Financial and Legal Implications of Iran's Cancellation of Arms Purchase Agreements

Questions were raised by members of Congress concerning the recent cancellation of foreign military sales contracts by the Iranian government, the legal requirements of the foreign military sales program, and the fiscal responsibility and liability of the United States for cancelled contracts. The report responds to these questions and provides financial information from the accounting records of the Department of Defense (DOD) concerning the sales program.

On February 3, 1979, the Iranian government cancelled $6.6 billion of its $12.6 billion of undelivered military sales orders. Regulation permits foreign governments to purchase Defense articles and services provided that they agree to pay the full amount of all contracts entered into on their behalf, and they must agree to meet progress payments required by the contractor and to cover any damages and costs arising from the cancellation of a contract entered into for them. However, foreign countries are only required to make such payments at the time they are due, as opposed to making them at the time they accrue. These funds are placed in a trust fund, which, in the case of Iran, was estimated at $640 million when the sales orders were cancelled. By June 30, 1979, this amount was estimated at $112 million, with the current disbursement rate being about $125 million a month. Controls do exist in the contract administration process of DOD to insure that payments from the trust fund are made only for justifiable contractor costs. However, for years, DOD has experienced serious accounting and financial management problems with regard to the foreign military sales program. Some of the production contracts have not been entered into and some that have, have been diverted to second buyers, thus avoiding potential termination costs estimated at $245 million. However, if DOD stops making payments to defense contractors, the likely result would be the filing of lawsuits against the U.S. for the unpaid amounts, and the liability of the U.S. would have to be resolved in the courts.

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