Political instability around the world is creating a boom for U.S. arms exports, and it’s putting the spotlight on the important difference between Direct Commercial Sales (DCS) and Foreign Military Sales (FMS).
The U.S. State Department reports that authorized sales of military hardware, services and technical data to foreign governments hit $153 billion in 2022, up 26 percent from the previous year. (The figures are based on a three-year rolling average that compensates for the multi-year nature of many of these deals.)
Three-quarters of that amount comes through DCS, in which a U.S. company negotiates a transaction with a non-U.S. business or foreign government. The government has no involvement until it receives the application for an export license. And then its role is strictly regulatory, assuring the transaction aligns with U.S. foreign policy and security concerns.
The other 25 percent of sales are through FMS agreements, in which the U.S. government negotiates the deal directly with a foreign government, and then contracts with private-sector businesses to fulfill the terms. These sales typically involve major arms systems and other lethal, high-tech or otherwise sensitive equipment.
For example, in November 2022, the State Department announced its approval of a proposed $700 million sale of Patriot Advanced Capability missiles to Switzerland under the FMS program, for the purpose of “improving national and territorial defense as well as interoperability with U.S. and NATO forces.”
Lockheed-Martin Corp. was identified as the primary contractor, and the deal included an array of additional equipment and services, including telemetry kits, training rounds, spare parts and technical support.
More than 70 such deals were disclosed in 2022 through press releases on the Defense Security Cooperation Agency website. After that, little information about them is made available.
The next step in deals made under FMS authority, the next step is a Letter of Offer Acceptance (LOA) – essentially a contract between the two governments. After that, the Department of Defense issues a contract to the U.S. manufacturer(s) that will fulfill the deal.
The FMS exemption in the ITAR
Prior to 2013, it would have been generally safe to assume that any items being exported through the Foreign Military Sales program were subject to the ITAR – and therefore eligible for a license exemption defined within that program.
It makes sense: Why should a U.S. company need an export license from one part of the State Department to complete a transaction another office in the same department has already approved? For people who routinely work with export regulations, the FMS exemption in the ITAR is pretty simple. It says no export license is needed for transactions authorized under the Foreign Military Sales program if:
- A valid LOA is in place and has not expired;
- The specific transaction is within the scope of that LOA;
- Authorized transportation for the materials has been identified. This might be U.S. military transport, an ITAR-registered freight forwarder or the foreign government’s own transport. (Not a contractor’s own logistics providers.)
Despite its seeming clarity, applying this exemption can pose a practical problem for exporters – especially in later years of an LOA as they fulfill orders for replacement parts, technical support, software upgrades and data. LOAs aren’t published, and often, contractors never even see them. So business operators know they have a contract that’s related to FMS authority, but they may still struggle to determine whether they can use the FMS exemption or need to apply for an export license.
The FMS exclusion from the EAR
Beginning in 2013, the Export Control Reform initiative began transferring control of many military items from the ITAR to the EAR. To avoid confusion over jurisdiction of items sold under FMS authority, a carveout was written into the EAR, saying:
Items that are subject to the EAR that are sold, leased or loaned by the Department of Defense to a foreign country or international organization under the FMS Program of the Arms Export Control Act pursuant to a Letter of Offer and Acceptance (LOA) authorizing such transfers are not “subject to the EAR,” but rather, are subject to the authority of the Arms Export Control Act.
The nuance here is that an item’s classification under the EAR – of central importance in Direct Commercial Sales – is irrelevant under FMS authority. Even if an item would ordinarily be subject to the EAR, the fact that it is being sold through FMS excludes the item from the EAR. So determining whether FMS authority applies becomes a high-stakes consideration.
If this is challenging for U.S. companies, it’s even more difficult for non-U.S. entities that may be involved.
The verification challenge
To understand why, consider the U.S. agencies and offices involved:
Bureau of Industry and Security (BIS), within the U.S. Commerce Department, has administrative jurisdiction over the EAR, and is responsible for export controls of items subject to the EAR, including military goods sold via DCS.
Directorate of Defense Trade Controls (DDTC), within the State Department, has administrative jurisdiction over the ITAR. It’s responsible, among other things, for licensing exports, reexports, and retransfers of defense articles and defense services on the U.S. Munitions List sold via DCS.
Defense Security Cooperation Agency (DSCA), within the Department of Defense, oversees the FMS program and handles details of FMS transactions.
Office of Regional Security and Arms Transfers (RSAT), within the same Bureau of Political-Military Affairs as DDTC at the State Department, manages political-military and regional security relations, and the transfer of U.S.-origin defense articles and services to foreign governments. It oversees reexports and retransfers of items sold through FMS transactions.
So, for entities outside the United States, permission reexport or retransfer items can involve different agencies depending on the type of transaction used for the original export – DDTC for DCS, and RSAT for FMS.
Finding details about the original transaction can be difficult – and only grows more so as time passes. The private companies involved may have never seen the original LOA, and as contractors get replaced and companies get sold, any relevant information can be lost. RSAT doesn’t have the original LOA, and the DDTC doesn’t have people charged with sorting out such inquiries. Currently, there is no regulation for handling such circumstances.
If you’re wrong they’ll let you know
To protect themselves, FMS contractors may try to cover all the bases by applying for an export license for any items in the deal that are subject to the EAR.
The issue has caused enough confusion that in 2021 a group of seven U.S. government offices – including all those listed above – assembled a Joint FMS FAQ document that addresses this and other common questions.
The document warns that if you apply for an export license under the EAR for an item sold through an FMS transaction, the likely response will be a Return Without Action notification (RWA) “because the items described in this proposed transaction were sold by the Department of Defense to a foreign country under the Foreign Military Sales (FMS) Program…”
The document also tries to correct a misconception that you need to receive this RWA as proof that an export is subject to FMS authority: “Exporters are encouraged not to apply for licenses or other authorizations when they know a license is not required from BIS and DDTC.”
How do you know?
- If the item isn’t found on the USML;
- If the item would be subject to the EAR if it wasn’t covered under FMS authority;
- If the item meets the criteria of the FMS carveout in the EAR.
Ascertaining these first two requirements is part of the routine in any military export compliance program. If there’s uncertainty about the third, the multi-agency FAQ starts to sound a bit impatient:
BIS does not administer the FMS Program nor does it enter into LOAs. Therefore, when an exporter is not sure … the exporter is advised to initially contact the Implementing Agency/Line Manager that has implemented the contract … and then, as needed, contact RSAT and/or DSCA to determine whether the export is within the scope of a particular FMS case and an LOA.
The takeaway is that you’re not going to get a document that says, “This item is OK to export or reexport without a license.” Playing it safe means understanding the regulations and maintaining meticulous records related to the contract.
To learn more, consider the Export Compliance Training Institute’s on-demand course, Exporting to the US and Foreign Governments.
Do you have questions about the differences between Direct Commercial Sales and Foreign Military Sales? Visit pwpl.panyao006.com to learn about our company, our faculty, our staff and our esteemed Export Compliance Professional (ECoP®) certification program. To find upcoming e-seminars, live seminars and live webinars and browse our catalog of 80-plus on-demand webinars, visit our ECTI Academy. You can also call the Export Compliance Training Institute at 540-433-3977 for more information. Scott Gearity is President of ECTI, Inc.