Who bears the risk of loss in a Foreign Military Sale?

3.1 The Purchaser recognizes that the USG will procure and furnish the items described in this LOA on a non-profit basis for the benefit of the Purchaser. The Purchaser therefore undertakes to indemnify and hold the USG, its agents, officers, and employees harmless from any and all loss or liability (whether in tort or in contract) which might arise in connection with this LOA because of:

3.1.1 Injury to or death of personnel of the Purchaser or third parties,

3.1.2 Damage to or destruction of (a) property of DoD furnished to the Purchaser or suppliers specifically to implement this LOA, (b) property of the Purchaser (including the items ordered by the Purchaser pursuant to this LOA, before or after passage of title to the Purchaser), or (3) property of third parties, or

3.1.3 Infringement or other violations of intellectual property or technical data rights.

3.2 Subject to express, special contractual warranties obtained for the Purchaser, the Purchaser agrees to relieve the contractors and subcontractors of the USG from liability for, and will assume the risk of, loss or damage to:

3.2.1 The Purchaser’s property (including items procured pursuant to this LOA, before or after passage of title to Purchaser), and

3.2.2 Property of DoD furnished to suppliers to implement this LOA, to the same extent that the USG would assume for its property if it were procuring for itself the items being procured.

Section 3 begins by reminding the international partner that the USG’s purpose in the case is not for financial gain. Obviously, the USG believes the sale is in its best interest, but financial profit is not the motivating factor. In recognition of this fact, this condition states that the international partner indemnifies the USG. This means that the international partner agrees to accept the risks of financial liabilities that may arise in the execution of the case.

At first, the requirement for indemnification may seem unfair and appear that the USG is placing undue risk upon the international partner. However, the USG is conducting business on behalf of the international partner in the same manner that the USG conducts business for itself. As a normal business practice, the USG exposes itself to a certain degree of risk. Given the broad range of risks the USG faces, it is less expensive to absorb the occasional loss than it is to purchase insurance to insulate against all these risks. In procurements, the USG may include limitation of liability clauses to relieve contractors from certain liabilities (like acts of God). The reason for limitation of liability contract clauses is to reduce overall procurement costs. If contractors were required to cover all potential risks, they would demand a higher contract price in compensation for being exposed to greater risk.

When it comes to executing cases, the USG faces certain risks just like it does while conducting business for itself. Under the case, the USG is simply requiring the international partner to absorb the risks that the USG would absorb if the actions were conducted in support of a USG requirement. So, in reality, the USG is not asking the international partner to be exposed to an extraordinary degree of risk. The USG is only requiring the international partner to stand in the USG’s place to face the same level of risk that the USG normally faces in conducting business for itself.

Under Section 3, there are two indemnification provisions: (1) international partner indemnifies and holds harmless the USG, its agents, officers and employees and (2) international partner relieves the USG’s contractors and subcontractors of liability. The first indemnification sections are much broader in coverage than the second. The first indemnification provision (3.1) covers injury or death of international partner’s personnel, damage or destruction of DoW property, international partner or third-party property, and infringement of intellectual property. Section 3.2, coverage for USG contractors and subcontractors, extends to damage or loss of international partner’s property and DoW property furnished to implement the case.

Suppose, under an FMS case, an international partner wanted to purchase an excess aircraft and have that aircraft’s avionics upgraded prior to delivery. Following case acceptance, the U.S. awarded a contract for the upgrade, removed the aircraft from storage, and transported it to a contractor for upgrade work. After the contractor completed the work, the contractor’s test pilot flew the aircraft on a functional check flight. During the check flight, a catastrophic problem developed, which caused the aircraft to crash and be destroyed, also causing significant property damage on the ground at the crash site.

In this hypothetical scenario, who is financially liable for the costs? The answer is that it depends. The USG would investigate the crash to determine the cause. In the investigation, the contractor’s contractual responsibility would be examined to determine if contractor non-performance or negligence contributed to the accident. If the contractor would have held some financial responsibility in the case the work was being done for the benefit of the USG, then the contractor would also be held to the same degree of financial responsibility if the work was being performed for an international partner.

If, at the conclusion of the investigation, it was found that the contractor had fulfilled all its contractual requirements and the accident cause was in an area where the USG normally accepts the liability risk, this LOA condition states that the international partner will assume this financial liability rather than the USG or the contractor. Again, this provision simply informs the international partner that they should be prepared to be exposed to the same degree of financial risk that the USG exposes itself to in the normal course of business.