Despite the strength and resilience of the defence industry, it is not immune to the effects of COVID-19. How companies in or associated with the sector adapt to the new circumstances and manage their business and legal risks could make the difference between those who fail, survive and thrive.
The defence sector is being shielded from the worst effects of the pandemic because of its strategic importance, with governments across the globe continuing their existing defence programmes, many of which are typically long term in nature. In the MENA region, governments’ defence spending commitments in, for example, the UAE and Saudi Arabia, have remained robust due to the fact that they engage large contracts with other governments or foreign manufacturers as in the case of foreign military sales.
Risks and challenges defence sector companies are facing due to COVID-19
But despite the resilience of the sector, the impact of COVID-19 on defence supply chains has been noteworthy. For example, there are emerging examples of the region’s defence programmes being affected by delays caused by supply chain, logistics and related disruptions.
There are also other emerging risks, including defence companies not meeting their contractual obligations as a result of COVID-19. This includes clients being able to vary, suspend or even terminate these contracts under either certain clauses (e.g. force majeure or frustration) or statutory protections, depending on the governing law (for more on the implications of COVID-19 on commercial contracts, see our briefing). Meanwhile, with MENA’s defence sector moving to performance-based contracting, the effective management of contractual obligations has become even more important, especially for those companies providing ancillary technology and support services, such as maintenance.
Companies may also be facing workforce issues. Employees themselves may be suffering from COVID-19 while travel restrictions have so far prevented foreign workers employed with defence companies from returning to the Gulf region (though such restrictions may be lifting in the UAE now). As a result, companies are grappling with challenges around working from home, such as operating in different time zones and having access to only limited resources (for more on these and other workforce management issues, see our checklist).
In addition, for foreign workers who remain out of the country for prolonged periods, their work visas may expire and, based on their activities, they could end up creating a permanent establishment in countries where their employer has no presence, which may have tax consequences (see our blog on cross-border home working).
It is important to set the impact of COVID-19 in the context of wider geopolitical trends, most fundamentally the underlying retreat from globalisation. The effects of the US-China trade war, together with stringent US export controls and foreign investment restrictions, could create potential risks around blending of US and Chinese technologies.
We are also seeing the region’s competition and financial regulators continuing their work and so, despite some flexibility in terms of timing, the rules themselves still stand. Companies will therefore need to monitor carefully compliance risks, and any risks that may arise from contractual breaches during and in the immediate aftermath of the COVID-19 crisis.
Managing business and legal risks
To manage these risks, defence sector companies operating in MENA need to strategise, collaborate with home governments, and innovate.
We are seeing proactive steps through government support to protect defence manufacturers. For example, Canada has re-negotiated a multi-billion USD contract with Saudi Arabia and lifted a freeze on licenses for defence exports to the Kingdom.
To prevent contractual breaches arising from COVID-19 effects, we are seeing some close collaborations between governments and manufacturers. For example, the EU has suspended the requirement to compete for defence contracts when it is in the interests of national security.
Similarly, in MENA, efforts are accelerating to build domestic defence supply chains. For example, Saudi Arabia is aiming to increase local military spending from the current level of 5 per cent to 50 per cent by 2030. Companies that capitalise on these opportunities when others may be focused more on immediate COVID-19-related issues may be more likely to prosper.
Economic stimulus programmes and other opportunities
Foreign defence companies in the region can also manage risks by looking for ways to access and benefit from the economic stimulus packages introduced in Gulf countries in response to COVID-19. For example, the UAE central bank committed 50 billion dirhams to a zero-cost facility that provides financial relief to private sector companies, SMEs and individuals resident in the UAE. Other measures include reductions to interest rates and the extension of deadlines for the filing of tax returns.
Meanwhile, the Saudi government has announced a set of support packages targeting the private sector, totaling almost $48 billion. The packages include: exemptions and the postponement of some government dues ($18.6bn); $13.3bn to support the banking and SME sectors; a $13.3bn allocation to ensure that government dues to the private sector are paid in a timely manner; and a wage subsidy of 60 per cent (up to SAR 9,000 per employee per month) of Saudi employees’ salaries in the private sector, up to a ceiling of $2.39bn. There are also numerous tax related-measures, including extending deadlines for filing tax returns and paying those taxes.
Despite the inherent strengths of the sector, defence companies – including those in the MENA region – are still feeling the effects of the geopolitical, economic and social fallout of the pandemic. So it is vital that defence companies think carefully about understanding the relevant business and legal risks and putting appropriate measures in place to manage them and capitalise on key opportunities the crisis presents.
Co-authors and other recognitions
We thank our co-authors of this article, Omer Tauqir (KPMG Head of Defence for KSA and the Levant) and Shiraz Sethi (DWF Middle East LLP Regional Managing Partner and Co-Head of Employment).
This article is based on comments made at a collaborative webinar held on 21 April 2020. We are grateful to the speakers who inspired this article: Freshfields Partners (Jane Jenkins, Sami Tannous, Fares Al-Hejailan, Nabeel Yousef) and Freshfields Counsel (Kate Gough); KPMG (Omer Tauqir, Simon Pilkington, and Mohamed Araji); and DWF Middle East LLP Regional Managing Partner and Co-Head of Employment, Shiraz Sethi.
This article is for information purposes only and should not be construed as or relied upon as professional advice.