Defence Procurements: Utilising Option and Repeat Order Clauses

Defence Procurements: Utilising Option and Repeat Order Clauses

Major General Mrinal Suman

The Defence Procurement Procedure (DPP) has two enabling provisions to facilitate expeditious procurement of additional quantity of equipment that has already been inducted into service – the Option Clause and the Repeat Order Clause. Requirement for additional quantity may arise either to make up existing deficiencies; or to cater for force accretion (new raisings); or to replace equipment lost/damaged. At times, orders are required to be placed on the original supplier for additional major assemblies, sub-assemblies, spares, special tools and test equipment.

The Option Clause

As per Para 39 of Schedule I to Chapter I of DPP, an option clause is included in all contracts signed between the Government and the seller. It empowers the Government to place a follow-up order on the seller for additional quantity of the main equipment, spares, facilities and services within the stipulated period from the date of the signing of the contract. The seller undertakes to sell the additional quantity as per the cost, terms and conditions set out in the original contract. He cannot renege on his commitment. Normally, validity period of this clause is one year from the ‘effective date of the contract’.

As the ‘effective date of contract’ is of critical importance, DPP clarifies that where specifically agreed to by the parties to the contract, effective date may be the date on which any or the last of the following conditions, as applicable, is complied with:-

(a) Furnishing of the performance bond by the seller.

(b) Obtaining of the export license for supply of stores by the seller and a confirmation in writing sent to the buyer within specified days of signing of the contract.

(c) Receipt of bank guarantee for advance payment.

(d) Date of issue of the end user certificate.

Importantly, the additional quantity that can be ordered under this clause is limited to 50 percent of the original order. It is to ensure that the option clause is invoked only for unforeseen requirements and exploited as an easier route for planned procurements. Further, the Contract Negotiation Committee has to verify and ascertain that there is no downward trend in prices of the items involved. As is well-known, prices of computers and other information technology equipment are going down. In such cases, it is beneficial to initiate fresh procurement proposal to seek competitive quotations from multiple vendors rather than invoking the option clause.  

Repeat Orders

According to Para 64 of DPP, repeat orders can be placed on a seller for subsequent procurement of already contracted equipment. They are not construed as single vendor cases. Repeat order cases are allowed under any of the following four categories:-

a)   Additional quantities to make up deficiency in the existing scaling or to cater for the requirements due to new raisings or war wastage rates or sector stores.

b)   Replacement requirements necessitated due to equipment declared ‘beyond economical repairs’ or damages or loss of the earlier equipment.

c)   Need for major assemblies, sub-assemblies, special maintenance tools and special test equipment.

d)   Spares for all levels of maintenance.   

Before placing repeat orders, it has to be ascertained that there are no change in the Services Qualitative Requirements (SQR) and that the repeat quantity does not exceed 100 percent of the previous order. In cases where the quantity exceeds 100 percent, specific approval of the Defence Acquisition Council (DAC) and the Defence Procurement Board (DPB) is required as per their financial powers. However, such restrictions are not applicable for proposals categorised as ‘Buy and Make’ or ‘Make’ or ‘Design and Development’ cases.

All repeat order cases involving minor changes/modifications in the specifications of the earlier inducted equipment are required to be debated by the categorisation committees. Recommendations are to be made either to issue a commercial Request for Proposals (RFP) with validation of the changes/modifications or to initiate a new case by issuing fresh RFP on multi-vendor basis. It is be for DAC and DPB to accord necessary approval. 

In cases where the equipment has been indigenously developed or for which technology has been obtained earlier by a public sector entity, only commercial RFP is required to be issued. Importantly, it should be checked prior to placing further orders that the technology absorption levels agreed to while concluding technology transfer contract have been achieved. DPP has widened the scope of repeat orders by including equipment that has already been procured by a sister service after due process.

Application of the Provisions

Although both the option clause and the repeat order provision provide avenues for the placement of orders for additional equipment, there is a major difference between the two. Whereas option clause is binding on the vendor, he can decline to accept repeat order if he finds it commercially unrewarding.

It is apparent that the option clause carries a cost penalty. As a seller is contractually obliged to supply additional quantity at the old rates, he cannot dismantle his manufacturing/assembly lines. Further, the seller has to keep all his sub-vendors duly geared up for additional orders. He may even be forced to purchase and stock certain critical sub-assemblies and components that are not readily available or whose production is likely to get discontinued.

Unfortunately, both the importance and the vulnerability to misuse of the two clauses have been totally overlooked. The Comptroller and Auditor General of India (CAG) has been repeatedly drawing the attention of MoD to lapses concerning non-utilisation of the above clauses which have been costing the country dear.  

In its Report No. 20 of 2011-12, CAG faults MoD for placing fresh orders at higher rates during the currency of the option clause under which the said items could have been purchased at earlier rates. In March 2008, MoD concluded a contract with M/s Bharat Electronic Limited for the procurement of 204 VLF-HF Receiver at a cost of Rs 32.96 crore with an option to buy 50 percent additional quantity within a period of 12 months. Surprisingly, during the currency of the option period, fresh orders were placed on the same vendor for 24 additional numbers at higher rates; thereby incurring an excess expenditure Rs 68.95 lakh. It was a serious and totally unjustified omission.

CAG has cited two similar cases in its Report No. 17 of 2012-13 (Air Force and Navy). A contract was signed with a foreign vendor for 10 Electro Optic Devices (EOD) in December 2003. The contract had an option clause valid for one year i.e. 17 December 2004 at the old price. As per DPP-2003, applicable at that time, option clause could be invoked even after the validity date with mutually agreed escalation percentage.

  

The Indian Navy moved a proposal for the procurement of 15 additional EOD. MoD accorded approval on 03 December 2004. When approached by MoD, the vendor agreed in March 2005 to supply 15 additional systems at the prices concluded in the contract of December 2003 with 4 per cent escalation up to June 2005. 

The case was received by the Navy in January 2005 and it had five months available for securing the formal commercial offer from the vendor and placement of orders. Inexplicably, the Navy took no action at all. Worse, it decided to process the case under DPP-2005 which was to come into effect in July 2005. It was a bizarre decision – the Navy wanted the equipment expeditiously, yet it chose not to exercise the most straightforward option.    

A perusal of the fallout of the Navy’s weird decision is very instructive. As the offer of the vendor had expired, it was decided to place an order on HAL which had already installed four EOD systems on aircrafts manufactured by it. The case had to be recategorised as ‘Buy Indian’ and the approval of the Defence Minister obtained as regards deviation with respect to the minimum indigenous content.

A contract with HAL could only be signed in January 2010, after a delay of five years. It also entailed an extra expenditure of Rs 10.95 crore. Thus the failure to exploit the benefits of the option clause deprived the Navy of the operationally required equipment for more than five years and cost the national exchequer considerably more. 

The second case pertains to the procurement of fuel barges for the Navy; wherein non-exercise of the option clause resulted in an extra expenditure of Rs 2.94 crore. A contract was concluded by the IN with M/s Shalimar Works Ltd, Kolkata in November 2007 for procurement of two fuel barges at a unit rate of Rs 16.04 crore. The contract carried an option clause which gave the purchaser a right to place a separate order on the same builder for one more barge at the same terms and conditions within one year from the effective date of contract i.e. up to November 2008.

Instead, MoD issued RFP for procurement of five fuel barges to 14 indigenous shipyards in June 2008 i.e. well before November 2008 deadline for exercising the repeat order option in the November 2007 contract. Subsequently a contract with M/s Modest Infrastructure was concluded (November 2009) with each barge costing Rs 18.98 crore a piece. Had the option clause of the earlier contract been invoked, MoD could have got at least one barge at the old rate, thereby affecting a saving of Rs 2.94 crore.  

CAG has regretted that MoD had either given unsatisfactory replies to the above observations or not responded at all. It has advised MoD to impress upon the procurement authorities to ensure that option clauses are exercised effectively and are not allowed to lapse in a routine manner.

The Way Forward

Whereas the repeat order rule is a facilitating provision without any cost implication, the option clause carries a significant cost penalty. Unfortunately, there is a general misconception that option clause is an insignificant provision and is of little consequence unless invoked.

As the defence industry is highly technology intensive, production of older models gets discontinued and newer models take their place at a rapid pace. Needless to say, it is a costly exercise for any sub-vendor to switch back to the production of the older models to cater for the option clause orders. Therefore, if a buyer wants to retain the right to order additional quantities at the old rates, the seller factors in the extra expenses involved in his initial quote. It implies that the option clause should not be included as a matter of routine in all contracts. It should be a well considered decision.

Procurements under the option clause and the repeat orders must be explored as the first alternative as they provide the following significant advantages:-

a)   It is generally the cheapest alternative as payments are made at the earlier prices. Since inflationary trends are impacting most items, considerable savings are affected.

b)   It results in most expeditious supplies.

c)   As no trials to evaluate performance attributes are required, significant effort and resources are saved.

d)   By procuring additional quantities of the already inducted equipment, inventory management becomes easy. In many cases, need for new jigs/fixtures and support facilities gets obviated. 

Finally, a word of caution will be in order. Total requirement should be purchased in one order to obtain benefits of economies of scale. The option clause and the repeat order facility should not be misused to split the total quantity to bring it within the powers of the competent financial authority. That will amount to a breach of fair procurement practices and go against the basic spirit of the procurement procedure.