“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)?”
"(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."
"(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."
"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…"
“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)”
“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.”
“It is important to note that the fee reduction will only apply to new cases starting on or after20 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.”
“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; …”
“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.”
“It is important to distinguish between the current preferences of firms, pre-change, and the potential future strategies they may adopt, post-change.”
“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.”
“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.”
“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 to20 March 2014 ).”