The argument that sex shop operators should not have to pay the full costs of regulating their own industry, but that these should be met instead out of general public funds, is hardly the stuff of which causes célèbres are made. So perhaps it is unfortunate that the first test case on the important Provision of Services Regulations 2009 should arise from precisely these facts.
Nonetheless, the case, which is the subject of a recent Supreme Court judgment in R (Hemming) v Westminster City Council, is likely to be significant beyond the narrow limits of its factual context.
Not only does Hemming have something to say about how regulatory systems in general are funded – as evidenced by its raft of interveners which included the Law Society, Bar Council, Local Government Association and HM Treasury – but it also draws attention to the largely neglected subject of how the Provision Of Services Regulations 2009 cut across well-established areas of UK regulatory law, with uncertain future consequences.
The Domestic Law
In order to operate lawfully, a sex establishment requires a licence issued by its local authority under Schedule 3 to the Local Government (Miscellaneous Provisions) Act 1982 (the ‘1982 Act’). Those licences need to be renewed annually.
Each authority has the power to require licence applicants to pay a fee (paragraph 19, Schedule 3 to the 1982 Act) –
‘An applicant for the grant, renewal or transfer of a licence under this Schedule shall pay a reasonable fee determined by the appropriate authority.’
It has long been established, following R v Westminster City Council ex p Hutton (1985) 83LGR 516, that this power can be used to recover the costs of regulation generally, including the ‘vigilant policing’ of unlicensed establishments.
In 2006, the European Union adopted the Services Directive – 2006/123/EC. Its purpose was to further liberalise the market for services in the EU. The Provision of Services Regulations 2009 (the ‘2009 Regulations’) are a more or less faithful transposition of the Directive into UK law.
A key principle of the Directive is that EU Member States must ensure that their regulatory systems, where they involve the need to obtain a prior authorisation (such as a licence) in order to provide a service, do not operate in a way that restricts the free market. To that end, they impose limitations on the operation of those systems. In particular, Article 13(2) provides –
‘Authorisation procedures and formalities shall not be dissuasive and shall not unduly complicate or delay the provision of the service. They shall be easily accessible and any charges which the applicants may incur from their application shall be reasonable and proportionate to the cost of the authorisation procedures in question and shall not exceed the cost of the procedures.’ [emphasis added]
This became Regulation 18 of the 2009 Regulations.
Mr Hemming runs a number of sex shops trading under the name ‘Simply Pleasure’. Several other respondents to the appeal all operate sex establishments of various types. Westminster City Council is the licensing authority for all those establishments in the area of London which includes Soho.
When faced with an application for the grant or renewal of a licence in its area, Westminster requests payment of an application fee. This is made up of two parts. The first part relates to the administrative cost of processing the application itself. It is by far the smaller element (£2667 in 2011/12).
The second part reflects a share of the total costs that the Council expects to incur in regulating sex establishments in its area. This includes not only the establishment that is the subject of the application, nor even all those which are licensed, but also those unlicensed establishments which the Council takes action to close down. As would be expected, this is much the larger part of the fee (£26,435 in 2011/12).
Clearly, If an applicant is unsuccessful and is refused a licence, it ought only to pay the first part of the fee which relates to the application itself. The second element is in respect of ongoing regulation to which, having failed to get a licence, it will never be subject. The Council deals with this by requiring applicants to pay the full fee up front, but reimbursing unsuccessful applicants for the second element.
There is no doubt that this approach is consistent with the domestic law. However, Mr Hemming claimed that it is inconsistent with Regulation 18 of the 2009 Regulation and that this, because of the primacy of EU law, overrides all previously established domestic authority.
Westminster, he argued, was levying a licence application fee that included an element which had nothing to do with its ‘authorisation procedures’ (the licensing process itself) but related to the wider costs of regulation. Whatever the 1982 Act said, this was now unlawful.
Both Courts agreed that the Directive’s reference to ‘authorisation procedures’ meant only the licensing process itself and not the regulation taking place under the licence. In principle, this should have meant that only the costs of the application could be charged. But by an interpretive sleight of hand they also held that, on any application to renew a licence, the costs of regulating that licensee in the previous year could also be passed on. The rationale for this was opaque at first instance, but clearer (if no more convincing) in the Court of Appeal –
‘It is clear and undisputed that costs incurred in investigating the suitability of an applicant for a licence can be reflected in the fee. In the case of an application to renew a licence, I consider that the costs of monitoring the applicant’s continued suitability can include the costs of monitoring compliance with the terms of their licences in the past.’ 
This allowed Westminster its costs of regulating licensees. But the rationale, strained as it already was, could not be extended to cover the costs of taking action against businesses operating without a licence. While recognising that licensed businesses benefit from action to close down unlawful competitors, the Courts thought that these costs at least could not be passed on in application fees.
The state of play left by the Court of Appeal judgment was summarised by Lord Mance in the Supreme Court as follows –
‘…unsuccessful applicants could only be charged with the costs of dealing with their application (including investigating their suitability), while successful applicants could only be charged with similar costs, and, on any renewal, with the costs of monitoring and enforcing their compliance with their licence in the past.’ 
The Supreme Court sought to cut through the lengthy and often tortured analyses in the Courts below and get to the nub of the case. In his short and robust judgment on behalf of the whole Court, Lord Mance said that the case came down to the following points –
First, there was no question that when the Directive referred to the costs of ‘authorisation procedures’, it meant only the costs of seeking to obtain a licence, and not all the subsequent costs of running the licensing scheme. 
Second, however, these provisions were concerned only with what happened at the point of authorisation. There was nothing in the Directive to stop fees being charged to successful applicants after the authorisation stage as a condition of the retention of their licences. 
Third, it follows that if Westminster had charged a fee for making the application which covered the costs of processing it, and then a separate fee on the grant of the licence (payable as a condition of its retention) which covered the costs of regulation, that would have been entirely compatible with EU law. 
Fourth, as it happened, the charge of an up front fee covering both sets of costs, and containing a refundable element, fell into a grey area. Was this a case of impermissibly passing on the cost of general regulation as part of the application fee? The answer was unclear, and so this question would have to be referred to the Court of Justice of the EU.  – 
Westminster’s appeal therefore succeeded in part, entitling it to a declaration that to charge a fee as a condition of a licence granted to successful applicants would be compatible with the Directive. However, as to the actual practice adopted by the Council of levying partly refundable fees, the question remains to be determined by the CJEU.
There are two aspects to the outcome of Hemming – the narrow one about regulatory funding, and a wider one about the impact of the 2009 Regulations
The Supreme Court’s judgment was not only short but also somewhat dismissive. It is hard to avoid the conclusion that it was unimpressed by the subject matter of the case, recalling the acerbic observation of Lady Hale in the earlier sex shop case of Miss Behavin’  UKHL 19 – ‘My Lords, there are far more important human rights in this world than the right to sell pornographic literature and images in the backstreets of Belfast City Centre’ (at ).
In some ways, this is unfortunate. It is certainly fair enough that Lord Mance sweeps away the need for some of the convoluted interpretations of the lower courts without expressly overruling them. His robust judgment will be welcomed by all regulators who have the ability to impose fees as a condition of authorisations granted by them. Most costs in most regulatory schemes are recovered in this way, and can now continue to be under the clear authority of the Court.
However, Westminster did not create its arrangements for a partially refundable fee out of desire to test the limits of the law or improve its own cash flow, but in order to work within its limited statutory vires. The 1982 Act expressly authorises fees to be charged when applications are made, but there is no equivalent authority for fees to be payable as a condition of licences once granted, and it is highly questionable whether its general power to impose licence conditions can be stretched that far. To say that such arrangements would be consistent with EU law is not the same as saying that the Council has the power to give effect to them.
The Court of Appeal acknowledged this problem (at  of the judgment of Beatson LJ), but the Supreme Court did not. Most readers of Lord Mance’s judgment may therefore wonder why Westminster does not simply change its approach, abandon the complicated arrangement of refundable fees payable by applicants, and adopt new licence conditions including an ongoing duty to pay.
The Council may well be questioning whether it can possibly do this consistently with Schedule 3 to the 1982 Act, but the answer is far from obvious. While it would not have changed the outcome, some recognition of this problem might have helped to clarify the impact of Hemming for a range of regulatory authorities with different types of statutory vires.
The 2009 Regulations Generally
The more fundamental issue relates to wider effect of the 2009 Regulations.
The UK has a strong service sector economy which generates a substantial annual trade surplus, and the UK government was (and remains) strongly committed to the Services Directive, which it sees as a way of unblocking the European service sector to UK exporters. The Directive is an example of the type of legislation which is consistent with its view of what the EU can and should be.
As such, for the purposes of setting an example to the rest of the EU, and therefore allowing it to take the moral high ground when others are non-compliant, the government is also committed to the strict application and enforcement of the Directive through the 2009 Regulations.
A crucial feature of the Directive is its anticipation of various ways in which EU member states might in practice throw up road blocks to liberalisation, even though at the same time paying lip service to it. In other words, it contains a number of anti-avoidance provisions. Most of these are related to national ‘authorisation schemes’ – systems of regulation which can be used to frustrate free trade by imposing spurious barriers to market entry. In this, the Directive builds on and codifies existing CJEU case law.
The UK government may well have thought, when negotiating the Directive, that these provisions ought to be of little concern domestically, since UK regulatory systems are already (on the whole) transparent, proportionate and subject to appropriate levels of judicial oversight.
However, the problem with legislation which uses general language to give effect to high level principles in a field as extensive as ‘services’ is that it is liable to cut across and undermine existing detailed systems of regulation, often in ways that are hard to predict and can now (after the Directive) no longer be controlled.
The 2009 Regulations therefore lay a set of booby traps for a range of sectoral regulatory regimes in the UK. The respondents in Hemming cleverly identified and exploited one of them, but the Supreme Court has been able to confine its effects to the quite narrow factual circumstances of that case. However, it would be a mistake to consider that this exhausts the potential of the Regulations.
The EU Commission, for instance, has already threatened action in relation to another, much more fundamental, matter. This goes to the heart of the UK’s internal devolution settlement, indicating just how wide ranging the effects of the Directive can be. A decision by the UK government to amend the Regulations (see the decision paper, which led to the Provision of Services (Amendment) Regulations 2014) averted immediate infringement proceedings, but without delivering a satisfactory resolution of the problem.
The UK government had patently not anticipated either of these issues, which indicates the difficulties caused by this kind of EU macro-legislation when it comes to be applied in each of the 28 member states.
However, so far, this aspect of the 2009 Regulations has received only limited commentary. In the long run the most important effect of Hemming, far transcending its narrow factual context, may be to draw the attention of the wider public law community to their potential use and effects.