Provider tells High Court leased assets ‘never in sector’, in challenge to regulatory judgement

“Unlawful”

 

Setting out Inclusion’s case in the Administrative Court of the Queen’s Bench Division, Mr Stilitz challenged the February judgement as being “unlawful” on grounds including a failure by the regulator to give adequate reasons for its decision; the “irrationality” of the regulator’s conclusions; and a lack of “proportionality” in the regulator’s intervention.

 

Mr Stilitz queried the regulatory judgement’s assertions that should risks crystallise and Inclusion be unable to meet its lease payments, it would be “reliant on the goodwill” of third parties to agree to renegotiate leases and agreements.

 

The provider would instead be subject to the “commercial good sense” of its landlords, he said, which he described as “sophisticated” investors that would act in their own best interests.

 

He added that were Inclusion to become insolvent, the funds would also have a “massive incentive” to enter into arrangements with alternative providers – meaning that vulnerable tenants were unlikely to lose their homes.

 

While acknowledging that Inclusion carried commercial risk, Mr Stilitz said that the RSH had “wholly failed to engage with [the nature of the risks in the context of the] benefits… inherent in this model”.

 

He also said the regulator had “failed to engage in any meaningful way” with representations put forward by Inclusion in correspondence regarding the mitigations it had put in place, as well as the steps it had taken to strengthen its model since a previous regulatory review in 2015.

 

Mr Stilitz claimed the RSH had failed to distinguish between “managed risks and uncontrolled loss” in a business that is “successful and profitable”.

 

Arguing that the 2019 regulatory judgement lacked adequate reasons, he labelled the document “entirely conclusionary” in nature.

 

“How helpful is this judgement to Inclusion in understanding [what it needs to do to return to compliance]? We would submit: ‘Not helpful at all’,” he said.

 

“What we don’t have is an explanation of why they thought it was all right to expand [by entering into leases] with precisely the issues [their advisors had highlighted in 2015]”.

 

“Clear and sufficient”

 

However, in its defence, the regulator argued that the reasons provided in the judgement were “clear and sufficient”. It emphasised that rather than a “worst case” or ‘perfect storm’ scenario needing to occur in order for Inclusion to be unable to meet its contractual liabilities, a single event – such as the inability of a major care provider to honour its void cover or a major change in relevant policy – could suffice.

 

Much of the evidence shared on Wednesday and Thursday centred around the journey from an initial (unpublished) regulatory review in 2015 – when Inclusion did not exceed the 1,000 unit threshold for a full regulatory judgement – to the disputed 2019 judgement.

 

This included communication in 2015 between Inclusion and the RSH regarding a report the same year by consultancy Campbell Tickell that had found the claimant was “not compliant with the HCA regulatory framework on either viability or by association with the topic of risk management, governance”, and a subsequent review of its leases by Ward Hadaway (Inclusion’s solicitors).

 

Mr Stilitz said that the regulator’s 2015 review had found the provider “fully compliant” and that since that report, Inclusion had “significantly improved” its risk management approaches.

 

However, setting out the regulator’s defence on Thursday 16 January, Monica Carss-Frisk QC said: “The claimant yesterday repeatedly made the claim they were signed off as fully compliant in August 2015.”

 

That does not tell the “full story”, she added, and she cited a paragraph in the regulator’s letter of 3 August 2015 that stated: “You have indicated that Inclusion is ‘pausing’ its expansion plans while it considers the risks and operating environment it faces.

 

“If you determine that you intend to grow beyond the 1,000 unit threshold for enhance regulatory engagement, please let us know.”

 

She referred to the Campbell Tickell report, which recommended that Inclusion implement changes including completing a risk analysis concerning its leases to address the fact that these were “long-term, with no break clauses and with very limited alternative viable options”.

 

The contract review by Ward Hadaway had also recommended the renegotiation of leases to introduce break clauses to cover market change such as a change in government policy.

 

The RSH has argued that in forming its opinion of Inclusion in 2015, it relied on its understanding that the provider was taking steps to implement its advisors’ recommendations and that it had paused its growth plans while it did so.

 

Ms Carss-Frisk drew the court’s attention to the fact that following the advice to introduce break clauses, Inclusion had attempted to test the approach on a selection of contracts and had been refused by its landlords.

 

She referred to the subsequent “rapid expansion” of the provider, including an increase of 30 per cent in terms of lease contracts in one year, and said the court should bear in mind the fact that the “new leases they have entered into do not have break clauses”.

 

At the time of the February 2019 judgement, the most recent statistical data return showed Inclusion had 1,814 units in management; its 2018/19 accounts recorded 2,358 units.

 

Ms Carss-Frisk said: “What we don’t have is an explanation of why they thought it was all right to expand [by entering into leases] with precisely the issues [their advisors had highlighted in 2015]”.

 

However, Mr Stilitz argued that Inclusion had implemented all the recommendations of Campbell Tickell’s report and had implemented “or tried to implement” all Ward Hadaway’s recommendations.

 

He also said that the attempts to renegotiate its leases in 2015 had not been successful because at the time “things were sailing on calm”. But he said that, in a crisis, it would be in the interest of investors to negotiate.

“Economic growth, like apple pie, is a good thing [most of the time] – but not at any cost”

 

Uncertainty and “mismatch”

Ms Carss-Frisk said that the regulator had identified a fundamental “mismatch” between Inclusion’s liabilities and the uncertainty of its income. She said that “laudable” as the mitigations it had outlined might be, these did not address the imbalance and would not allow the claimant to trade for more than two years.

 

Referring to Mr Stilitz’s argument that funds would be incentivised to renegotiate leases, Ms Carss-Frisk said “that is speculation”. She added that it could not be said to be “irrational” for the RSH to say there was uncertainty about whether head landlords “holding all the cards” would renegotiate.

 

Ms Carss-Frisk also queried an assertion by Inclusion that the provider’s growth would decrease rather than increase its level of risk through spreading its liabilities and growing its income.

 

She said that growth had “compounded” Inclusion’s issues, and cited the fact that at the time of the February judgement, over 50% of its nomination agreements were with one private care provider, Lifeways.

 

“Economic growth, like apple pie, is a good thing [most of the time] – but not at any cost,” she said.

 

According to the regulatory standards for viability, a provider has to have “the financial capacity to deal with a reasonable range of adverse scenarios, but needs to manage material risks to ensure continued compliance”, to be rated V2.

 

Ms Carss-Frisk said: “[That] raises the question: ‘Can it manage these risks?’ In this case, the regulator concluded, [we say] reasonably and rationally, that it could not.”

 

She also appealed to Mr Justice Chamberlain to refer to case law concerning the degree to which the court should “step into the shoes” of a specialist sector regulator.

 

Mr Justice Chamberlain will hand down his judgement on the case at a future date.