suit.

Leasing holds promise, but there is an apprehension in some quarters that it would facilitate indirect entry of the foreign vendors. They are worried that the Services may become dependent on leased military assets and eventually end up buying them from the Lessors rather than acquiring them through open competition involving other OEMs who may have similar products to offer. The argument has some merit, but the OEMs need not be too apprehensive as everyone will get an opportunity to offer the product for lease. In any case, assets needed in large numbers and on regular basis are unlikely to be acquired through lease arrangements. Leasing as a mode of procurement only aims at striking a balance between the operational requirement of the Services and the commercial interest of the A&D industry in the face of growing financial constraints and delay in normal acquisitions.

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