Drax v HM Treasury – How Green (or any other) Subsidies Can Be Withdrawn Without Notice

Renewable energy has been subsidised in the UK for at least 25 years. However, the nature, scope and level of the subsidy has been subject to significant change over time. In recent years, due to a range of fiscal and political pressures on the government, various support schemes have been either scaled back or abandoned.

Government subsidies provide an incentive to invest in commercial activities which would otherwise be uneconomic. That is their point. So what happens if a business, having made those investments in the expectation of a subsidy, finds that it is then withdrawn with little or no warning? Does it have any legal right to a notice period, or compensation in lieu of one?

This was the question considered by the High Court in the recent case of Drax v HM Treasury, which has important implications for business planning in any industry which currently benefits from government financial support.

The Background

The case concerned the Climate Change Levy (CCL), a tax on supplies of electricity which has effect under Schedule 6 to the Finance Act 2000. Electricity generated from renewable sources has been exempt from the levy, therefore giving renewable generators advantages in the wholesale market which they could convert into a revenue stream. The exemption functioned as one of the ways in which a state subsidy was provided for renewables.

By the middle of 2015, the exemption was costing HM Treasury about £500m per annum in the loss of CCL that would otherwise have been payable. That sum that was projected to rise steeply over the course of the Parliament, with the Treasury estimating a likely five-year cost of almost £4bn. At the same time there were policy questions about the efficacy of the measure, and whether it directed support to the right companies. In consequence, it presented a tempting target for the Chancellor of the Exchequer, George Osborne.

In his first post-election budget on 8 July 2015, Osborne summarily announced that the exemption was to cease. This announcement had not been trailed in advance. However, statutory mechanisms exist to allow taxation changes to be given effect almost immediately. Parliament passed a resolution on 14 July 2015, and the exemption came to an end with effect from 1 August 2015.

Inevitably, companies which held substantial positions in the renewable energy sector were adversely affected by this change, which few (if any) of them had anticipated.

Drax is a major electricity generator, operating the UK’s largest power station in North Yorkshire. It is heavily invested in a conversion to biomass generation. The Financial Times reported that the ending of the exemption would cost it £60m in lost revenue in 2016 alone. On the day of the budget, its share price fell by 28%.

Infinis operates a significant portfolio of landfill gas and onshore wind generation. Over the three days following the budget, its share price fell by 26%.

While both companies continued to benefit from other subsidies provided to renewable energy, the market reaction is sufficient to indicate the extent to which their revenues were perceived to be dependent on the continuation of the CCL exemption.

The two companies responded to the change by judicially reviewing HM Treasury, arguing that there was a duty to give them due notice – in effect to provide a grace, or adjustment, period – before the exemption was withdrawn.

The Difficulties with the Claim

The immediate problem for the claimants was that they had five high hurdles to surmount.

First, the decision to remove the exemption was embodied in a resolution of Parliament, and by the time of the hearing had found its way into primary legislation – section 49 of the Finance (No 2) Act 2015. It was therefore immune from challenge on domestic grounds, and could effectively be attacked only if it could be shown to be contrary to EU law.

Second, there had never been an express assurance from the government that the exemption would  be brought to an end only after a notice period had elapsed. So the claimants had to demonstrate that whatever rights they possessed arose as a result of the conduct of the government, or could be derived from features of the wider legal or policy framework.

Third, the claimants had to show not just a general entitlement to notice, but identify the notice period which they said was required (they argued for two years) and then demonstrate the source of that very specific expectation.

Fourth, even if there was an entitlement to a notice period, the circumstances giving rise to it must have been created by the actions of previous governments. This raised the question of the extent to which it could be binding on a newly-elected Parliament and an administration with some claim to a fresh democratic mandate.

Fifth, in any event, the courts typically extend a considerable margin of discretion to governments in relation to fiscal and macro-economic questions, and there was no question that removing the CCL exemption fell into this territory.

The Judgment

The outcome of the case turned mainly on the law relating to legitimate expectations.

Although there were several issues in play, the success of the claim depended on whether Drax and Infinis could clear the second and third hurdles identified above, and show that they had a legitimate expectation of two years’ prior notice before the exemption was withdrawn.

Domestic law would have been doubly fatal to such a claim. First, because ‘at this national level legitimate expectations cannot be raised against a sovereign Parliament’ [66]. Second, because the apparent absence of any clear, unambiguous and unqualified representation would have undermined the foundation on which any legitimate expectation has to be built in UK law.

As to the first point, the judge concluded, relying on the judgment of the Court of Justice of the EU (CJEU) in Plantanol, that the CCL exemption was giving effect to ‘specific, substantive requirements of EU law’ – in particular Article 15 of the Energy Taxation Directive and Article 4 of the Renewable Energy Directive [71]. The claim therefore fell within the sphere of EU law and could be considered on EU law principles, circumventing the first problem that national law would have thrown up.

Being in EU law territory, the question then became whether the European equivalent of the doctrine of legitimate expectation  would prove any more mutable than its common law counterpart. Grounded as it is in general EU law principles of legal certainty and foreseeability, does it offer greater flexibility, or does it also insist on the same kind of unqualified and unambiguous representation as UK law would?

HM Treasury unsurprisingly argued for a narrow interpretation of the EU law doctrine; Drax and Infinis for something much more expansive and flexible.

Legitimate Expectations in EU Law

The claimants’ assertion of the mutability of the EU law doctrine was assisted – and this fact will come as no surprise to anyone familiar with the CJEU – by a lack of consistency in the relevant case law.

As the judge put it, following a review of the CJEU jurisprudence: ‘Counsel had difficulty in picking out a clear and consistent set of principles from these decisions, and so do I’ [82].

This allowed counsel for Drax and Infinis some room to argue that ‘the giving of a precise assurance’ was not always a necessary ingredient of the EU law doctrine of legitimate expectations. However, the judge, Mr Justice Jay, relying in particular on the Grand Chamber decisions in Masdar (UK) and Schenker, as well as the recent case of Accorinti, disagreed –

‘In my judgment, the Claimants cannot succeed unless they establish to my satisfaction that the Defendants promoted a legitimate expectation of there being no withdrawal of the [CCL exemption] without a two year lead time, or equivalent fiscal benefit in lieu.’ (emphasis in the original) [99]

As to why it was necessary that the legitimate expectation must have been positively promoted, this was because –

‘…the principle is a sub-set of the doctrine of legal certainty; it cannot depend merely on a generalised sense of unfairness; and must logically require that Government has said or done something in particular such as to generate specific expectations in individuals or groups of persons which EU law demands will be honoured…’ (emphasis added) [100]

This ‘something in particular’ might involve either an express assurance, or implication from conduct. However, if the latter, the threshold for establishing it was extremely high.  It was not simply that the implication could derive from the words or actions of the government, but that it must ‘irresistibly’ do so –

‘…it seems to me that a quest for the identification of “something in particular” means, in practice, either that Government has given an express assurance that any withdrawal of the [CCL exemption] would be coupled with this specific lead time, or that this may irresistibly be inferred from what Government has said and done such that the giving of an assurance may be implied: in other words, the giving of something tantamount to an express assurance.’ [100]

The Arguments for ‘Irresistible Inference’

In passing, it should be noted that the impact of these conclusions is that EU law leads to essentially the same place as the common law. In UK public law an express assurance is usually required, and while a course of conduct which is so clear as to amount to a representation may suffice, it will arise only in exceptional cases – see, for example, the ‘unique’ circumstances of R v Inland Revenue Commissioners ex p Unilever [1996] STC 681.

In any event, because there was no express assurance here, the claimants were forced to make the case that their expectation arose out of ‘irresistible inference’ from the background circumstances [110].

One of these was that, over the last 15 years, government policy in relation to renewables had been relatively stable, and abrupt changes had, on the whole, been avoided. Jay J thought that this was ‘of some relevance, but not much’.  Mere good practice adopted by previous governments did not by itself generate a legitimate expectation. [115]

Another argument was that all of the overlapping renewable support schemes had to be considered together. They formed an ‘integrated package’ [111] because, in calculating the amount of some of the other subsidies – for instance, the strike price under the new Contracts for Difference regime – account had been taken of the value of a CCL exemption that was assumed to be continuing. This, it was suggested, meant that the various support schemes operated in a kind of lockstep.

The judge described this argument (tongue firmly in cheek) as being that the various support schemes worked ‘like exquisitely designed cogs in a perfectly conceived, finely calibrated clock’. In his own view they were more like a ‘patchwork quilt’ [37]. From the mere fact that one subsidy was modelled to take into account others in existence at that time, which happened to be ‘the only honest, straightforward basis on which such modelling could have been undertaken’ [109], it could not reasonably be inferred that they were locked together so that none of the component parts could be changed within a given time period [108].

As to the argument that two-year lead times had been allowed when changes had been made to other renewable support schemes in the past, Jay J found as a fact that, while this was true on occasions, those periods had sometimes been longer and sometimes shorter [39]. There was no consistent body of practice [116] and therefore no basis for grounding a legitimate expectation in a precise two-year notice period.

The ‘Prudent and Circumspect Operator’ Test

Taking an overall view, the judge considered how to approach the question of whether a set of facts, documents and features of a policy regime gave rise to an ‘irresistible inference’ which amounted to an express assurance. He said that it needed to be approached from the perspective of a notionally prudent and circumspect operator –

‘The critical issue for me is how a prudent and circumspect operator, equipped with all the information, knowledge, experience and understanding reasonably to be attributed to an individual, should have interpreted these key materials.’ [107]

On the facts of the case, that notional operator ‘could not and should not’ have had any expectation of a two-year grace period [108].

The effect of all of this was that Drax and Infinis cleared the first hurdle of  bringing their case within the scope of EU law, but failed to surmount any of the others. Interesting questions such as whether one administration can bind its successors, and specifically a subsequent Parliament, did not need to be addressed [121].

Other Arguments – Proportionality

The claimants also attacked the removal of the exemption under a discrete head of proportionality. However, the failure of the legitimate expectation argument effectively prevented this head of challenge from getting off the ground.

Jay J directly connected these two threads. If the claimants had indeed had legal rights in the form of legitimate expectations, it would have affected the balancing aspect of a proportionality assessment [126]. The government in these circumstances would probably not have done enough to justify the necessity for its peremptory change of policy [127].

However, since there were no legitimate expectations, what fell to be given weight as part of the exercise was not a set of public law rights, but only the claimants’ ‘private commercial and economic interests’ – these were ‘relevant considerations…but the weight they carry must be weaker’ [141].

The government enjoys a generous margin of appreciation on macro-economic and fiscal matters [132], and the justification given for removing the exemption was sufficient to fall within it in these circumstances [151].

Conclusions

Although some of the underlying public law was complex, the lessons of Drax are quite simple, and of application not just to the renewable energy sector but to all industries in receipt of some form of government support.

The starting point is that it is both good policy and good practice for a government to create a stable regulatory and fiscal framework which encourages investment. As the judge observed –

‘Few will dispute the general desirability of giving plenty of warning to commercial taxpayers of fiscal changes which will benefit or harm their interests, in order to facilitate measured rather than precipitate business planning.’ [39]

In practice, even well-informed commentators appear not to have seen the removal of the CCL exemption coming. The government may well have had good reasons for what it did. But its actions had a significant short-term impact on the affected companies [59], and must also have a longer-term cost to the wider economy, diluting the perception that the UK provides a stable and predictable fiscal climate in which to invest.

Nonetheless, an abandonment of good policy or practice, even if that is what this was, is not the same as unlawfulness.

In the early stages of the current wave of restructuring of green energy support schemes, under the last coalition government, DECC found itself in some difficulties for promoting a retrospective change (see Friends of the Earth). Even the proposal to do this, ultimately not carried through, came at a cost  (see Breyer).

But DECC appears to have learned the lessons of these initial difficulties, has avoided any repeat of them, and now makes much greater use of primary legislation as a means of immunising itself against certain grounds of challenge.

A judicial review brought in 2014 against the early closure of another support scheme, the Renewables Obligation, failed on all grounds, including legitimate expectation, though the grounds for argument under that heading were certainly stronger than than in Drax – see Solar Century*.

In this context, the lesson of Drax, once its complexities are stripped away, appears a fairly obvious one.

While the position may well be different if any specific promises were made, businesses certainly have no inherent entitlement to any grace period if government support is being withdrawn. Legitimate expectations do not arise from silence. They have to have been promoted. If they are not based on an express assurance, they need to arise from words and actions by the government which are so clear as ‘irresistibly’ to have the same effect as if that assurance had been given. This is a high hurdle.

Industries in receipt of state support should make the most of it. But any business which becomes dependent on the continuation of subsidy does so at its own risk.


* An appeal against the Solar Century decision was heard in early February 2016, and at the time of writing is currently awaiting judgment.