Arbitration in the defense/military sector

The surge of dual-use technology and defense expenditure 

Defense spending is on the rise. Triggered by the Ukraine war, shifting transatlantic policies, and a broader reassessment of global security risks, States worldwide are accelerating procurement efforts and expanding industrial capacities.

The European Commission's "ReArm Europe/Readiness 2030" plan, aimed at mobilizing €800 billion, and the SAFE (Security Action for Europe) budget initiative, under the framework of the European Defence Fund (Regulation 2021/697) with an an overall budget of €7.953 billion for the 2021-2027 period,^[imply a strong commitment toward joint procurement, scaled production, and the creation of strategic stockpiles. NATO allies have adopted the 2025 Hague Summit Declaration, which sets an ambitious defense spending target of 5% of GDP by 2035. Even countries that historically have fallen short of NATO's former 2% GDP target, such as Spain, have made good progress to meet this milestone by successfully implementing its 2025 Industrial and Technological Plan for Security and Defense.

In September 2025, the European Commission updated the list of dual-use products incorporated into Annex I of Regulation (EU) 2021/821, which imposes export control of those items, software and technology such as quantum technology, semiconductors, advanced circuits and electronic assemblies on all Member States —see  Post | Update of EU dual-use products and technologies list—.

Against this backdrop, major military contracts are being procured across key areas including air and missile defense (Patriot, IRIS-T, SAMP/T), artillery and rocket systems (PzH 2000, CAESAR, HIMARS), military mobility, ammunition, drones and counter-drone systems, maritime vessesls and equipment, infrastructure protection, ISR/space capabilities, cyber defense, and industrial resilience.

This conforms a pipeline of large, technical, and transnational programs, marked by complex supply chains, industrial participation obligations, and reliance on dual-use technologies, which gives rise to potential conflicts at multiple layers of stakeholders, such as government-to-governemnt (G2G), government-to-prime contractors (G2B), and prime contractors-subcontractors supply chains (B2B).

Defense contracting typically leads to procurement disputes with procurement administrations, often resolved before national courts. However, issues related to performance and termination may be referred to international arbitration. In addition, contractors commonly resort to arbitration to regulate their private downstream international relationships.

Arbitration disputes in the defense/military sector

In recent years, the defense sector has experienced an increase in arbitration disputes, garnering attention in the media. The Ukrainian Ministry of Defense has been involved in numerous arbitrations against foreign contractors on allegations of deficient delivery of critical military equipment, including bulletproof vests, protective gear, and ammunition supplies. The Indonesian Ministry of Defence has acted in an arbitration over the development of communication satellites and ground facilities for dual-use purposes. French and Japanese aerospace contractors have disputed the assignment of rights for the sale of two surveillance aircrafts and their spares. A German contractor has initiated arbitration against the Greek Army concerning the supply of tanks. Similarly, the Greek Navy has pursued arbitration against shipyards based in Germany and the United Arab Emirates for the procurement of submarines.

Given their nature, defense contracts are susceptible to political shifts, allegations of corruption, and regulatory constraints, frequently leading to complex disputes. As this industry has become more global, the incidence of cross-border disputes has increased, highlighting the strategic importance, high value, and national security implication of defense contracts. 

Commercial disputes generally arise from contractual obligations, operational challenges, and compliance with defense-specific standards. Key categories include:

• Compliance with "flow-down" mandatory clauses included in main contracts. Subcontracts often incorporate mandatory compliance obligations (e.g., security, export controls, ethics, audits, intellectual property, quality assurance, counterfeit parts prevention, cybersecurity) that are required by the main contracts. These obligations align with the legal and regulatory framework established by the end-client’s military procurement regime (e.g., the Spanish PECAL standards, the European Union Defense & Security Procurement Directive (2009/81/EC), NATO AQAP standards, the American FAR/DFARS frameworks, the UK DEFCON/DEFFORM requirements, or the Australian ASDEFCON standards). Compliance with these flow-down obligations may lead to interpretative and performance conflics in the form of back-to-back commitments.
• Compliance with export controls and security standards. Violations involving classified data, export licenses and prohibitions, or security standards pose additional legal challenges, with remedial and jurisdictional complexities. In this context, allegations of rebus sic stantibus, hardship or force majeure under the applicable law may be raised by contractors. In Spain, the Royal Decree-Law 10/2025, effective as of September 25, 2025, has imposed restrictions on trade and activities involving Israel, including a ban on transfers of defense materials, dual-use products, and technologies to or from Israel —see Post | News developments in foreign trade with Israel—.
• Offsets and industrial participation obligations. Offset agreements refer to obligations imposed on defense suppliers to invest in the purchasing country's economy as part of the procurement deal. These agreements serve as a strategic tool for buyer nations to derive additional value from defense contracts, often including technology transfers, local industrial participation, co-production, and other benefits aimed at enhancing the local industrial and economic base. These type of covenants often give rise to friction points and contractual performance disagreements.
• Scope and change-control issues. Ambiguities or changes in requirements, mid-project adjustments, and reliability challenges often lead to claims for constructive change and equitable adjustment. These issues trigger disputes between prime contractors and subcontractors in large, intensive projects.
• Joint venture conflicts. Disputes between contractors of joint ventures, especially in multinational collaborations, highlight the difficulties of managing shared objectives towards an end-client.
• Quality, service, and warranty claims. Defense equipment must meet stringent quality and service requirements. Disputes often arise when performance or reliability falls short of these standards, leading to warranty claims.
• Schedule and performance. Delays caused by supply-chain disruptions, immature technologies, or regulatory hurdles (e.g., licensing delays) often result in penalties like liquidated damages, default notices, or implementation of corrective plans.
• Intellectual property and data rights. Issues may emerge over ownership, usage, and transfer of technical data during sustainment or modernization programs.

On the other hand, investment disputes may arise from regulatory shifts or State actions, rather than operational issues. Common triggers include:

• Revocation of export licensing and approvals, or exclusion from public tenders. Denial, or abrupt policy changes regarding export licenses, tender requirements, localization, or offset agreements often frustrate investor expectations. Claims may allege indirect expropriation, lack of fairness, or discriminatory administration, while States defend themselves invoking essential security powers.
• Sanctions-driven measures. Sanctions involving contract cancellations, asset freezes, or blocked payments can lead to arbitration. Investors argue against host State actions under applicable international laws, while States may assert their right to regulate. In this context, the sanctions package under Council Regulation (EU) No 833/2014 of 31 July 2014, which concerns restrictive measures in light of Russia's actions destabilizing the situation in Ukraine, and its subsequent amendments, prohibits trade of military or dual-use equipment with Russian counterparts.
• Ownership and control regulations. Defense sector investments often undergo rigorous foreign investment screening, national security reviews, and compliance with changing ownership restrictions. Disputes focus on due process, proportionality, and non-discrimination.
• Regulatory changes and stabilization clauses. Governments sometimes alter the economics of defense arrangements through new legislation or executive measures. However, stabilization clauses in contracts or industrial agreements may be invoked to protect against such changes.

Practical tips for in-house counsel

To prevent future disputes and succesfully defending prospective claims, it is crucial to take proactive approach and adopt specific measures, such as:

• Establish a claim management framework from day one. Develop a comprehensive protocol aimed at systematically identifying and documenting potential constructive changes, delay events, and reliability concerns. Ensure the maintenance of contemporaneous records and the quantification of any impacts throughout the prime–subcontractor chain. Additionally, proactively preserve legal positions including force majeure, hardship, or rebus sic stantibus provisions to safeguard contractual rights and address unforeseen circumstances effectively.
• Map out flow-down mandatory clauses effectively. Ensure precise flow-down of mandatory clauses from the end-client to subcontractors. Mirror the end-client's contractual requirements in all subcontracts and establish regular compliance audits to prevent interpretative ambiguities and performance conflicts.
• Reinforce joint venture governance. For multinational collaborations, implement clearly defined decision-making rights, escalation protocols, and exit frameworks. Tailor these mechanisms to accommodate the unique delivery pressures imposed by sovereign end-customers.
• Strengthen change-adjustment discipline. Require written approvals and pricing for requirement changes and mid-project adjustments to pre-empt constructive change and equitable adjustment disputes.
• Monitor sanctions with kill-switches. Track EU and other sanctions (e.g., EU 833/2014) and embed automatic suspension/termination and payment-block clauses to address any adverse impacts arising from such sanctions.
• Guarantee regulatory compliance, and minimizing legal and operational risks. Adopt internal compliance programs (ICP) involving export controls must also be adapted to ensure that internal procedures reflect the new regulatory requirements in line with international and EU guidelines. Reclassify products and technologies, and carefully review new entries included on the list, e.g., categories 3A501, 3B501 and 4A506. Training relevant departments and areas -e.g., engineering, sales and logistics- on the key changes introduced in the regulation.
• Draft arbitration-ready contracts across the stack. Establish uniform arbitration clauses across prime contracts, key subcontracts, and supplier agreements. This uniformity ensures coherent and streamlined dispute resolution pathways throughout the contractual framework.
• Preserve valuation evidence for regulatory disputes. Keep contemporaneous financial models and records to support valuation at the time of any adverse regulatory action.
• Integrate cross-functional teams. Align expertise across public law, compliance, and arbitration to proactively address the intersection of regulatory, geopolitical, and commercial risks.