BEIS0000977
BEIS0000977
OFFICIAL SENSITIVE - COMMERCIAL
Date: 11 February 2022
From: David Barnett _
SCS clearing: Tom Cooper
Recipient To Note / Comment To Approve / Decide
Minister Paul Scully x
Permanent Secretary x
Special Advisers (SpAds) Xx
POST OFFICE LIMITED (‘POL”) BUDGET FOR 2021/22 AND RELEASE OF NETWORK
SUBSIDY AND NETWORK INVESTMENT FUNDING
Summary
1. As part of the Funding Agreemententered into to fund POL for 2021/22,Network
Investment and Network Subsidy payments are due to be paid periodically in-year from
BEIS to POL.
i f funding due to POL has been withheld in 2021/22 following the
recommendation ofofficials in May 2021,be f the absolute scale, inadequate
I and forecasting of legal costs. The Or includes:Network Investment
‘, due 1/10/21) and Network Subsidy 6 payments off Reeteant! due 1/7/21, 1/10/21
and 1/1/22, 2022). For prior submissionson this matter, please seeAnnexes A-D.
3. BEIS and UKGI officials have been working intensively together with the company to
challenge and improve POL's legal cost controls and forecastingsuch that POL can
present a 2021/22 budgetthat could be approved by BEIS.After considerable effort
and engagementsome reductions inlegal costs have been obtained, albeit offset by
other unforeseen costs, and there has been some improvement in PO's oversight
4. The position remains unsatisfactoryhowever and this note puts forward options for
dealing with the funding that has been withheld in the current financial yeaand the
legal costs issue It is recommended that POLs budget for 2021/22 is approved so
that funding can be releasedbefore the end of the financial year.
Recommendation avons,
5. To release the.!RREEVANT; of withheld funds to POL alongside clear commitments
from Management about the further work and collaboration needed in managing legal
cost. Options 2 and 3at paragraphs [30] and [31] set out differentapproaches to this.
Timing
6. A decision by close 23 February is requested allow orderly payment in line with the
BEIS cash forecasting assumption (payment on 8 March 2022)nd avoid potential
cash forecasting penalties POL must receivefunds by mid-March 2022 in order to
remain a Going Concern.
BEIS0000977
BEIS0000977
OFFICIAL SENSITIVE - COMMERCIAL
Background
Table 1: Extract from POL HMBU Paper22. 1.2022 — Long Term Forecasts
£m
9+3 Forecast
Pre 21/22 Total
ae Uae
Forecast Costs
GLO
HSS
OHC
Postmaster Detrimer
CCRC
Inquiry
Other
Total
7. ” Projected POL ‘egal spendis set out in Table 1 ‘Sper r the next 2 yearsis now
projected at - a material increase over the c. issumed irPOL’s August
SR submission, with subsequent increases driven by the Inquiry(which has since
announced an extended timeframe)and Historical Shortfall Scheme (HSS). POL
spend on historical matters is already subject to significant public scrutiny (including
BEIS Select Committee and PAC enquiries) soofficials and POL note these costs are
sensitive, especially in the context of compensation paid to Postmasters.
8. Initial 21/22 legal cost budget of was presented to March 21 POL Board.
UKGI advised BEIS that the legal c get and overall POL budget should not be
approved given quantum and visibility concerns, leading to the initial withholding
(Annex A).
9 A revised budget of {" iwas prepared for November 21 POL Board, with most of
flectingthe Inquiry ('°* crease). This revised budget also
legal cost challenge, meaning gross costs were estimated at £60.7m
10. After significant challenge from officials and effort from POL, current 21/22 forecasts
over the March budget Increased Inquiry costs account for most of the change(up
£9.5m) and results fromthe move to Statutory footing and expanded scope
11. The evolution ofthese 21/22 forecasts by major activity is set out at Table 2 and shows
the underlying movements within thesecategories:
Table 2: Extract from POL HMBU Paper 22.1.2022- 2021/22 Forecasts
Nov Board Mar 21 Bud
943 Forecast
_ orencpeerecinenpcnsneettes BSE wei Bascansnmen
FY Chet Prete by Mafor Project 93 Qe Tevez Totat MM FY22 Total (IM FY22 Total
Hictorieat Shortfal Scheme
HSS Post Offer 1 i
CCRC Prosecutions
=~ IRRELEVANT
Other
Total
Further Legal Cost Challenge
Revised Total
Actions Undertaken Since Cost Saving Challenge& Savings Achieved
12. Following challenge from UKGI and BEIS POL have undertaken extensiveand
challenging discussions with their primary legal advisorsHerbert Smith Freehills (HSF)
and Peters and Peter . Savings achieved wi '&P reflect process and
approach efficiencie: against a budget o' t+ a c.21% rate discount
2
BEIS0000977
BEIS0000977
OFFICIAL SENSITIVE - COMMERCIAL
13. The relationship with HSF is more complex. The firm was appointed in 2019 at short
notice following Justice Frasets judgment. HSF’s mandate was to settle theGroup
Litigation Order GLO) which was achieved in December 2019. POL has since
expanded HSF's role to advise on HSS, historical governance matters related to
Horizon, the civil litigation related to postmaster prosecutions, potential claims against
Fujitsu, Project Starling and the Inquiry. HSF has become embedded in working for
POL and much of the work has been awarded without competition. ThShareholder
team has challenged the use of HSF throughout, recognising that without competition
their commercial leverage would behard to challenge, but given timelines, complexity
and risk POL concluded the best course was to continue withHSF.
14. HSF have been resistant to engagement on fees- both with POL and Shareholder
Team officials — and have been slowto provide cost forecasting in required formats.
the majority of these savings set by increases in scale and / or
scope of work (visible in the ‘Benchmark Rates lines), including, for example, the.
implementation of options to accelerate the HSS to meet March 22argets. The :"
represents c41% discount on rates. HSF spend is summarised in Table 3 below.
Table 3: Extract from POL HMBU Paper 22.1.2022- 2021/22 HSF Costs (savings in red)
HSF Costs & Discounts IMarch Budget] Nov Board 4
ser I ons
Historical Shortfall Scheme
Benchmark Rates
Rate Discounts
Other Negotiated Savings
Acceleration Savings
Total HSS Costs H
‘Overturned Historical Convictions I
Benchmark Rates
Rate Discounts
Total OHC Costs
Statutory Inquiry
Benchmark Rates
Rate Discounts
Total inquiry Costs
‘Total #885, ONC, inquiry
16. Although POL has achieved significant reductions irHSF’s charge-out rates, it has
been extremely difficult to establish 1) whether the amount of time HSF hasbeen
devoting to the various tasks assigned to it represents good valueand 2) whether the
work could have been done more cost-effectively by POL using its own oadditional
contracted-in resource, or indeed by a combination of legal firms.
17. POL, UKGI and BEIS officialscontinue to push HSF for further savingsgiven the belief
that, by spend, POL is among HSFs top 5 clients However, HSF have so far pushed
back hard on further discounts and engagementin addition to working level challenge
escalated conversationshave been held between HSF, Ben Tidswell (the POL Legal
NED) and Tom Cooper. Given the limited progress that has been madeand
recognising that a large proportion of the legal costs have already been incurreWKGI
continued to encourage POL to negotiate a retrospectivaebate of HSF’s fees, but
POL has not taken thisidea up with much enthusiasm — perhaps coloured by ther
commercial dynamic with the company and success to date
18. The November POL Board saw the matter of BEIS approval for legal cost control
delegated to Nick Read and Al Cameron. Separately, POL have acknowledged the
3
19.
BEIS0000977
BEIS0000977
OFFICIAL SENSITIVE - COMMERCIAL
poor leadership and organisationto date in the Historical Matters business unit
(HMBU) which has been responsible fora significant proportionof legal costs incurred.
A new HMBU Director, Simon Ricaldin, joined POL in January 2022.Simon has
substantial, relevant experienceand has already signalled a focus on delivery and cost
control which should drive improvements compared toprevious leadership structures.
POL have secured some savings.
in the budgethas been achieved
Overall, following UKGI and
Excluding the Inquiry, — a c.
Controls
20.
21
22.
23.
24.
Following significant concerns expressed byUKGI and BEIS officials about the
absence of a modelling tool that would enable POL to forecast and control its
substantial legal costs POL commissioned KPMG to build a detailed cost modeto
improve the monitoring and scrutinyof HSF costs. The model is not yet fully
operational (expected ahead of the MarchPOL Board). POL have worked in an open,
collaborative and constructive fashion with UKGI and BEISfficials during model
development which has been encouraging, but it is not clear yet whether the model will
serve its purpose and enable POL to fully understand legal costs on an activity basis
that would better enable negotiation ofreductions fee reductions with HSF and P&P.
POL have recently added further discipline HSF cost control by introducing single
points of contact for sign-offof HSF work, and pausing invoice paymentssubject to
assurance on the cost/ content of work being aligned to wider cost efficiency efforts.
POL are planning further active negotiation with HSF on costsn the coming weeks—
supported by the improved modellingand controls. They would like senior POL, BEIS
and UKGI representatives to present a united frontwhich officials support and will take
forward. POL ensured HSF are aware that legal costs are likely to come under
significant public scrutinywhich may bring reputational riskto the company, further
strengthening the case forsignificant savings to be offeredgiven overall fee levels.
These efforts are part of drive by POL to optimally act as an intelligent client, ensuring
work is scoped as efficiently and effectively as possible for output and cost Simon
Ricaldin is well placed to take forward and enhance this intelligent client approach.
POL has also augmented controls across 14 areas including:monthly Board reporting
and scrutiny, monthly invoice reviews; formal forecasts change control, and monthly
challenge meetings on forecast v actualsamong numerous other measures.
We have requested that POL’s Internal Audit function review thequantum of legal
spend and the control frameworkas soon as they practicably can in 2022.
Confidence on Future Spending (Visibility and Cost)
25.
26.
27.
Although there has been progress on bothcosts (though offset with additional
substantive worke.g., the Inquiry) and visibility (primarily through development of the
KPMG model), officials are disappointed by the progress that has been made so far
POL has decided torefocus on its negotiation with HSF for FY22/23o0nce the cost
forecasting model has been fully developed.This means that BEIS must take a
decision in relation tothis years budget approval and the release of funds befor¢he
negotiations with HSF have concluded. A number of optionson how BEIS can signal
its continuing disappointment with lack of progressare set out below.
In all cases, BEIS would approve POLs 2021/22 budget in order to release the
withheld funding. BEIS could also obtain formal and renewed Senior commitment from
POL to meet and maintain improved monitoring and cost controls of legal costs. This
4
BEIS0000977
BEIS0000977
OFFICIAL SENSITIVE - COMMERCIAL
could be through a exchange of letters with Tim Parker and Nick Read, emphasising
Shareholder expectations that are directly related to the release of withheld funds.
Options
28. OPTION 1: Do not pay part of the withheld funds to POL(e.g. £10m). This is not
recommended. Firstly, some elements of overall cost have been upward pressures
outside of POL control— notably the Inquiry. Secondly, unless agreed by BEIS Finance
and HMT (with such agreementconsidered unlikely), failure to remit funds by 31 March
2022 would mean they are permanently lost and cannot carry over into the next
financial year. This would exacerbate the already difficult SR funding position
29. OPTION 2: Pay the withheld fundsin exchange for clear, renewed commitments
from POL on legal cost visibility and contralThis would mitigate the risks of option
1 by ensuring funds are transferred and made available to POL as originally agreed
and assumed in SR projections. The requirement for POL to make renewed
commitments and acknowledge the need for further progress would ensure clear
senior understanding and focus The SR settlement could be an opportunity to amplify
these asks. For example, part of the SR settlementcould be tied to achieving
reductions in the level of legal costsand achieving satisfactory controls
30. OPTION 3: Augment Option 2 by also writing to the POL RemCo Chair to set
expectations on legal cost management being factored intwemuneration and
reward decisions for the years 2021/22 and 2022/23 This option would adda further
tangible lever to incentivise strong control and managementBy making clear to
RemCo the Shareholder expectation that legal cost management should impacBenior
team reward we would expectdirect recognition to feed through into performance
assessments. However, in the context of a management team that is already under a
lot of pressure and, rightly or wrongly, somewhat resentful about théevel of incentive
pay over the last two years this option is likely to bevery badly received and could
lead to further instability in the management teamTom Cooper as Shareholder NED
engaged UKGI Senior colleagueswho did suggest the RemCo lever should be used.
Tom informally flagged the issue to Tim Parker and Lisa Harrington Tim confirmed
this approach would likely cause challenges with the management teamThe aim of
releasing withheld funds is to settle the current year position while ensuring the
continued Shareholder dissatisfaction with legal costs is clearly articulated to POL. As
such Option 3 may have a small incremental risk of being less of a&lean break’ than
Option 2. You could choose to formalise thisoption by writing to the RemCo Chair.
31. Do you agree with the recommended optionto release withheld funding due to
POL, totalling £101.5m? Please confirm whether you prefer Options 2 or 3. If you
prefer Option 3 do you wish to write to the Remco Chair?
Annexes
Annex A: Minister Scullys letter to POL on 8 June 2021
Annex B: 2 June 2021 submission re. POLs original budget
Annex C: 27 September 2021 submission re. 1 October funding due to POL
Annex D: 14 December 2021 submission re. January funding due to POL
Annex E: January 2022 HMBU Budget Paper from POL
Clearance checklist
Team Outcome of conversation
Finance Cleared by Daniel Heath (BEIS)
Communications I Not applicable. Funding specifics between POL and shareholder are not public
Legal Cleared by Eleri Wones (BEIS)
Delivery Not applicable.
BEIS0000977
BEIS0000977
OFFICIAL SENSITIVE - COMMERCIAL
Annex A: Letter from Minister Scully toPOL on 8 June 2021
Dear Nick,
POST OFFICE: BUDGET 2021/22
I am writing to you regarding Post Office’s proposed budget for 2021/22 that requires
shareholder approval from BEIS
In our discussions, I have been pleased to hear about improved trading conditions and I look
forward to seeing the Post Office operating at full capacity of its branch network during
2021/22.
In reviewing Post Office's 2021/22 budget, I am encouraged to see debate and challenge on
Post Office’s budget targets and urge continued ambition to grow Post Officés profitability to
ensure its future relies on a more self-sustained footing.
However, based on advice from UKGI officials, I understand that there is not adequate control
regarding the Post Office's litigation costs. Clearly, the Post Offices litigation proceedings are
a very important matter given its history, scale and doing the right thing for postmasters.
The operation of strong controls in this area is critical to the Post Officés financial future and
until I am content that there is a robust forecast in place, I am not able to approve the budget.
Consequently, under the 2021/22 Funding Agreement, I am not able torelease payment of the
Network Subsidy until there is a shareholder approved budget
I trust you understand my concerns andI look forward to considering Post Office's budget
which has an improved grounding for forecasted litigation costsI thank you for your continued
cooperation and collaborative efforts with officials.
Yours sincerely,
PAUL SCULLY MP
Minister for Small Business, Consumers & Labour Market, Minister for London
BEIS0000977
BEIS0000977
OFFICIAL SENSITIVE - COMMERCIAL
Annex B: 2 June 2021 submission re. POLs original budget
Attached under separate cover for reference and to avoid any confusiobetween submissions.
Annex C: 27 September 2021 submission re.1 October funding due to POL
Attached under separate cover for reference and to avoid any confusiobetween submissions.
Annex D: 14 December 2021 submission re. 1 January funding due to POL
Attached under separate cover for reference and to avoid any confusiobetween submissions.
Annex E: January 2022 HMBU Budget Paper from POL
Attached under separate cover for reference and to avoid any confusiobetween submissions.