PENTLAND FERRIES AGAINST SCOTTISH MINISTERS
OUTER HOUSE, COURT OF SESSION
[2019] CSOH 39
P1291/18
OPINION OF LORD BOYD OF DUNCANSBY
In the petition
PENTLAND FERRIES
Petitioner
against
SCOTTISH MINISTERS
Respondent
Pursuer: Lindsay QC; MacRoberts LLP
Defender: Crawford QC, Campbell; Scottish Government Legal Directorate
26 April 2019
[1] Orkney and Shetland (“the northern isles”) are presently served by a subsidised ferry service which runs from Aberdeen to Kirkwall and Lerwick and between Scrabster in Caithness and Stromness (the Scrabster route). It comprises both passenger and vehicle services using “Ro-Pax” ships and a freight only service on “Ro-Ro” vessels. Together these services are known as the northern isles ferry services (NIFS). The current operator, Serco Ltd, (operating under the name Serco NorthLink Ferries (SNF)) has operated these routes since July 2012.
[2] The Scrabster route crosses the Pentland Firth. Two other services cross this stretch of water. The petitioner operates a ferry carrying passengers and vehicles between Gills Bay on the north coast of Caithness and St Margaret’s Hope in Orkney (the Gills Bay route). A passenger only service runs between John O’Groats and Burwick during the summer months. Neither of these routes is subsidised.
[3] On 27 September 2018 the respondents published a contract notice in the Official Journal of the European Union giving notice of a procurement of a subsidised public service contract (PSC) for the NIFS in succession to the present PSC which expires in October 2019. The petitioner challenges the decision to subsidise the Scrabster route and to “bundle” the route with the rest of the NIFS. The petitioner claims that the Scrabster route is a direct competitor with the Gills Bay route and that the provision of a subsidy for the Scrabster route poses an existential threat to its business.
[4] The petitioner is a family run business set up in 1997. It has operated a ferry service on the Gills Bay route since 2001. The petitioner has exclusive rights to the use of Gills Bay terminal. At no time has the petitioner received a subsidy. The petitioner currently uses a twin hulled Ro-Pax ship the MV Pentalina. A second larger ship, the MV Alfred, is due to enter service this summer. The petitioner’s public stance has been that the Alfred will be a replacement for the Pentalina. However in his affidavit, Mr Andrew Banks, the petitioner’s managing director, says that it would be possible to operate both vessels and meet all the demand for crossings of the Pentland Firth. I will return to this later.
[5] For some time up until the mid-1990’s the ferry services to the northern isles were operated by P&O Ferries Ltd without a subsidy. Following P&O’s indication that they could no longer operate the services on a commercial basis the routes were put out to tender. P&O won the tender and operated the ferry services, including the Scrabster – Stromness route, between 1997 and 2002. Following a further competitive tender a contract was awarded to NorthLink, a joint venture between CalMac and RBS Group, for the period 2002-2007. In 2003 NorthLink indicated that it would be unlikely to complete the contract due to financial difficulties. Following a period of interim arrangements and a tendering exercise CalMac operated the service between 2006 and 2012 under the name NorthLink Ferries Ltd.
[6] Prior to advertising the new contract the respondents, through Transport Scotland (TS), commissioned an appraisal of options through a consultancy, Peter Brett Associates (PBA). That resulted in the production of a number of documents, namely:
i. a draft market analysis
ii. socio-economic baselining and future planning horizon
iii. draft consultation report
iv. pre-appraisal and part 1 appraisal report (the pre-appraisal report), and
v. final report
These documents were produced by the parties. I was also given a copy of TS’s Scottish Ferry Services – Ferries Plan 2013–2022. The respondents produced an affidavit from Mr Graham Laidlaw, the head of the Ferries Unit at TS, along with a supplementary affidavit. The petitioner produced an affidavit from Mr Andrew Banks, the petitioner’s managing director.
[7] In 2017, which is the latest year for which data is available, the Scrabster route carried 146,000 passengers; Gills Bay, 150,000. These figures represent 38% and 39% of the market share respectively. The balance was carried on the Aberdeen–Kirkwall route and on the John O’Groats passenger ferry. The corresponding figures for cars was 41,000 (40%) on the Scrabster route and 56,000 (55%) on the Gills Bay route. In 2017 the Scrabster route carried 59,000 lane metres of commercial vehicles. TS did not have figures for the petitioner’s route but Mr Banks in his affidavit gave the figure of 89,860 lane metres.
[8] The pre-appraisal report emphasised that passenger and ferry services between the northern isles and the Scottish mainland are essential for the economies and sustainability of Orkney and Shetland Islands. Orkney has an increasing population with recent rates of growth exceeding the Scottish average. However the population is aging and the retention of younger people remains the challenge for the years ahead. The economy is relatively stable though some individual sectors have had significant changes. In particular the proportion of the GVA represented by transport and storage rose from 7.5% to 11.4% between 2000 and 2014. This has implications for demand for ferry services. The report concluded that frequent reliable and affordable transport to the Scottish mainland was a critical issue for Orkney in keeping younger “cohorts” on the islands. The report noted that Orkney and Shetland are unusual in that they are significant exporters of physical products. The success of agriculture, the principal industry on Orkney, was highly dependent on the provision of frequent and reliable ferry services with sufficient capacity and a timetable specifically attuned to the needs of exporting industries.
[9] Chapter 3 of the pre-appraisal report analyses how the NIFS is used. Principally this looks at the SNF ferries though in section 3.5 the report brings in the petitioner’s service. The report noted that there was a significant decline in the use by passengers of the Scrabster route in 2013. This coincided with the withdrawal of the middle of the day sailing on the off-peak timetable. So far as car traffic is concerned the report notes that it was particularly noticeable that the carryings on the Scrabster route experienced a sharp decline when the MV Pentalina was introduced in 2009.
[10] On freight there had been a steady decline in volumes on the Scrabster route with the 2015 freight carryings being around 15% less than in 2007. The report notes that this was in part due to enhanced Kirkwall to Aberdeen services since 2011 and in part due to the “ramping up” of operations by the petitioner. It is noted that as a commercial operator the petitioner can agree individual pricing packages with freight operators providing, for example, volume based discounts.
[11] A number of surveys had been carried out as part of the baseline research. These included online surveys of residents and businesses and onboard surveys of residents and visitors. Amongst other findings 85%, of Orkney respondents had used a NorthLink ferry in the last year of whom 91% had used the Scrabster route. The cost of travel was cited as the single most important issue for island residents and businesses.
[12] The removal of the middle sailing on the Scrabster route was seen by the public, business and Orkney Islands Council as having a series of negative impacts on the Orkney islands. There was a particular issue with those wishing to travel onwards to or from other islands served from Stromness. There was also a perceived loss of resilience for the community especially when linked with the closure of the Churchill barriers which link South Ronaldsay to the Orkney Mainland. The number of closures and the length of time for which the barriers are closed varies from year to year but there is a general upward trend.
[13] The report concludes that the Scrabster route and the Gills Bay route together provide the capacity to meet demand on the Pentland Firth (paragraph 12.1.1).
[14] The pre-appraisal report noted that it was and would continue to be challenging to develop options and appraise their potential impact when there is a competitive dynamic in the Pentland Firth market. At present there was an equilibrium of sorts in the market but there were a number of prospective changes which could impact on this before or during the next contract. One of these was the purchase by the petitioners of a new vessel. The authors of the report understood that this was to be a replacement for the Pentalina by a slightly larger vessel. The report continues,
“This easing of capacity restraints could lead to an increase in the market share for Pentland Ferries, whilst a two vessel service would be transformative. Questions could therefore be raised over the justification for a continuing PSC service, across the Pentland Firth, particularly in any two vessel scenario.”
[15] The report also examined the option of discontinuing the Scrabster route and deploying the MV Hamnavoe (the NFS ferry on the Scrabster route) to the Kirkwall–Aberdeen route. The Pentland Firth market would be served by Pentland Ferries alone with an appropriate contractual arrangement established with the operator. This was rejected in the report. The rationale for rejection is given as “reasons of public acceptability. It is not acceptable to remove the Stromness–Scrabster service as a publicly supported lifeline service.” (paragraph 6.5.18).
The law
[16] Parties were in general agreement on the applicable law. The differences between them related to interpretation and applicability.
[17] The following sections of the Treaty on the Functioning of the European Union (TFEU) are relevant
Article 106(2):
“Undertakings entrusted with the operation of services of general economic interest (SGEI) or having the character of a revenue-producing monopoly shall be subject to the rules contained in the Treaties, in particular to the rules on competition, in so far as the application of such rules does not obstruct the performance, in law or in fact, of the particular tasks assigned to them. The development of trade must not be affected to such an extent as would be contrary to the interests of the Union.”
Article 107(1):
“Save as otherwise provided in the Treaties, any aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods shall, in so far as it affects trade between Member States, be incompatible with the internal market.”
[18] In 1992 the Council adopted the Marine Cabotage Regulations (EEC No 3577/92). The following provisions are relevant:
Ninth preamble:
“Whereas the introduction of public services entailing certain rights and obligations for the shipowners concerned may be justified in order to ensure the adequacy of regular transport services to, from and between islands, provided that there is no distinction on the grounds of nationality or residence;”
Article 2:
“3. 'a public service contract' shall mean a contract concluded between the competent authorities of a Member State and a Community shipowner in order to provide the public with adequate transport services.
A public service contract may cover notably:
- transport services satisfying fixed standards of continuity, regularity, capacity and quality,
- additional transport services,
- transport services at specified rates and subject to specified conditions, in particular for certain categories of passengers or on certain routes,
- adjustments of services to actual requirements;
4. 'public service obligations' shall mean obligations which the Community shipowner in question, if he were considering his own commercial interest, would not assume or would not assume to the same extent or under the same conditions;”
Article 4:
“1. A Member State may conclude public service contracts with or impose public service obligations as a condition for the provision of cabotage services, on shipping companies participating in regular services to, from and between islands.
Whenever a Member State concludes public service contracts or imposes public service obligations, it shall do so on a non-discriminatory basis in respect of all Community shipowners.
2. In imposing public service obligations, Member States shall be limited to requirements concerning ports to be served, regularity, continuity, frequency, capacity to provide the service, rates to be charged and manning of the vessel.
Where applicable, any compensation for public service obligations must be available to all Community shipowners.”
[19] Counsel also referred to the following cases; Analir v Adminstracion General del Estado Case C-205/99(Analir); Altmark Trans and Regierungspräsidium Magdeburg, C280/00, EU: C:2003:415 (Altmark); Société nationale maritime Corse Méditerrané (SNCM) v European Commission Case T-454/13.
[20] The Altmark case laid out four principles which must be followed in order to avoid classification as a state aid. The first three are of relevance.
“87 … where a State measure must be regarded as compensation for the services provided by the recipient undertakings in order to discharge public service obligations, so that those undertakings do not enjoy a real financial advantage and the measure thus does not have the effect of putting them in a more favourable competitive position than the undertakings competing with them, such a measure is not caught by Article 92(1) of the Treaty.
88 However, for such compensation to escape classification as State aid in a particular case, a number of conditions must be satisfied.
89 First, the recipient undertaking must actually have public service obligations to discharge, and the obligations must be clearly defined ...
90 Second, the parameters on the basis of which the compensation is calculated must be established in advance in an objective and transparent manner, to avoid it conferring an economic advantage which may favour the recipient undertaking over competing undertakings.
...
92 Third, the compensation cannot exceed what is necessary to cover all or part of the costs incurred in the discharge of public service obligations, taking into account the relevant receipts and a reasonable profit for discharging those obligations. Compliance with such a condition is essential to ensure that the recipient undertaking is not given any advantage which distorts or threatens to distort competition by strengthening that undertaking's competitive position.
...
94 It follows from the above considerations that, where public subsidies granted to undertakings expressly required to discharge public service obligations in order to compensate for the costs incurred in discharging those obligations comply with the conditions set out in paragraphs 89 to 93 above, such subsidies do not fall within Article 92(1) of the Treaty. Conversely, a State measure which does not comply with one or more of those conditions must be regarded as State aid within the meaning of that provision.”
[21] If the Altmark principles are met then services of general economic interest (SGEI) may be subsidised by the member state compatibly with the internal market and TFEU. It is also necessary that any subsidy is shown to be necessary and proportionate to the aim being pursued; Analir paragraph 35.
[22] The European Commission has issued guidance on the interpretation and application of the regulations; Communication from the Commission on the interpretation of Council Regulation (EEC) No 3577/92. The document recognises the importance of maritime transport services for the inhabitants of Europe’s islands (p10). It recognises that it is for the member state, and not the shipowners to determine which routes require public service obligations (p11). At paragraph 5.3.1 (p12) the guidance says:
“Member States can impose public service obligations and conclude public service contracts only if they have determined for each route in question, that the regular transport services would be inadequate ... if their provision was left to market forces alone.”
Member states have a wide margin of discretion (p13). Intervention in the market must be proportionate and should not go beyond what is strictly necessary (pp16, 17). The document also recognises that member states may wish to group public service routes in order to generate economies of scale and attract operators. Bundles are not contrary to Union law provided they do not lead to discrimination or undue market distortion (p18).
[23] Parties were agreed that the test for this court is whether or not there has been manifest error on the part of the respondents; Analir, paragraph 31, SNCM paragraph 93. Manifest error is broadly equivalent to Wednesbury unreasonableness; Wood Building Services v Milton Keynes Council
[2015] EWHC 2011 (TCC) paragraph 14; BY Development v Covent Garden Market Authority
[2012] EWHC 2546 (TCC), paragraphs 11-17; Smyth v Secretary of State for Communities and Local Government
[2015] EWCA (Civ) 174 paragraph 80.
Submissions for petitioner
[24] Mr Lindsay QC for the petitioner explained that the petitioner’s route was a profitable one. They provided the ferry and also the terminals. Over the years they have upgraded the ferries and a new ferry, the MV Alfred, is to be in service for the summer. The business was growing. The competing Scrabster route was heavily subsidised. The extent of the subsidy exceeded the petitioner’s operating costs by some margin. The respondent provided the ferry the MV Hamnavoe through a leasing arrangement and they had to pay wharfage charges for the terminal. Despite the high level of subsidy the Stromness route was losing market share to the petitioner. The potential new subsidised contract had an estimated subsidy of £370 million for the whole bundle of routes. The proportion attributable to the Scrabster route had more than doubled from that available under the present contract. It was for this reason that the petitioner was concerned that the existence of the subsidy provided a threat to their profitability and continued trading.
[25] There was no dispute between the parties on the applicable legal principles. It was accepted that the award of the contract was governed by the Marine Cabotage Regulations. It was accepted that these regulations had direct effect and were thus binding on Scottish Ministers. In addition Scottish Ministers had to follow the Altmark principles.
[26] Mr Lindsay submitted that the following principles could be seen from the Marine Cabotage Regulations and case law. First, the starting point was that the payment of a subsidy was an unlawful state aid as it distorted the market. Second, under the Marine Cabotage Regulations a payment of a subsidy was only lawful if the state had first identified a market failure. The onus was on the state to demonstrate that such a failure existed. Third, market failure occurred when regular transport services would be inadequate if left to market forces alone. Fourth, if the state has identified a market failure any subsidy requires to be necessary and proportionate. In this case if there was a market failure a proportionate subsidy would be one that met the cost of lease payments and wharfage. Fifth, a subsidy is only proportionate if some objective could not be attained by measures less restrictive than the freedom to provide services. Sixth, a subsidy can never be proportionate if it leads to undue market distortions. Seventh, any subsidy has to be available on a non-discriminatory basis. It was not sufficient for the respondents to say that they would like to have two routes. They had to first identify the market failure and make sure that any subsidy is non-discriminatory, necessary and proportionate.
[27] There was agreement between counsel that in order to succeed the petitioner required to show a manifest error on behalf of the respondents. While there was some academic discussion as to what was meant by manifest error it was agreed that it equated to the Wednesbury test. However, this would only apply if the respondents had carried out the appropriate analysis. It was the petitioner’s case that no such analysis had been carried out.
[28] It was not lawful to separate out a particular route from the market. In this case the market was the route from the north coast of Caithness across the Pentland Firth. In SNCM the analysis was carried out on the basis that the Corsican routes were one market. While public desire or particular routes was a relevant consideration, these could not be given effect to unless it was possible to identify a market failure.
[29] The evidence relied upon by ministers to justify their decision demonstrated that there was an effective market in which there is competition. The unsubsidised and profitable competing ferry service provided by the petitioner has gained market share at the expense of the subsidised Scrabster route. This was irrefutable evidence that a competitive market was functioning effectively. In any event the decision was unlawful because it has not been demonstrated that the subsidy was necessary and proportionate to the aim of providing ferry services across the Pentland Firth to Orkney and it had not been made available on equal and equivalent terms to the petitioner’s competing ferry service.
[30] The pre-appraisal report contained no analysis justifying a conclusion that there was a market failure in the provision of ferry services between the mainland and Orkney. Indeed the findings demonstrated that there had been no such market failure. The report recognised the “competitive dynamic” in the Pentland Firth market and noted that the reduction in carryings on the Scrabster route was a result of competition with the petitioner. This was an express recognition that there is an effective market in which there is competition. The pre-appraisal report also noted that the petitioner was purchasing a new larger vessel which would ease capacity constraints and lead to an increase in market share for the petitioner. It stated that a possible “two vessel service” could be transformative. The report questioned the justification for a continuing PSC service across the Pentland Firth. It did not address these questions and they are left unanswered. Such failure was fatal to the lawfulness of the decision. This again was an acceptance of an effective market not of market failure. The report made no mention of subsidy proposals. It noted the option of a joint approach for the provision of services involving the petitioner. The respondents did not discuss any such joint approach with the petitioner. Accordingly there had been no exploration of such an option of the joint provision of services between the mainland and Orkney involving the petitioner. Although the Scrabster route was described as a lifeline service, no such recognition was given to the Gills Bay route. The report contained no justification for including the Scrabster route and the Aberdeen to Kirkwall route in the same subsidised public service contract. The pre-appraisal report did not provide the necessary evidential basis to support the respondents’ decision.
[31] The respondents had now produced two affidavits from Graham Laidlaw in ex-post facto justification. However, Mr Lindsay described the evidence submitted within that document as a superficial analysis that fell short of convincing evidence. At paragraph 67 of Mr Laidlaw’s first affidavit he said that four scenarios had been considered in the context of the petitioner’s service. However, there was no consideration of the petitioner using two vessels on the Gills Bay route. The failure to consider such a solution was an error. While it was true that the public position taken by Mr Banks was that the Alfred would be a replacement for the Pentalina, Mr Banks had raised the possibility of operating two ships on this route in informal discussions with the Minister of Transport in 2010 and again in 2018.
[32] Mr Laidlaw had addressed the issue of bundling of the two routes at paragraphs 81 onwards. He had noted that in 2009 the European Commission accepted the justification for bundling the routes together. At paragraph 89 of his affidavit, Mr Laidlaw had concluded from the Transport Scotland research that there had been no significant change in the market since then that would remove the public need for the routes. The tender documents had therefore been framed round the existing service specification. Mr Lindsay submitted that the conclusion that there had been no significant change in the market was a manifest error for two reasons. First, the level of subsidy now being proposed was very much larger than that under the existing contract. Secondly, in 2009 the Pentalina was just coming into operation. The report had shown that there had been a decrease in the market share on the Scrabster route from the 2003 base attributable in the report to the new ship.
[33] Mr Laidlaw had produced a supplementary affidavit in response to the affidavit from Mr Banks. He had analysed the operational costs and sought to explain why the subsidy figures were large compared to the petitioner’s service. However this analysis did not demonstrate why the high level of subsidy was necessary. If there were failings in the market then they need to be addressed but that would be done by analysing why the Scrabster route was not profitable. In particular there was no analysis as to whether it was now necessary to double the level of subsidy.
Submissions for the respondent
[34] Ms Crawford QC for the respondents submitted that this case was about whether there was a real public need for the Scrabster route. The question was whether that route was required in order to ensure the adequacy of required transport services to Orkney which would not be met by the market alone. Put another way, was there a shortage of private initiative to ensure the adequacy of transport services to Orkney? If the answer to the question was yes, then the decision to offer a subsidy was lawful provided that it was necessary and proportionate to the identified need. The respondents had identified that there was a real public service need for the ferry routes between Scrabster and Stromness and between Aberdeen-Kirkwall-Lerwick. These routes were commercially unviable and would not be operated by a private initiative. As a result, the failure to provide a subsidy would result in the loss of ferry services on these routes. The loss of these routes would result in inadequate provision of ferry services to the islands of Orkney and Shetland.
[35] Passenger and freight services between the northern isles and the Scottish mainland were essential to the economies and sustainability of both the Orkney and Shetland Islands. The Scottish Ferries Plan had established the respondents’ commitment to strengthening and approving the ferry services provided to island communities. The respondents were under a statutory obligation to provide a national islands plan with a view to improving, amongst other things, transport services to the islands; Islands (Scotland) Act 2018, section 3. A modern travel and transport system was fundamental to sustainable and inclusive economic growth. It opened up new opportunities for people and directly impacted the health and well-being of the communities and the effectiveness of the country’s public services; “Delivery for Today, Investing for Tomorrow: the Government’s Programme for Scotland 2018-2019” at page 37.
[36] What was meant by adequate? It did not require to be the absolute bare minimum to get to and from the mainland. The respondents were entitled at the very least to take into account the need for Orkney as an island community to prosper and grow when considering the question of adequate provision of ferry services. The decision-making process was set out by Mr Laidlaw in his affidavit. In addition to the report and other documents ministers had knowledge themselves from the supervision of the existing contracts. Transport Scotland had within their own corporate knowledge an understanding of how the existing contracts worked, the carriers and the capacity on the Scrabster to Stromness route. They had some knowledge of the petitioner’s undertaking, though more information had been provided in the affidavit from Mr Banks.
[37] In order to avoid classification as a state aid in a particular case, four cumulative criteria must be fulfilled; Altmark paragraphs 87-88. This permits services of general economic interest (“SGEI”) to be subsidied compatibly with the internal market and therefore lawfully. The first of the four Altmark criteria is that the recipient undertaking must actually have public service obligations to discharge and the obligations must be clearly defined; Altmark paragraph 89. The petitioner’s challenge proceeds on the basis that the first criterion has not been met. The Marine Cabotage Regulations permit the award of public service contracts where the regular transport services would be inadequate if their provision was left to market forces alone. Such contracts are compatible with the internal market and therefore lawful provided they are necessary and proportionate to the identified need; Regulations articles 2(4) and 4; Analir paragraphs 31-33; SNCM paragraphs 45 and 124. The respondents have a wide discretion to define what they regard as the market, what constitutes adequate service provision and consequently if there is a real public need; Analir paragraph 31; SNCN paragraph 93. The respondents’ assessment may only be questioned in the event of manifest error. The respondents had a wide discretion to determine what constituted adequate transport services to and from Orkney. So far as the Pentland Firth crossings were concerned, the respondents had concluded that both the petitioner’s service and the Scrabster to Stromness route constituted adequate transport services. That was vouched by the report at paragraph 12.1.1 as well as the Ferries Plan at paragraphs 95-97.
[38] Having identified what was required to ensure adequate transport services, the next question was whether or not it could be met by market forces alone. It was clear that no one could run the Scrabster to Stromness route without subsidy due to the cost. There was accordingly a market failure in relation to that service.
[39] In so far as the petitioner was now suggesting that it could run two vessels from Gills Bay across the Pentland Firth, that had not been the position publically adopted by Mr Banks. The petitioner had been a consultee to the draft and not suggested that it might run two vessels.
[40] The provision of the subsidy was necessary and proportionate. The subsidy only reflected what was necessary to ensure an adequate service with a reasonable profit to the operator. The contract had gone out to open tender. In 2012 Scottish Ministers had tendered the contract in two lots. One lot was for the Aberdeen-Kirkwall-Lerwick service. The second lot was for the Scrabster to Stromness service. Bidders could bid separately or for both. No bidder was interested in the Scrabster to Stromness service and accordingly all bids were for both services run together.
[41] While it was accepted that there was no separate document which showed that there was a market failure so far as the Scrabster to Stromness route was required, there was no requirement in law to have such a formal document. What the respondents had was sufficient material to demonstrate such a failure. The respondents had before them a number of documents and policy statements which guided their decision-making process. These included the PBA reports, the Ferries Plan, the general policy commitment to ferry services, the Programme for Scotland 2018-2019 and the obligations contained in the Islands (Scotland) Act 2018 at section 3. The respondents also had a commitment to the introduction of Road Equivalent Tariff (RET) on the Orkney route. This should lead to an increase in traffic which would impact on the requirements for capacity on the Pentland Firth routes. Both passenger and freight services were essential to the sustainability of the island communities.
[42] An extensive consultation process had been undertaken with stakeholders who were met on a face to face basis with a circulated written note for approval thereafter. The petitioner participated in that process. As a result of these consultations a number of appraisals of options for the specification of the contract were drafted. These had been produced. The Scottish Ministers knew that passenger and freight ferry services between the northern islands and the Scottish mainland were essential to the economies and sustainability of both the Orkney and Shetland Islands. They also knew that a subsidised ferry service played a critical role in facilitating the economies of both Orkney and Shetland. Sixty percent of Orkney residents surveyed had used the petitioner’s ferry service in the past year. Seventy seven percent of Orkney residents had used the Scrabster route in the past year. Taken together the petitioner’s service and the Scrabster route provided the necessary capacity. The petitioner’s current service, even with the replacement vessel would have insufficient capacity to subsume the entirety of the users of the Scrabster route. The petitioner’s service was dependent on the Churchill barriers being open. There had been occasions when they had been closed due to weather conditions. Maintaining populations and fostering a culture of in migration was seen as essential if the islands were to have a sustainable future. The cost of living in Orkney is higher than many other parts of rural Scotland and cost of travel to the mainland is one factor which increases the cost of living for residents. Orkney is unusual compared to other island groups in that they are both significant exporters of physical products. The success of the principal industries on each island group is therefore highly dependent on the provision of frequent and reliable ferry services which offer sufficient capacity and a timetable attuned to the needs of exporting industries. The food and drink sector was of critical importance to Orkney and the subsidised services are crucially important for transporting produce off the islands. There were a range of other factors including the overnight B&B option on the Scrabster route for those with onward travel to non-mainland Orkney that together with timetabling on that route were significant. The petitioner had barred all past, present and future appointed St Margaret’s Hope pier trustees from using their service while as a private commercial operator they were entitled to do so. This was incompatible with the provision of a lifeline service. While public transport at Scrabster was limited and a problem, it had better public transport connectivity than Gills Bay. The community of Orkney was keen to retain the Scrabster route because it was a fast 90 minute service.
[43] The provision of a subsidy on the Scrabster route was necessary, proportionate and non-discriminatory. Scottish Ministers knew that a subsidy had been necessary in the past. No other options had been put forward either by the petitioner or others. The contract when awarded would contain provisions regarding the subsidy which would only reflect what was necessary to cover costs and a reasonable profit. The bidder was not given a blank cheque. The price has a greater weighting than other criteria in the awarding of the tender. There was no discrimination because there were different services. It was inaccurate to say that there was a doubling of subsidy. The subsidy would vary with attendant costs. The £370m identified in the tender documents was merely an estimate of what might be provided under the contract.
Discussion
[44] As I have indicated above parties are agreed that the test for this court is whether there has been manifest error on the part of the respondents. Such a test broadly equates to Wednesbury unreasonableness. It is also, I think, accepted that the respondents have a wide margin of discretion in the decision making process. That discretion however has to be exercised in accordance with the Marine Cabotage Regulations and the case law of the CJEU. In particular they must follow the principles enunciated in the Altmark case.
[45] There is a fundamental disagreement between the parties on the interpretation and applicability of the law. The dispute is this. The petitioner says that in order to assess market failure it is necessary to look at the Pentland Firth as one market. The petitioner is able to operate their service without a subsidy. That in itself, the petitioner submits, is testimony to the fact that there is no market failure. It follows that the decision to subsidise the Scrabster route is unlawful. The respondents, on the other hand, say that they first have to determine what routes are required in order to provide adequate maritime transport services and then assess in relation to each route whether it can be provided without a subsidy. The question then is whether or not it was lawful for the respondents to designate the Scrabster route as an SGEI.
[46] There is no doubt from the evidence presented to me that the Gills Bay and Scrabster routes are in competition with one another. I accept that there is a Pentland Firth market which is distinct from the services that run from Aberdeen to Kirkwall. If the petitioner is right in the interpretation of the legal position then it must succeed.
[47] I am satisfied that the respondents were entitled to designate the Scrabster route as an SGEI. I can find nothing in the case law that suggests that the fact that there is a route across a stretch of water which requires no subsidy means that another route across the same stretch of water cannot be subsidised. Indeed the indications in case law point the other way. In Analir (paragraph 34) the CJEU stated that:
“the application of a prior administrative authorisation scheme as a means of imposing public service obligations presupposes that competent national authorities have first been able to determine for specific routes (my emphasis) that the regular transport services would be inadequate if left to market force alone. In other words it must be possible to demonstrate that there is a real public service need.”
[48] The CJEU has recognised that the issue to be addressed is whether the compensation for providing the service on a specific route has the effect of putting the subsidised route at a real financial advantage over undertakings competing with the subsidised route; Altmark (paragraph 87). That is why the CJEU went on in Altmark to enunciate a set of principles against which to measure proposals to subsidise specific routes. In my opinion that reinforces the view that the starting point is not to look at the market but to look at the specific routes that serve that market.
[49] I accept the submission of the respondents that in considering specific routes the first issue for them is the adequacy of transport services to Orkney. That is clear from the Analir decision (paragraph 31), the ninth preamble to the Marine Cobotage Regulations and from the guidance from the European Commission (paragraph 5.3.1).
[50] I do not consider that the decision of the respondents to support the Scrabster route as a SGEI was either irrational or unfounded in evidence. There was indeed a wealth of evidence to support such a conclusion. There are four strands to the reasons advanced by the respondents for considering that in order to provide adequate transport services it was necessary to support the Scrabster service. The first relates to the demand and capacity on the Pentland Firth. The figures, quoted above, demonstrate that the conclusion in the pre-appraisal report (12.1.1) that the “Stromness–Scrabster route and the petitioner’s route together provide the capacity” is a reasonable conclusion to reach (see also Ferries Plan, paragraphs 95 to 97).
[51] The petitioner does not dispute the conclusions regarding the volume of traffic and demand on the Pentland Firth routes but maintains that this demand could be met by the petitioner using two ships. It points to the passage in the pre-appraisal report at paragraph 4.4.24 which stated that a two-vessel service (operating from Gills Bay) would be transformative and questions whether there should be a floor beyond which the viability of the Scrabster route should be considered. Mr Lindsay argued that that finding in the report placed an obligation on the respondents to engage with the petitioner to see whether he would be willing to operate such a service. In his affidavit Mr Banks suggested that no decision had been taken on the future of the Pentalina and that it could operate alongside the new ship, the Alfred. He said that he had mentioned this possibility on two occasions to Transport Ministers. Mr Banks’s public position has long been that the Alfred would be a replacement for the Pentalina. That is the stance he has taken when speaking to the press and it is what was conveyed to the authors of the report, which noted “It is our understanding that this vessel will replace rather than supplement the MV Pentalina.”
[52] I do not consider that the comment in the pre-appraisal report imposed any obligation on the respondents to engage with the petitioner on the possibility of it running two ships. The pre-appraisal report was dated September 2016. Prior to that Transport Scotland had consulted on options. The draft consultation report is dated April 2016. It is clear from that document that representatives of the respondents met with representatives of the petitioner. A note of that consultation was prepared and sent to the petitioner for their comments. It is clear that at no point during that process did the petitioner suggest that the Alfred could be used alongside the Pentalina. Mr Lindsay quoted no authority for his proposition that the terms of the report imposed a further duty on the respondents to consult with the petitioner beyond that which he had already undertaken. Nor do I consider that two informal conversations with Transport Ministers are any substitution for participation in the consultation process. The consultation was the opportunity to make concrete proposals for operating two vessels. If such a proposal had been made I am in no doubt that the respondents would have had to consider it and respond. It is of course impossible to know what their response might have been. The petitioner has at no point suggested that they might operate a service from Scrabster to Stromness but might have operated one from Gills Bay to Stromness. No doubt the respondents would have had to consider the cost of running a subsidised service to Scrabster against the petitioner’s proposals.
[53] The second strand of reasons concerns the needs of the Orkney community and the aspirations for future growth. Orkney is unusual in that it is both an importer and exporter of goods. Frequent and reliable ferry services are vital for the economy of the islands. The population is growing but also aging. Good transport links are a factor in attracting and retaining young people. The cost of ferry services was cited as the single biggest deterrent for travel to and from Orkney (pre-appraisal report 4.2.87). The respondents are committed to the introduction of RET (road equivalent tariff). If and when that goes ahead it is likely to increase demand.
[54] The respondents are under a statutory duty to prepare a national islands plan setting out their main objectives and strategy in relation to improving outcomes for island communities. The identified outcomes include increasing population levels and improving and promoting sustainable economic development. It also includes improving transport services; Islands (Scotland) Act 2018, section 3. Mr Lindsay suggested that EU law had to take precedence over that duty. That may be so but I see nothing in section 3 which conflicts with EU law. In any event these remain legitimate aspirations for any government.
[55] Thirdly it cannot be said that the desire to have two routes across the Pentland Firth is irrational. The Gills Bay route has certain advantages. It is shorter. It has been able to reach discount deals with regular freight traffic and it has taken traffic from the Scrabster route. The Scrabster route is more exposed and occasionally has to sail via Scapa Flow, increasing journey times. On the other hand Stromness serves the western end of the Orkney Mainland and the isles served from Stromness. The Hamnavoe has cabins for a B&B facility for those travelling on to other islands. St Margaret’s Hope is reached from the Orkney Mainland by the Churchill barriers which can be closed in bad weather. The statistics suggest that this is an increasing occurrence. While both Scrabster and Gills Bay have issues with transport links Scrabster is considered to be better served by public transport (pre-appraisal report 2.9.4).
[56] The petitioner has barred all past, present and future trustees of St Margaret’s Hope pier from their vessels as a result of a commercial dispute. While a minor point (though presumably not for the trustees or those travelling with them) it is not consistent with running a lifeline service. If there was no other route across the Pentland Firth the options for them to leave Orkney would be to either go via Kirkwall to Aberdeen or fly.
[57] Fourthly there is strong support for the continuance of the Scrabster service. The figures from the survey show that it is well used. The local Council supports its continuation and its possible discontinuance was rejected as publically unacceptable. While any decision to support a particular service has to be within the law, issues of resource allocation and aspirations for future growth are essentially political decisions. The respondents are publically accountable for such decisions.
[58] The next question is whether there is a market failure on the Scrabster route. As Ms Crawford acknowledged there is no document entitled ‘market failure’ but there is ample evidence that the route is unviable without a subsidy. I did not understand the petitioner to suggest otherwise. Mr Laidlaw’s affidavit shows that the shortfall between operating costs and revenue on the Scrabster service was £8.1m in 2017 and £7.5m in 2018. He sets out the reasons for the high operating costs including the commitment to maintaining a 90 minute crossing. This requires more fuel and is thus more expensive. Other costs are ones which are imposed on the operator as a result of the PSC. The operator is required to maintain certain environmental standards as well as obligations in relation to staff training and employment conditions. As I understand it these are costs which a private operator may legitimately elect not to meet but which the state requires from those undertaking public service obligations. It was not suggested that the state could not impose such obligations. Nobody has suggested that this route could be operated without a subsidy. Indeed PBA in the pre-appraisal report pose a question as to whether the respondents should consider a cap on the extent to which they will subsidise the Scrabster route. It is I think significant that when the contract for NIFS was last advertised in 2012, the Scrabster route was offered as a stand alone contract. No one was prepared to bid for that route on its own.
[59] The next question is whether the subsidy is necessary and proportionate (Analir paragraph 35). One of the petitioner’s main concerns was the level of subsidy for the Scrabster route. Mr Lindsay estimated that it was double that under the existing contract. If that was true then that would be of serious concern and raise real questions as to how such a large increase in the amount of subsidy could be justified. On that basis one well understands the petitioner’s concern.
[60] It should be noted that this was not something that was foreshadowed in the petition though Ms Crawford took no objection. Indeed it appears to have arisen from an erroneous, or at least incomplete, answer in the pleadings. It is not necessary for me to rehearse Mr Lindsay’s calculation but it comes from figures for the subsidy for the Kirkwall–Aberdeen service incorporated in the answers without making it clear that this applied to the “Ro-Ro” freight only service and not the “Ro-Pax” passenger and vehicle service. The contract let in 2012 estimated the level of subsidy for the whole NIFS contract as £222m.
[61] Ms Crawford produced figures for the subsidies paid under the 2012 contract for the Northern Isles Ferry Service in the years from July 2012 to June 2018. The total amount so far for the whole contract is approximately £244m. If the final year to June 2019 is in line with past years the final total for the contract is likely to be in the region of £285m–£290m. That compares with an estimate at the start of the contract of around £220m. The new contract for the whole NIFS is given as £370m.
[62] At this stage it seems impossible to say what the final outcome will be in terms of subsidy. While there is a substantial projected increase in the level of subsidy it appears that the petitioner’s fears about the doubling of subsidy are misplaced.
[63] The proposed contract includes a section related to the payment of the grant. The grant is to be used solely to meet part of the costs and expenses of the NIFS and for no other purpose. There is a base case which is the financial model for the provision of the NIFS. That is to be set out in schedule 10. That is said to show the cumulative difference between operating costs and revenue for each service year plus the operator’s return, again set out in the base case. The grant for each service year is the projected cumulative difference between operating costs, including the operator’s return, and revenue for that service year shown in the base case, together with the projected fuel liability as shown in the fuel management programme and any capital supplement. There are also provisions for the recoupment of overpayments, recovery of any illegal state aid, dispute resolution and governance of the contract.
[64] How such a mechanism will work in practice is difficult to determine and will no doubt depend on the calculation of the base case which will only be known at the conclusion of the tendering process. What I think can be said at this stage is that the proposed contract is a detailed document which includes fairly stringent methods for the calculation of the grant. It also includes sections detailing the services to be provided, the standards, including environmental management to be adhered to and provisions relating to human resources.
[65] Various suggestions were made as to what might be a better way of providing a subsidy without “creating an unfair advantage”. This included payment of specified costs, such as wharfage and fuel. These suggestions seemed largely to ignore any notion of reasonable profit which is a legitimate part of the subsidy (Altmark, third principle, paragraph 92). No doubt other methods of constructing the contract could be made but there is no manifest error in the way in which the respondents have framed the present contract.
[66] Another suggestion was that a direct payment should be made to the petitioner as some kind of equalising mechanism. I cannot see how that would work. In the first place since the petitioner can operate the Gills Bay route without a subsidy any payment would be classed as a state aid and prima facie illegal. In any event any payment would require to meet the Altmark principles. Although it was suggested that a payment could be made direct to the present operator if the European Commission agreed the strong expectation would be that the route would be put out to tender.
[67] Finally the petitioner complains about the bundling of the Scrabster route with the other routes for the northern isles. The basis of this complaint is that the Pentland Firth is one market distinct from the Kirkwall–Aberdeen route. I am satisfied that there is no error on the part of the respondents. The bundling of routes together is a common practice endorsed by the European Commission; Communication from the Commission on the interpretation of Council Regulation (EEC) No 3577/92.
[68] The European Commission considered the issue of bundling in relation to CalMac services when it examined the provision of state aid for maritime transport services in Scotland in 2009. That involved the bundling of 26 routes. The Commission considered that there were benefits from bundling. It was possible to provide relief vessels in the event of a break down or in poor weather conditions or during maintenance (para 185). Bundling enhances the integration of the network by making it easier to combine safety, quality and environmental aspects of vessel and port operations (para 186). There are economies of scale, ticketing and marketing (para 187). The administrative costs and burden of tendering each route separately could be too high (para 189). The Commission concluded that given that the legal framework explicitly allowed for the bundling of routes it could not be concluded that the bundling of routes was unnecessarily unfair.
[69] Although the Commission did not specifically consider the NIFS, it is clear that the same considerations apply. The petitioner argues that things have changed since the Commission’s decision; the Pentalina is now in operation and the petitioner has a larger market share than before. I reject the submission that this has significantly changed the situation. The benefits to be obtained from bundling of routes are not dependent on these variables. The considerations that the Commission had in mind when considering the CalMac bundling apply just as much to NIFS in 2019. Mr Laidlaw in his supplementary affidavit demonstrates the overheads associated with the managing of large contracts. Unbundling the route would have a significant impact on resource and staffing costs within Transport Scotland (para 37 and Schedule A). It is notable that on the last occasion when the NIFS was tendered the Scrabster route was offered as a standalone contract. No one bid for it and no operator has since shown an interest in operating the Scrabster route alone.
Decision
[70] I shall sustain the respondents’ third and fourth pleas in law and refuse the petition.
