The Law Society & Ors, R (On the Application Of) v The Lord Chancellor

This is the judgment of the Court, to which all its members have contributed, on an appeal from the judgment of the Divisional Court (Laws LJ and Cranston J) at [2015] EWHC 295 (Admin). In that judgment, the Divisional Court dismissed claims for judicial review of the decision of 27 November 2014 by the Lord Chancellor (“the November 2014 decision”) to introduce a tendering process for 527 contracts for solicitors to provide Duty Provider Work (DPW) across England and Wales, to advise criminal suspects at local police stations and, in certain circumstances, at magistrates’ courts. For ease of reference, we will refer to the appellants as the claimants, as in the Divisional Court (the London Criminal Courts Solicitors’ Association and others being the first claimants and the Law Society the second claimant).

The Lord Chancellor’s decision to introduce 527 DPW contracts is one part of wider reforms of the legal aid system in the area of criminal law, according to which fee reductions of 17.5% are to be introduced alongside a restructuring of the market for provision of legal services. In very summary terms, the limited number of new DPW contracts proposed will provide a flow of work under each contract which it is hoped will encourage consolidation of providers in the market, so that they are able to absorb the reductions in fees by taking advantage of economies of scale and by being able to deal with a wider spread of cases which will allow providers the better to average out profit-making and loss-making cases so as to realise overall profits on a ‘swings and roundabouts’ approach.

Whether this will in fact be the effect of the reforms is very controversial. It is strenuously contested by the claimants. They say that the Lord Chancellor has not made a proper and lawful assessment of the likely impact of his proposed reforms on the legal services market: his assessment is based on a number of unsustainable and irrational assumptions.

At the centre of the claimants’ case is the contention that, in his assessment, the Lord Chancellor has simply left out of account an important element of costs which will have to be incurred by providers in restructuring their affairs to put themselves into a position to bid for and implement the proposed DPW contracts while sustaining their own commercial viability. We will refer to these costs as “investment costs”: they include the costs of funding any increased working capital needed to provide a service under larger DPW contracts, costs involved in achieving staff efficiency levels implied by the proposed contracts and costs involved in achieving consolidation to bid for and implement those contracts. The Lord Chancellor has set as one objective of his reforms that the DPW contracts should be large enough in volume and value to be “sustainable in their own right” and in his assessment that objective will be fulfilled in relation to the proposed 527 contracts. However, the appellants contend that by leaving investment costs out of account in the way they say he has done, the Lord Chancellor has acted unlawfully and could not rationally conclude that his objective that the DPW contracts be sustainable in their own right will be met.

In the Divisional Court, Laws LJ made the following introductory remarks to set the present dispute in context, which we gratefully adopt:

“1.

These applications concern proposals by the Lord Chancellor to make profound changes in the market for the provision of criminal legal aid services by solicitors. The essence of the policy is the introduction of two types of contract to be entered into between his department, through the Legal Aid Agency (LAA), and the profession: contracts for Own Client Work (OCW) and contracts for Duty Provider Work (DPW). OCW consists in cases where the client comes to the solicitor because he chooses to engage that firm. DPW consists in casework carried out by solicitors on duty at local police stations (and in some circumstances magistrates courts), where they advise and represent persons detained or brought there. Under the existing regime some 1600 Standard Crime Contracts are in place, under which firms carry out both kinds of work.

2.

The Lord Chancellor does not intend to impose any limit on the number of OCW contracts, and some 1808 such contracts were awarded in June 2014 and are due to be operated from summer 2015. But by his decision of 27 November 2014, sought to be challenged in these proceedings, he proposes to restrict the number of DPW contracts to 527. Alongside this dual contract system the Lord Chancellor introduced a cut in legal aid fees of 8.75% on 20 March 2014, and a further cut of 8.75% is now planned for July 2015.

3.

There are two sets of proceedings, though their target is the same and the proposed grounds of challenge tend to converge. Both are applications for permission to seek judicial review of the November 2014 decision. In the first there are four claimants, the London Criminal Courts Solicitors Association, the Criminal Law Solicitors Association, Nelson Guest & Partners and Payton's Solicitors. I shall refer to them compendiously as the first claimants. The Law Society is the claimant in the second application. The Lord Chancellor is the defendant in both. Directions have been given in both claims (by Holroyde J in the first on 19 December 2014 and by Jay J in the second on 22 December 2014) for an expedited rolled-up hearing of the permission applications with the substantive judicial review to follow if permission granted. On 23 December 2014 Jay J ordered that the tender process for the DPW contracts should be suspended until after judgment in the proceedings.

4.

The principal focus of both claims is the Lord Chancellor's use, in arriving at his decision, of a Report published in February 2014 which he had commissioned from KPMG and which I will describe in greater detail. The figure of 527 DPW contracts was derived from a model developed in the KPMG Report. The model proceeded on various assumptions. KPMG gave warnings about unknowns and uncertainties inherent in the model's application, in particular as regards the need for investment finance that would be required for firms to achieve improved staff efficiency and to restructure or consolidate: these were, and are, evolutions seen as essential to the dual contract scheme.

5.

The Law Society's principal complaint, advanced by Miss Dinah Rose QC, is that the Lord Chancellor's adoption of the 527 figure ignores the fact that the KPMG assumptions (especially what may be called the "break-even" assumption: see further below) take no account, as KPMG themselves made clear, of the cost of the investment finance which would be needed for firms to improve efficiency and restructure or consolidate to meet the challenge of the new system; that the Lord Chancellor misunderstood (or failed to take into account) what KPMG were saying about investment finance; and that since receiving the report he has taken no steps to inform himself of the likely realities, for example by obtaining information from financial institutions, against a background in which there was substantial evidence that law firms would find it difficult to obtain funds. Miss Rose also submits that the Lord Chancellor's response to the difficulty – a reliance on support packages – is flawed, principally in relation to his proposals for interim payments.

6.

… [Laws LJ referred here to the arguments below for the first claimants, which have been refined for the purposes of this appeal: see below] ….

7.

Aside from the point on [Article 1 to the First Protocol to the European Convention on Human Rights – “A1P1”], the challenge falls under two heads of claim. (1) There is a breach of the Lord Chancellor's duty articulated in Tameside [1977] AC 1014 (per Lord Diplock at 1065) to "ask himself the right question and take reasonable steps to acquaint himself with the relevant information to enable him to answer it correctly". (2) The decision has been unfairly arrived at and is unreasonable. …

8.

This is not the first judicial review directed to this policy initiative by the Lord Chancellor. On 27 February 2014 he issued an earlier decision, to the effect that there would be 525 DPW contracts. The first 8.75% cut in criminal legal fees was announced at the same time. The 525 figure, like the later 527 figure, was based on KPMG's model. The assumptions on which it proceeded and which were set out in the KPMG Report were largely developed by the Ministry of Justice in light of a Report from Otterburn Legal Consulting LLP commissioned by the Law Society. KPMG's Report, together with the Otterburn Report, was as I understand it published at the same time as the February decision (it was re-issued on 11 March 2014). This earlier decision was challenged before Burnett J, as he then was, on the ground that fairness required the Lord Chancellor to disclose the Otterburn and KPMG Reports so that representations might be made as to their contents; that had not been done before the decision. There was also a challenge to the proposed cut in criminal legal fees. Burnett J rejected the latter complaint, but held (with respect, plainly correctly) that the Otterburn and KPMG Reports should have been disclosed for consultation. His judgment was given on 19 September 2014 ([2014] EWHC Admin 3020). He quashed the Lord Chancellor's decision of February 2014 to provide for 525 DPW contracts. His account of the background to the case at paragraphs 8 – 31 is very clear and full, and should be read with this judgment: [this is appended as Annex A to this judgment, as Laws LJ appended it to his].“

The Divisional Court handed down its judgment on 18 February 2015. Permission to appeal was granted by Moore-Bick and Sales LJJ at an oral hearing on 27 February. The appeal hearing was expedited. In the meantime, the interim relief ordered by Jay J was extended.

The arguments for the second claimant on the appeal were again advanced by Miss Rose QC. They revolved around issues relating to the extent, if at all, that the Lord Chancellor took into account the investment costs which would need to be incurred by providers in restructuring in order to bid for and then deliver services under the new DPW contracts. These were the same issues which were identified by Laws LJ at para. [53] of his judgment in the Divisional Court:

“1)

Did the Lord Chancellor squarely understand that the break-even assumption [i.e. a particular assumption in the KPMG Report that service providers under the proposed DPW contracts would make profits of at least 0.1%] made no allowance for investment costs? If he did not (as the claimants assert he did not), he would have misapprehended a significant dimension of the KPMG material. (2) Should the Lord Chancellor have taken steps to investigate the likely impact of investment costs on firms which might bid for DPW contracts? More accurately: was it perverse not to do so? (3) In the circumstances, are the Lord Chancellor's proposed measures of support (notably interim payments) legally sufficient (in Wednesbury terms)?”

The Divisional Court held (1) the Lord Chancellor did understand that the break-even assumption in the KPMG Report made no allowance for investment costs (paras. [54]-[55]); (2) the Lord Chancellor acted reasonably in declining to investigate the likely impact of investment costs further than he did (paras. [56]-[62]); and (3) the Lord Chancellor’s proposed measures of support, in particular in the form of interim payments of legal aid fees, were legally sufficient in Wednesbury terms to address the issue of investment costs (paras. [63]-[74]). On this appeal, Miss Rose submits that the Divisional Court erred in its conclusion on each of these points, though we think it is fair to say that the main emphasis of her submissions was on her challenge to the conclusions in relation to questions (2) and (3).

On the appeal, the arguments for the first claimants were presented by Mr Swift QC. Mr Swift adopted Miss Rose’s submissions and made some additional submissions to challenge certain other assumptions made by KPMG in their Report and adopted by the Lord Chancellor in his November 2014 decision. Mr Swift maintained that the Lord Chancellor had attached insufficient weight to representations made by solicitor firms regarding what they maintained was the unreality of the assumptions made and had acted irrationally by accepting and proceeding on the basis of the assumptions. On this part of the case, Mr Swift took issue in particular with paras. [79]-[82] and [88]-[89] of the judgment of the Divisional Court, in which it rejected similar submissions made below.

In the Divisional Court, the first claimants also advanced submissions based on A1P1. The claim based on A1P1 was rejected by the Divisional Court at paras. [90]-[94] of its judgment. In this court, Mr Swift accepted that on proper analysis, even if well-founded, the claim based on A1P1 added nothing to the other submissions which he and Miss Rose advanced. Accordingly, whilst not formally abandoning this part of the appeal, he did not seek to develop it and Mr Chamberlain QC for the Lord Chancellor was not required to answer it. It is unnecessary, therefore, to say anything more about it.

Section 1 of the Legal Aid, Sentencing and Punishment of Offenders Act 2012 ("LASPO") provides in relevant part as follows:

"(1)

The Lord Chancellor must secure that legal aid is made available in accordance with this Part.

(2)

In this Part 'legal aid' means—

…

(b)

services consisting of advice, assistance and representation required to be made available under section 13… (criminal legal aid).

…

(4)

The Lord Chancellor may do anything which is calculated to facilitate, or is incidental or conducive to, the carrying out of the Lord Chancellor's functions under this Part."

Section 2:

"(1)

The Lord Chancellor may make such arrangements as the Lord Chancellor considers appropriate for the purposes of carrying out the Lord Chancellor's functions under this Part.

…

(3)

The Lord Chancellor may by regulations make provision about the payment of remuneration by the Lord Chancellor to persons who provide services under arrangements made for the purposes of this Part."

Section 13(1):

"Initial advice and initial assistance are to be available under this Part to an individual who is arrested and held in custody at a police station or other premises…"

It was common ground that, under LASPO, the Lord Chancellor has a binding duty to ensure that legal aid in the form of the kind of legal services to be provided under the DPW contracts is in fact provided at local police stations (and, so far as relevant, in magistrates’ courts), but that he has a discretion as to how to achieve that end result.

Mr Chamberlain realistically accepted that, under these provisions, even if a decision-maker starting with a blank canvas might have a wide discretion how to proceed in order to achieve the result required, he might proceed in stages and gradually structure his consideration of how to move forward. A decision-maker who structured his approach in this way might adopt criteria as a guide for himself. If he does so, the rationality of his decision-making might in principle be tested by reference to the rationality of his assessment whether his own chosen criteria have been satisfied. The rationality of steps in his reasoning could in this manner be assessed in a more precise and determinate way. In the present case, the Lord Chancellor decided that each DPW contract should be “sustainable in its own right”. Mr Chamberlain therefore accepted, in this context, that the issue of investment costs was identified as a matter of concern which the Lord Chancellor was obliged to consider and take into account. Mr Chamberlain’s submission was that the Lord Chancellor did just that; he made a rational assessment of their impact on the financial modelling he adopted as the basis for determining that there should be the 527 DPW contracts which he proposed to introduce; and he made a rational assessment that those contracts would each be “sustainable in their own right” for the legal services provider who won the tender for it.

Mr Chamberlain also submitted that the other assumptions made by the Lord Chancellor which were challenged by the first claimants were rationally defensible and were a proper and lawful basis for his decision to introduce the 527 DPW contracts.

An aspect of the arguments in the Divisional Court received greater emphasis in the submissions below as compared with the way in which the appeals were presented in this court. This was the part of the case regarding intensity of review, which the Divisional Court addressed at paras. [25]-[37] of its judgment. In this court, there was little difference between the parties about this. All sides accepted that where a matter is identified by a decision-maker as relevant to his decision, “it is for the decision-maker and not the court, subject … to Wednesbury review, to decide upon the manner and intensity of inquiry to be undertaken into any relevant factor accepted or demonstrated as such”: R (Khatun) v Newham LBC [2004] EWCA Civ 55; [2005] QB 37, at [35] per Laws LJ; see also R (Khatib) v Secretary of State for Justice [2015] EWHC 606 (Admin), [51]-[52] per Elias LJ.

Before this court, the first and second claimants contend that the Lord Chancellor acted irrationally, contrary to the Wednesbury standard, either by leaving investment costs out of account in his assessment whether the DPW contracts would be “sustainable in their own right” or by failing to investigate the extent and financial implications of the investment costs. The first claimants also argued that the Lord Chancellor had made an irrational appreciation in respect of each of the other assumptions which they seek to challenge.

The claimants contended that the risk posed to fulfilment of the Lord Chancellor’s duty to provide full coverage for legal assistance under the relevant provisions of LASPO was high if the Lord Chancellor had made a mis-prediction about the effect of limiting the number of DPW contracts as he proposed, and that this could be taken to indicate that some higher obligation of investigation arose. However, Mr Chamberlain pointed out that the Lord Chancellor would have a period of months of notice if insufficient providers came forward to bid for the new contracts, before the contracts were supposed to take effect. This would enable the Lord Chancellor to take a range of measures to adapt to such a situation, if (contrary to his considered expectation) it arose, and still ensure that he would fulfil his statutory duty. The Ministry of Justice internal documents made it clear that contingency options had been considered and would be kept under review as the situation developed.

In our view, this aspect of the case does not affect the application of the usual Wednesbury standard of review in relation to decisions regarding investigative steps, as set out in Khatun. The obligation of investigation on the Lord Chancellor regarding the individual commercial viability of the proposed DPW contracts was not a special or unusually heightened form of that normal obligation.

A good deal of the factual background is explained in the judgment of Burnett J on the previous judicial review, in the section appended as Annex A to this judgment, and is not repeated here. The salient points for present purposes are as follows.

On 9 April 2013 the Lord Chancellor launched a consultation in which he made it clear that he sought immediate savings of 17.5% in criminal legal aid, and presented proposals as to how that objective could be achieved. The proposals were highly controversial, and a range of objections was presented in the responses to the consultation.

The proposals were modified, and the new proposals were presented in a second consultation paper dated 5 September 2013. As Burnett J explains (paras. [16]-[19] of his judgment: see Annex A), there were two significant changes: (i) the 17.5% reduction in criminal legal aid fees would be introduced in stages, with a first 8.75% cut in the spring of 2014 and a further 8.75% cut in the spring of 2015; and (ii) criminal legal aid work was to be divided between an unlimited number of OCW contracts and a limited number of DPW contracts, with the DPW contracts to be large enough in volume and value to be “sustainable in their own right” after taking into account the full 17.5% reduction in fees.

Solicitors who would be affected by these changes urged the Lord Chancellor to undertake research before carrying these proposals into effect. Two reports were prepared to examine the commercial viability of the proposals and what form the DPW contracts should take and at what fee rates to be “sustainable in their own right”: the Otterburn Report (by Andrew Otterburn and Vicky Ling), commissioned by the Law Society in consultation with the Lord Chancellor, and the KPMG Report, commissioned by the Lord Chancellor.

The Otterburn Report emphasised that the financial position of many solicitor firms providing services under the criminal legal aid scheme is “fragile”, and that the supplier base is “not financially robust”. In that context, the Otterburn Report took “achieving a 5% [profit] margin as a minimum definition of a viable practice”. The Report also recommended that the fee cut be introduced after consolidation of the market (i.e. not before any new DPW contracts commenced).

The KPMG Report set out an analysis regarding the number of DPW contracts which would, in KPMG’s view, be “sustainable in their own right”, meaning that the providers of services under those contracts would be able to be financially viable in providing those services without cross-subsidy from other work. As a result of their analysis, KPMG gave a range between 432 and 525 DPW contracts. As set out in their Report, KPMG made a number of assumptions for the purposes of their analysis, of which the following are relevant on this appeal:

KPMG specifically referred to the investment costs (i.e. costs which providers would be likely to need to incur in order to re-structure their affairs and put themselves in a position to realise the increased efficiency assumed by KPMG in their modelling), but explained that they had not taken those costs into account in their modelling. KPMG said this:

“Investment funding may be required in three areas

* To fund increased working capital that would arise as a result of larger contracts

* To fund the investment required to achieve the staff efficiency levels implied by the proposed contracts

- For example, IT spend on digital technologies and virtual working could increase productivity and enable greater geographic coverage

* To fund the costs of consolidation as outlined above

We have not sought to quantify the likely size of this funding although we highlight risks to its availability

* Otterburn’s survey data indicates that firms have limited cash on their balance sheets available for investment

* Other studies indicate that the market believes that it will struggle to obtain funding from lenders (see page 57)”

(p. 11 of the Report)

…

“Ability to source funds for investment in consolidation

Any structural change within an organisation will likely incur investment costs (professional fees, relocation and redundancy costs, opportunity cost of management time) – The scale of this cost has not been estimated – However, Otterburn analysis demonstrates that providers have limited reserves to fund these costs …”

(p. 56 of the Report)

…

“Firms are likely to require a level of investment funding to successfully transition to new duty provider contracts

Investment funding may be required in three areas

* To fund increased working capital that arise as a result of larger contracts

* To fund the investment required to achieve the staff efficiency levels implied by the proposed contracts

- For example, IT spend on digital technologies and virtual working could increase productivity and enable greater geographic coverage

* To fund the costs of consolidation as outlined on the previous slide

We have not sought to quantify the likely size of this funding.

In this context, it is important to note that Otterburn’s survey data indicates that firms have limited cash available for investment

* The median cash balance across the full sample was £16,490, with a significant range between the upper and lower quartiles and also by size of firm

* Both the median 13-40 and 40+ solicitor firms were in an overdraft position of -£30,000 and -£371,860 respectively

In addition, the market believes that it will struggle to obtain funding from lenders

* ‘The investment opportunities which may occur in 2015, such as our applying for contracts in neighbouring areas could not be taken up with our balance sheet taking a further hit…We will simply not be able to secure investment funding' [Transforming Legal Aid: Next Steps, A Report for the Law Society of England and Wales and the Ministry of Justice’, Otterburn Legal Consulting, November 2013]

* This aligns with Deloitte’s interview findings with financial service providers: ‘We see the legal aid sector as being challenging in terms of cash flow and profitability, compared to several other areas of legal work’ [Deloitte, ‘The Government’s proposed legal aid reforms: A report for the Law Society’, May 2013]”

(p. 57 of the Report)

Investment costs would need to be incurred to assist many providers to achieve scale and efficiencies so as to be able to absorb the full 17.5% fee cut whilst providing the services set out in the DPW contracts. Although KPMG modelled their viability analysis by reference to single firm providers of services bidding for DPW contracts, the Lord Chancellor assessed that many bidders would take the form of delivery partnerships under joint venture arrangements between different firms (“the delivery partnerships assumption”). The costs involved in setting up delivery partnerships would be a sub-set of the investment costs referred to by KPMG, and hence were put to one side by them for the purposes of their analysis.

Investment costs could be of different types, as described in general terms by KPMG. Some might be one-off costs (such as the outright purchase of a new computer to increase the productivity of staff), but that would not necessarily be the case (e.g. a computer might be bought on hire-purchase or acquired using money borrowed from a bank, with an ongoing cost of borrowing). The unifying general theme in relation to investment costs is that they represent advance expenditure or financial commitments in order to enable service providers to operate more efficiently and effectively, and hence with a better chance of realising greater profits from their income in future than would otherwise be the case.

There is an important issue in this appeal regarding the relationship between investment costs and cash-flow of providers. The claimants contend that these are two very different things, with little or no bearing on each other. The Lord Chancellor, on the other hand, submits that they are inter-connected: an improved cash flow in an early period means that a provider is able to finance investment costs in that period with a view to making greater profits at later stages during the life of a DPW contract. We address this aspect of the dispute in the discussion below. At this stage, however, it is relevant to note that the section at page 57 of the KPMG Report quoted above links availability of cash with the ability to bear investment costs in order to realise later gains, indicating that there is a relationship between improved cash-flow and an ability to incur investment costs.

The KPMG Report was eventually put into final form in a version dated 11 March 2014, but it was available to the Lord Chancellor in substantially the same form in February 2014, as was the Otterburn Report. An earlier report by PA Consulting was also available. The KPMG financial modelling was “stress tested” within Government by statisticians before the Lord Chancellor took his decision regarding the number of DPW contracts to introduce.

On 12 February 2014, the Lord Chancellor and the Minister for Legal Aid met with representatives of the Law Society to discuss the proposed legal aid changes. As a note of the meeting records, “Much of the discussion focused on what transitional support could be offered to firms to help them to adapt”, and the Law Society’s concerns about the availability of finance for this were raised. It was agreed that Ministry of Justice officials should continue to work with the Law Society to try to agree a package of transitional support measures.

On 14 February 2014 a Submission to Ministers was sent to the Lord Chancellor and the Minister for Legal Aid. It had appended to it, among other materials, the Otterburn Report and the KPMG Report (both in draft at that stage, effectively in the forms in which they were later finalised). The Submission made recommendations in relation to the number of new DPW contracts to be introduced and recommended that the first fee cut of 8.75% for new cases should be announced and then brought into force on 20 March 2014. The Submission noted that it was an absolute priority to ensure that the Lord Chancellor complied with his statutory duty under LASPO, and reviewed contingency options. It included this section, headed “Interim Fee Reduction”:

“20.

The criminal legal aid market (both litigators and advocates) has sustained a series of fee reductions and fee structure changes over the past ten years and yet still remains relatively the same size and structure of provider base that existed ten years ago. This market has been extremely resilient to previous fee cuts. That said, we have heard from the profession that further cuts without creating opportunities to exploit economies of scale could lead to serious risk to viability for firms and destabilise the market.

21.

We acknowledge that some providers would find it challenging to cope with a 8.75% fee reduction ahead of the opportunity to exploit economies of scale from a more consolidated market structure. However, we believe that there are others that could sustain the fee reduction without any significant structural changes to their business and most providers could look at more efficient ways of working, such as better use of duty solicitors and if necessary reducing salaries. Some providers will choose to take early steps to join with others and explore opportunities to share back office functions and cost of support staff. In fact, some have already done so.

22.

It is important to reiterate our earlier advice to you that any fee reduction would only apply to new cases starting after the commencement of the change and would therefore take a period of time to take effect and have any significant impact on claiming levels for providers. Current initial analysis shows that after five months, half of the legal aid fee revenue will still be on the existing higher renumerated scheme, as applying the proposed new fee scheme only to new cases means moving from one fee scheme to another is a gradual process. This means that providers would be increasingly required to explore opportunities to consolidate and make efficiency savings over a period of months. It is important to note that we are proposing the cut to come into effect three weeks after it is announced and this will be the first time confirmation has been given to providers. We highlight the risks associated with this approach in the Key Risks section below.

23.

A number of respondents have argued that the interim fee cut would present challenges for providers in terms of securing upfront investment which they suggest may be very difficult to obtain. We therefore intend to work alongside the Law Society to establish a working group to explore the types of support, both financial and non-financial, we could offer to practitioners both prior to and during the procurement process to help with the changes they face. The interim payment measures described below would also help to mitigate the financial challenge faced by providers.”

The Submission gave further consideration to this under the heading of “Sustainability”, at paras. 108 to 128. In this section, the Submission reviewed advice from PA Consulting, KPMG and in the Otterburn Report regarding the ability of the market to absorb fee cuts and to make efficiencies to adjust to them (paras. 110-112, in particular). Issues regarding the procurement of criminal legal aid were also reviewed, and the ability of providers to draw on latent capacity, as indicated by the KPMG Report and the Otterburn Report, was identified (para. 114), Contingency measures, if the prediction of viable adaptation to the new legal aid system proved not to be correct, were also reviewed (para. 115 and Annex E).

On 25 February 2014, there was a further meeting between the Lord Chancellor and Minister for Legal Aid and representatives of the Law Society, at which progress in the consideration of transitional support measures was discussed.

On 27 February 2014, the Lord Chancellor announced the Government’s decision as to how to proceed (“the February 2014 decision”). There was to be a tendering process for 525 DPW contracts. There was to be a phased fee reduction: a cut of 8.75% in fees for new cases from 20 March 2014, with a further 8.75% reduction “upon commencement of the new contracts in spring 2015” (para. 74). In other words, the second fee reduction would coincide with the consolidation of the market around the new DPW contracts. Paragraph 76 of the decision stated as follows:

“It is important to note that the fee reduction will only apply to new cases starting on or after 20 March 2014 and will take a period of time to take effect and to have any significant impact on claiming levels for providers. This is because the proposed new fee scheme will only apply to new cases, which means moving from one fee scheme to another will be a gradual process. We believe this gives those providers who have not already taken steps sufficient opportunity to make necessary efficiency improvements to be able to cope with the fee reduction. Our analysis suggests that after five months of the introduction of the interim fee cut, on average, around half of the legal aid revenue paid will still be on the existing higher remunerated scheme.”

The February 2014 decision included the announcement of a “transitional support package” to support service providers “in terms of information and guidance and specialist support to help firms invest in their infrastructure” (paras. 60-72). The main measures discussed were an information pack to assist those interested in bidding for the new contracts, a “business partnering support network” to provide advice regarding seeking financial support for restructuring and contact with the British Business Bank (“BBB”) regarding loan guarantees which it might offer (at a cost of an additional 2% of interest) to assist firms to obtain commercial loans. The claimants are dismissive about the effectiveness of this package.

The February 2014 decision also announced an enhanced system of interim payments at the start of trial in long-running cases (trials of 10 days or more) and in relation to an effective plea and case management hearing (“PCMH”) ahead of a trial of any length, “to help with the cashflow of legal firms … and to cushion the impact of the fee reductions” (para. 89). The first of these types of interim payment was to be introduced later in 2014, the second “in summer 2015” (para. 94).

On 26 March 2014, the Lord Chancellor again met with representatives of the Law Society, this time to discuss a proposal by him for “further transitional support” for law firms. The Lord Chancellor emphasised the need, in the current economic climate, for the Ministry of Justice to make substantial savings across the entire range of its work. Nonetheless, as recorded in the note of the meeting, the Lord Chancellor said that, in addition to the package of transitional support measures already proposed “to help providers manage the implementation of the fee reductions and market restructuring”, he could go further: he offered either a grant of £9 million, to be spread between providers who won DPW contracts “to support providers investing in their restructuring or IT, relocation, recruitment etc” (option A), or to bring forward the interim payments for the PCMH stage “by twelve months, easing cashflow for all providers during 2014/15” (option B). By an email dated 27 March 2014, the Law Society stated that its Chief Executive and President had consulted and chose option B. The Ministry of Justice proposed to implement this extension of the interim payments scheme in the summer of 2014; in the event, there was some slippage in this timetable.

Although option A would have involved outright payment of additional money to providers and option B, by contrast, involved earlier payment of money which would eventually have to be paid to providers in any event, the evidence for the Lord Chancellor explains that the Ministry of Justice valued option B at about £9 million as well. This assessment reflected government accounting principles, according to which the year in which expenditure occurs is important. The Law Society preferred option B, at least in part, because it would benefit all its members, not just those who might successfully bid for DPW contracts.

In our view, this meeting is an important feature of the factual background to the present proceedings. We consider that it is clear that by this stage that Lord Chancellor had received and digested the KPMG Report which he had been sent with the February Submission, and that he had focused on the concerns being raised with him personally in the meetings he attended on 12 and 25 February and 26 March 2014 regarding the difficulties providers would have in dealing with investment costs. It is also clear that option B was being offered as an alternative way of providing additional finance to help providers with their restructuring (i.e. to help them fund investment costs), and that this was to be done by improving cash-flow.

The discussion at the meeting and the proposals made indicate that there is no hard and fast division between cash-flow issues and the funding of investment costs. If providers had better cash-flow at an earlier point in time (as contemplated under option B) they could use the increased money in their hands at that time to make investments to restructure and improve their productivity to help them remain profitable at the later period when the second round of fee reductions was implemented and the new DPW contract system was in place. To the extent the Ministry of Justice paid them fees earlier than it would otherwise have done, providers would have less need to borrow money to fund investment costs at the critical time. This is so even though the overall capital saving for providers, on a simple comparison of option A and option B, would be a good deal less (i.e. the amount of interest payments they would receive, or would not have to pay on borrowed money, as a result of having fees paid into their bank accounts at an earlier time) than the £9 million which would be gained in capital terms by providers under option A. Such a simple comparison leaves out of account the further benefits which might be achieved at a later stage by having money in hand to invest at the earlier stage.

In our judgment, the Lord Chancellor was entitled to attribute weight to the cash-flow benefits of option B as a means of assisting providers to bear the investment costs associated with the restructuring likely to be needed under his reform proposals. It is important to note that this extension of the interim payment scheme to the PCMH stage (like the original extension to long trials announced in the February decision) was something which had not been factored into the analysis for the KPMG Report.

The first claimants then commenced the first of their judicial review proceedings, challenging the making of the February 2014 decision regarding the number of DPW contracts without allowing an opportunity for consultation on the Otterburn Report and the KPMG Report and challenging the introduction of the first fee reduction. Those proceedings culminated in the hearing before Burnett J, in which, by his judgment of 19 September 2014, he dismissed the challenge to the introduction of the first fee reduction but upheld the claim to quash the decision to introduce 525 new DPW contracts.

Meanwhile, after those proceedings were commenced, on 2 May 2014 the Law Society wrote a letter to the Director of Legal Aid Commissioning and Strategy at the Legal Aid Agency, pointing out (among other things) that KPMG had not estimated the scale of investment costs and asking what further analysis the Ministry of Justice had done “to satisfy itself that firms will be able to source the capital needed to undertake the growth and consolidation its proposals require”. There was no reply to this letter. Mr Chamberlain gave as the reason for this that legal proceedings were then on foot against the Lord Chancellor. We do not regard this as a good excuse; but in the event we do not think it is something material to the outcome of the present proceedings. As a result of the judgment of Burnett J, there was a further round of consultation in which both the first claimants and the second claimant (the Law Society) had the opportunity to make all the points they wished. We refer to this below.

As set out in Burnett J’s judgment of 19 September 2014, the first claimants succeeded in their claim that the Lord Chancellor had acted in breach of the obligation of fairness by failing to consult on the Otterburn Report and the KPMG Report. This meant that the Lord Chancellor had to consult further on the proposed changes to the arrangements for criminal legal aid, and in particular on the number of new DPW contracts which should be put in place. However, the first claimants failed in their challenge to the introduction of the first fee reduction, which “was driven by an immediate financial imperative” (see para. [55] of the judgment of Burnett J). There was no appeal against any part of the judgment.

On 24 September 2014, as a result of Burnett J’s judgment, the Lord Chancellor commenced a further round of consultation on the number of new DPW contracts which would allow for a future legal aid scheme which would be “sustainable with viable providers”. The consultation period was to end on 15 October 2014.

Pending the handing down of Burnett J’s judgment, the Ministry of Justice came to appreciate that its proposals to extend the interim payment scheme to the PCMH stage were going to cost more than it had previously thought, at £16 million (£1 million in 2014/15, £14 million in 2015/16, £1 million in 2016/17) rather than the £9 million it had previously thought (again, this is from a government accounting perspective, and is all in terms of advancing into earlier years payments which would otherwise be due in later years). A Submission to Ministers dated 1 September 2014 (“the 1 September Submission”) reviewed the options for the Lord Chancellor. It recommended that, despite the additional cost, the Lord Chancellor should stick to the commitment to implement the interim payments (unless Burnett J quashed the first fee reduction, which in the event did not happen).

At this stage, the Ministry of Justice was contemplating that it would still introduce the second 8.75% fee reduction in July 2015 (essentially, this was a financial imperative), even though there was now likely to be some delay in the introduction of the new DPW contracts until about October 2015, as a result of the further consultation which Burnett J might require, which would push back the timetable for deciding on the number of new contracts and the tendering arrangements in relation to them. This was a variation from what the Lord Chancellor had originally decided, in the February decision, namely that the second fee cut and the new DPW contracts would come into effect at the same time. The Lord Chancellor accepted the recommendation in the 1 September Submission that the introduction of the PCMH interim payments system should not be delayed.

Amongst other points, the 1 September Submission included the following reasoning:

“If our overall objective is to secure the fee cut next July, and achieve consolidation in the duty contract market next year, then the introduction of interim payments with no significant delay will help with that. Given the new procurement timetable, our current plan is to implement the second fee cut slightly earlier than the date on which new duty contracts start next year. It will greatly strengthen our argument that the market will be able to withstand this gap between the fee cut and consolidation if interim payments are in place, effectively giving a cash flow boost to providers through that critical time. It will also play into our analysis and assessment that we have said we will undertake in December/January before confirming that the second fee cut should proceed; …”

Miss Rose argued that this reasoning contemplates that the PCMH interim payments would assist the Government in its argument that the legal services provider market would be able to withstand the (new) gap between introduction of the second 8.75% fee cut from July 2015 and the introduction of the new DPW contracts (with a consolidated provider market) in October 2015. She submitted that this was of considerable importance, because it showed that even if in March 2014 the Lord Chancellor had proposed the interim payments for the PCMH stage as a way of providing some financing to assist with investment costs, by the time of the November decision now under challenge the benefit of those interim payments had been assigned in the Lord Chancellor’s reasoning to helping the market absorb the new three month delay between the introduction of the second fee cut and the coming into effect of the new DPW contracts (reflecting consolidation in the market). Accordingly, says Miss Rose, even if it might have been open to the Lord Chancellor to say as at March 2014 that the advanced implementation of the PCMH interim payments scheme provided assistance to cover investment costs, by the time he took the November decision he could no longer rationally maintain that he had properly considered the issue of investment costs and made a reasonable provision in respect of them by means of bringing forward that interim payment scheme.

In further support of this contention, in her oral submissions in reply Miss Rose referred to a table of figures (Table 3 at para. 10 of the 1 September Submission) and argued that they showed that the whole value of bringing forward the PCMH interim payments would be used up by offsetting the effect of the second fee reduction in the three months before consolidation in the market with the coming into effect of the new DPW contracts. Since Mr Chamberlain had not had an opportunity to deal with the point on Table 3 in his submissions, we invited him to put in short written submissions about it after the hearing. Miss Rose put in some further submissions in writing as well.

Mr Chamberlain disputes the claimants’ general submission in relation to the 1 September Submission and the detailed submission in relation to Table 3. He maintains that nothing in the 1 September Submission indicates that the Lord Chancellor had now notionally assigned the whole benefit of the advance in the PCMH interim payments scheme to offsetting the cash-flow effect of the introduction of a gap in time between the introduction of the second fee cut (for new cases commencing from about July 2015) and the commencement of the new DPW contracts, so that he could not rationally maintain the position arrived at in March 2014.

In our judgment, Mr Chamberlain is correct in these submissions. First, Table 3 does not have the significance for which Miss Rose contends. The part of Table 3 on which she sought to rely simply (i) shows, among other things, how much it would cost to delay the second fee cut by three months, at £13.2 million in total, concentrated in 2015/16 and 2016/17, and (ii) compares the benefit for the Government of a delay in the introduction of interim payments from 2014 to May 2015 (benefit of £1.4 million in 1014/15 and £7.9 million in 2015/16), but with an increase in costs in later years, adding up overall to zero by the end of 2017/18. The distribution in (i) reflects the fact that the fee cut would only affect new work from the date of its inception. The distribution in (ii) reflects the cash-flow savings for the Government by delaying the introduction of the PCMH interim payments, meaning that less had to be paid in the earlier period but more had to be paid later on.

Contrary to Miss Rose’s submission, these figures do not show that the cash-flow effect of the advance in the PCMH interim payments scheme would be swallowed up by the introduction of a three month gap between the second fee cut (in the event, it was decided that it would be introduced in July 2015) and the commencement of the new DPW contracts (in the event, it was decided this would occur in October 2015). If anything, the figures show that, on the parameters for the November decision - i.e. bringing forward the PCMH interim payment scheme into 2014; commencement of the second fee cut for new work in July 2015; and commencement of new DPW contracts in October 2015 – there would continue to be a significant cash-flow benefit for providers associated with bringing forward the PCMH interim payment scheme into 2014. The new interim payments commenced in 2014, while the second fee reduction would only take effect for new cases commenced in or after July 2015 and so would not have a major impact upon the improved cash-flow for law firms associated with the introduction of the interim payments.

More generally, the 1 September Submission does not indicate that the “cash flow boost” from interim payments to which it referred would notionally be allocated by the Lord Chancellor purely and in full to absorbing the impact of the commencement of the second fee cut three months before the inception of the new DPW contracts. The point made in the reasoning quoted above was a general one, which is consistent with the Lord Chancellor’s previous decision in March 2014 to assist with investment costs by provision of a cash-flow benefit for the provider market. Improvements in cash-flow can reasonably be assessed as providing both assistance for firms to cope with the (new) three month gap before the introduction of the new DPW contracts and assistance with investment costs. In fact, by the time of the November decision, certain aspects of the picture regarding cash-flow for the market had improved from what the Lord Chancellor expected in March 2014: (i) the value of bringing forward the interim payments now appeared to be about £16 million, rather than £9 million, and (ii) there had been a delay in the introduction of the second fee cut beyond that contemplated in the February decision, from “spring 2015” to July 2015. The Lord Chancellor assesses that the cost to his department (with a corresponding benefit to law service providers) is of the order of £5 million per month of delay in the introduction of the second fee cut (and this is broadly reflected in the figures in Table 3 in the 1 September Submission).

In our view, therefore, the 1 September Submission does not represent a radical transformation in the financial outlook for law firms in terms of cash-flow from that which the Lord Chancellor had in mind in March 2014.

A range of representations were received by the Lord Chancellor in response to the further consultation on the number of DPW contracts. In the representations from the first claimants and the second claimant at this stage it was not contended that the Lord Chancellor could not assess the number of DPW contracts unless he did further work to calculate the likely investment costs and factor those costs into the KPMG analysis. Rather, emphasis was placed on the broad-brush assessment in the Otterburn Report that a 5% profit margin should be taken as the marker of future viability of providers under the new DPW contracts (the Otterburn Report, like the KPMG Report, was produced without knowledge of and took no account of the interim payment arrangements included in the February decision and the extension of those arrangements in March 2014).

Mr Otterburn and Ms Ling put in a consultation response which similarly did not contend that the Lord Chancellor should conduct further work to assess the investment costs; rather, they repeated the recommendation of a 5% profit margin as a safeguard. Their response included the following, which is of significance in the context of Miss Rose’s argument on this appeal:

“KPMG also assumed that a positive profit was sufficient to ensure viability for providers. We disagree. Our financial analysis allowed for a notional salary for the equity partners of just £51,750, based on the median salary of the highest paid employed fee earners in the participant firms. Having allowed for this notional salary the firms were currently achieving a net margin of 5% in crime and even at this level the financial viability of many of the firms was fragile. This profit is needed to provide working capital and the cash needed to run a contract. Without this firms would be highly vulnerable to any cash flow issues, and in particular would not be able to survive any delays in payments by the LAA, which, for various reasons can occur. We do not believe that a break-even figure would enable firms to remain in the market when developments in IT and changes introduced by the new contracts themselves will require increased investment. They would not be able to generate the working capital and reserves essential to run any business and would be highly likely to fail. We do not believe they would be viable businesses and may have difficulty obtaining bank finance as their business case would be so weak. It is also debatable whether many people would take the personal financial risk of setting up and running a firm when they could earn virtually the same as an employee elsewhere.”

In that passage, Mr Otterburn and Ms Ling ran together the issues of cash-flow and coverage of investment costs, in much the same way that KPMG had done in the KPMG Report. The Otterburn/Ling consultation response is a further indication that the Lord Chancellor has not behaved irrationally in linking those two issues in his decision-making.

The Lord Chancellor instructed KPMG to review the consultation responses. KPMG produced a report dated 13 November 2014 on the responses (“the KPMG Review”). In the KPMG Review, KPMG noted that “market participants may have found themselves commenting upon market changes which they would not wish to be imposed” and commented: “It is important to distinguish between the current preferences of firms, pre-change, and the potential future strategies they may adopt, post-change.”

In their Review, KPMG also called attention to, and again adopted, the same qualifications which had applied in relation to the KPMG Report, including that investment costs had not been brought into account in their financial model. KPMG discussed the consultation responses received which were critical of their break-even assumption, but affirmed their view that (since they had already highlighted in the KPMG Report the same risks to which consultees called attention) they did not consider it necessary to change the analysis in the KPMG Report.

On 21 November 2014, a further Submission to Ministers was sent to the Lord Chancellor and the Minister for Legal Aid (“the 21 November Submission”). The 21 November Submission reviewed the position which had been arrived at after the consultation. It reviewed the differences between the Otterburn Report and the KPMG Report. The Submission recommended a modest adjustment to the number of proposed DPW contracts, from 525 to 527.

The 21 November Submission included a discussion of profit margins and the finances of providers at paras. 27-36. It referred to measures to provide information and guidance to service providers by way of transitional support, including through discussion with the BBB (paras. 31-32); and at para. 33 referred to the new interim payment arrangements as additional measures “to combat cash flow issues”. It was noted at para. 33 that “Those provisions will substantially help to soften the impact of the first fee cut, before the consolidated DPW contracts are offered.”

Miss Rose focused on this in order to suggest that by this stage the Lord Chancellor regarded the interim payment arrangements as referable to helping firms cope with the fee cuts, and not as a means of providing assistance in relation to investment costs. We do not accept this. The two issues are not distinct in the way she suggests: see paras. [39]-[41] and [48]-[55] above.

The 21 November Submission included discussion regarding the key assumptions which had been made for the purposes of the analysis in the KPMG Report, including the 50% OCW assumption, the organic growth assumption and the latent capacity assumption. In relation to the break-even assumption, the 21 November Submission included the following discussion:

“55.

The other assumption that generated a lot of debate was the minimum level of profitability for sustainable trading. Following discussions with KPMG, we agreed to set the level at 0.1%. Some respondents misinterpreted this assumption, believing that KPMG and MoJ were suggesting that organisations would bid for a contract accepting that they would only receive a 0.1% profit margin.

56.

A 0.1% profit assumption assumes that all staff including equity partners will be properly paid and all existing costs met. A firm will not know in advance of being awarded a contract what level of profit they might make, and will clearly not be aiming to make a profit as low as 0.1%. However, on the assumption that (contrary to its own expectations) the firm only achieves a profit as low as 0.1%, then bearing in mind all staff had been paid and costs met the firm would not become unviable simply by virtue of only having broken even and could continue to trade. A firm which did get as low as 0.1% profit would then have to find ways to make further efficiencies so as to improve its profitability going forward. Conversely, organisations may offset the need to find greater staff efficiency savings by exploring mechanisms to use latent capacity.

57.

The model showed that in order to achieve a higher profit margin, organisations would need to explore greater staff efficiency savings.

58.

No new evidence has been presented by respondents. All of the points raised were either raised by the Law Society, by practitioners or by other representative bodies through the extensive engagement throughout that process.”

Miss Rose focused on paragraph 56. She submitted that this demonstrated the fundamental error that the Lord Chancellor made. Miss Rose says that the reasoning in this paragraph shows that the Lord Chancellor and those advising him believed that the financial modelling in the KPMG Report assumes that all costs are met before the break-even assumption is arrived at, whereas in fact an important element of costs (the investment costs) are not assumed to be covered in that modelling, but are left to one side.

We do not agree with this submission. Paragraph 56 of the 21 November Submission falls to be read against the background of the KPMG Report and the KPMG Review, and the qualifications which appeared on their face. In our view, the reference to “existing costs” in paragraph 56 is a reference to the cost elements which KPMG had expressly allowed for in their Report and Review, leaving out of account the investment costs element (which was not a matter of “existing” costs); and the later reference in the paragraph to “all … costs” is to all the existing costs referred to in the preceding sentence. In the light of all the other material in the case, this paragraph does not indicate that any error of understanding has occurred on the part of the Lord Chancellor or his officials. No-one familiar with the KPMG Report and Review or closely involved in the decision to be made and the way in which matters had developed since February 2014, as the Lord Chancellor and his officials were, could have made the error which is alleged. Paragraph 56 of the Submission can be read and should be interpreted accordingly.

The Lord Chancellor accepted the recommendation in the 21 November Submission. By an email dated 22 November 2014 from Hannah Payne in the Lord Chancellor’s private office, the Lord Chancellor and the Minister for Legal Aid indicated that they considered that there should be 527 DPW contracts and that the second fee cut should take place in July 2015 (subject to further consideration). In the same email, the Lord Chancellor sought further advice regarding what would be said in the decision with respect to the concern raised by respondents to the consultation “that firms do not have the financial capability to fund the transitional costs associated with scaling up.” A further short Submission to Ministers dated 25 November 2014 was sent in reply (“the 25 November Submission”). This referred to transitional support (including by way of discussions with the BBB) and, in addition, the new interim payment provisions which had been “designed to combat cash flow issues” and would “substantially help to soften the impact of the fee cuts” and “help providers to manage any cash flow challenges posed by the transition”.

Miss Rose submitted that the email indicated that the Lord Chancellor had taken his decision regarding the number of DPW contracts before he appreciated that the financial modelling KPMG Report left investment costs out of account. We do not agree. In our opinion, the email shows clearly that by the time of the November decision the Lord Chancellor understood very well that KPMG had left investment costs to one side. By the email, he was asking for advice regarding how that sensitive aspect of the November decision would be communicated to law firms. This was a presentational issue which indicates that he well appreciated the significance the point had in the context of the decision to be made. It is a further item of evidence which corroborates other evidence indicating that the Lord Chancellor had received and had digested and understood the KPMG Report.

Miss Rose also referred to the email of 22 November as further evidence in support of her thesis that the Lord Chancellor had notionally allocated the benefits from the introduction of the PCMH interim payments to absorbing the effects of the gap between introduction of the second fee cut and the commencement of the new DPW contracts, and therefore could not rely upon them as a means of addressing investment costs issues. In our view, however, the email does not support this inference. The answer to Miss Rose’s thesis, as explained above, is that the Lord Chancellor did not make the distinction between cash-flow and investment costs that she alleges; and in any event, the email is explicable as explained in the previous paragraph – the Lord Chancellor was understandably concerned about how such a sensitive matter would be presented.

By the Ministry of Justice Paper, Transforming Legal Aid: Crime Duty Contracts, dated 27 November 2014, the Lord Chancellor announced the November decision and set out his reasoning in relation to it. The discussion in the November decision reflected that in the 21 November Submission. There was a section on the finances of legal service providers, at paras. 2.16 to 2.22. Paragraphs 2.19 and 2.20 addressed concerns which had been raised by respondents regarding their “financial capability to scale up” (i.e, their ability to fund investment costs), by reference to the support and guidance measures mentioned in the April decision and the approaches made to the BBB. In relation to those costs, paragraph 2.21 added that the new interim payment arrangements had not been announced at the time of the Otterburn Report; stated (in line with the 21 November Submission) that the PCMH interim payment provisions, which had been introduced in October 2014, were “designed to combat cash flow issues”; and stated that the provisions would “substantially help to soften the impact of the fee reductions, before the DPW contracts are offered.”

Miss Rose submitted that the 21 November Submission and paragraph 2.21 of the November decision again showed that by this stage the PCMH interim payment measures were being allocated to soften the impact of the fee reductions, and so were not available to be relied upon to meet concerns regarding transitional costs. We do not agree. In our view, the answer to this point already given in para. [63] above applies.

The November decision included a discussion of the Lord Chancellor’s reasoning in relation to the key assumptions which had been made:

The profitability, or break-even, assumption was addressed at paras. 2.52 to 2.56, as follows:

“2.52

Respondents said that break-even was not the minimum level of profitability for sustainable trading. Some respondents misinterpreted his assumption, believing that KPMG and MoJ were suggesting that organisations would bid for a contract accepting that they would only achieve a 0.1% profit margin.

2.53

0.1% is the floor in the KPMG model – not a suggested aspiration. The model certainly permits providers to make a profit (including a profit over the 5% outlined by Otterburn) and the Government is not preventing providers making such a profit. However, the Government does not consider that it would be appropriate to build into the model for determining how many DPW contracts an assumption that providers should make a significant profit from work which is publicly funded or to specify what that specific level of profit should be.

2.54

The model showed that in order to achieve a higher profit margin, organisations would need to explore greater staff efficiency savings. Conversely, organisations may offset the need to find greater staff efficiency savings by exploring mechanisms to use latent capacity. The model focuses on the smallest bidding provider within an area and assesses the staff efficiency challenge for that particular provider to break-even. The larger bidding providers within that area are likely to be more profitable than the smallest [See page 34 of the KMPG report]

2.55

A 0.1% profit assumption assumes that all staff including equity partners will be properly paid and all existing costs met. An organisation will not know in advance of being awarded a contract what level of profit they might make, and will clearly not be aiming to make a profit as low as 0.1%. However, on the assumption that (contrary to its own expectations) the organisation only achieves a profit as low as 0.1%, then bearing in mind all staff had been paid and costs met the organisation would not become unviable simply by virtue of only having broken even and could continue to trade. A organisation which did get as low as 0.1% profit would be likely to strive to find ways to make further efficiencies so as to improve its profitability going forward. Conversely, organisations may offset the need to find greater staff efficiency savings by exploring mechanisms to use latent capacity.

2.56

No new evidence has been presented by respondents. All of the points raised were either raised by the Law Society, by practitioners or by other representative bodies in previous consultation exercises or through the extensive engagement throughout that process.”

Miss Rose focused on paragraph 2.55 of the November decision, to suggest (as she had done in relation to paragraph 56 of the 21 November Submission, set out above, which was in similar terms) that it showed that the Lord Chancellor did not appreciate that investment costs had been left out of account in the financial modelling for the KPMG Report. We do not accept this submission. The answer to it is the same as the answer to the submission on the 21 November Submission: see para. [66] above.

Section 3 of the November decision was entitled “Next Steps”. Paragraphs 3.4 to 3.11 appeared under the heading “Fee Reduction”. Paragraph 3.5 stated that the new DPW contracts (and new OCW contracts) would not now commence until October 2015, while paragraph 3.6 stated that the second fee reduction would occur in July 2015. Paragraphs 3.7 to 3.10 stated as follows:

“3.7

This approach will create a three month gap between the implementation of the fee reduction and the start of the new 2015 Crime Contracts and so depart from the approach announced in February. Assessing the likely impact of such an approach on providers, suggests that this gap would not be expected to pose a threat to service provision. This is because a number of factors help to reduce the impact of this headline reduction in fees.”

3.8

The second fee reduction will only apply to new cases. Much of the value of work that providers bill for during this three month gap will have started before July 2015 and will therefore be under previous, higher fee schemes. Consequently, as it takes time for new cases to complete and be billed for, it follows that providers will not be immediately operating with all of their fees at 17.5% lower levels for this period.

3.9

Interim payments also reduce the impact of fee reductions on providers in the short term by improving cash-flow. Following our agreement with the Law Society in March to bring forward the implementation of interim payments for litigators in Crown Court cases (which was originally planned for next summer but was implemented on 2 October) providers are already able to benefit from improved cash-flow. This will have a substantial positive effect on provider revenues in the period from July to October 2015.

3.10

Using 2013-14 billing data, we have made an assessment of how the mix of cases on different fee schemes, combined with the interim payments, impacts on the level of fee reduction that providers face during the 2014-15 financial year until the October 2015 service commencement date. We acknowledge that providers will all be affected differently by interim payments and this will be largely dependent on the amount of Crown Court work a provider does. Indicative analysis suggests that the average firm will be subject to an overall reduction in the legal aid fee income they receive of, on average, approximately 5% during the period April 2015 to October 2015 when compared with fee income prior to the first and second fee reductions (ie. Fee income prior to 20 March 2014).”

As part of her submission that the Lord Chancellor did not, by this stage, regard the cash-flow benefits for providers associated with the interim payments scheme as an answer to the investment costs issue, Miss Rose emphasised that this section of the November decision was distinct from the discussion of legal service provider finances in section 2 of the decision. However, in our judgment, the inference cannot be drawn from this that the Lord Chancellor considered that the cash-flow benefits which he emphasised in these paragraphs were irrelevant to the question of investment costs. The reasoning in this section of the November decision is consistent with, and supports, the basic position which the Lord Chancellor had adopted in his meeting with the Law Society in March 2014, namely that the cash-flow benefits associated with interim payments would assist providers in dealing with investment costs they would face.

It is by no means the case that the new three month gap which now existed between the implementation of the second 8.75% fee cut and the commencement of the DPW contracts swallowed up the cash-flow benefits on which the Lord Chancellor was relying to provide assistance for providers in meeting investment costs: see the discussion of the 21 September Submission at paras. [46]-[55] above. As Mr Chamberlain pointed out in his submissions, the work done by officials underlying paragraph 3.10 of the November decision showed that in the period April to October 2015 (when law firms would be looking to scale up their activities in order to be able to bid for DPW contracts on a viable and profitable basis), revenue was estimated to be on average only 5% below the level at which it had been prior to the first fee cut (i.e. prior to implementation of any part of the 17.5% fee cuts which the Government was seeking to implement). This bears comparison with what the Lord Chancellor had expected in the February decision, in which it was estimated that after 5 months from the inception of the first fee cut only about half of revenue would still be paid at the original, higher rates (para. 76). Paragraph 3.10 of the November decision indicates that in the period under consideration, more than 12 months after the first fee reduction in March 2014, average revenue was estimated to be down by only 5% on pre-March 2014 levels. This, combined with the fact (see para. 3.9 of the November decision) that the second fee cut would only have a gradual, delayed impact, meant that the Lord Chancellor was entitled to maintain his earlier assessment regarding the significance of interim payments for helping to meet investment costs.

We have dealt with the facts at some length above, because ultimately this appeal turns predominantly upon factual matters. In what follows we will first discuss the ground of appeal based upon the Lord Chancellor’s approach to investment costs, then turn to deal with the grounds of appeal in relation to other assumptions.

The Divisional Court posed three questions at para. [53] of its judgment: see above. We are now in a position to deal with the appeal in relation to them.

The Divisional Court answered this question in the affirmative: paras. [54]-[55].

In our view, it is clear on the facts that the Lord Chancellor did understand this. He was provided with the KPMG Report, which is very clear on its face. He personally discussed the Law Society’s concerns regarding investment costs at meetings on 12 and 25 February 2014, and again at the important meeting on 26 March 2014. Investment costs was a topic with which he was personally and extensively engaged. The email sent on his behalf on 22 November 2014, just before the November decision, again shows that he knew about the issue, understood it and appreciated its sensitivity.

Accordingly, we unhesitatingly reject the appeal against this part of the Divisional Court’s judgment.