As both an LSAT and GMAT teacher, let me see if I can use this as an excuse to shed a bit of light ... and by light, of course I mean formal logic!

This question contains CONDITIONAL statements, and such questions are best attacked by "translating" the English sentences into formal logic ... or "if/then" statements. This happens with enough frequency on the GMAT to make it worth knowing how to do. The first sentence is essentially background: these two things, a police force and a legal system, are the foundations of government. The substance of the question deals with how they relate to each other.
Let's try translating; I've come up with "symbols" but you can use whatever makes sense to you.
EVIDENCE:
"... there cannot be a good legal system (L) where the police are not well paid (WP) ..."
This translates to something like "If no well paid police, then no legal system" (if ~WP then ~L)
From which we can correctly infer: "if there is a legal system, there MUST be a well paid police force" (if L then WP)
The inference we've made is called the CONTRAPOSITIVE, and it can be made from any "if/then" statement. To form it, we reverse the conditional, AND negate the terms. We must do BOTH, and this is the ONLY valid inference that can be made (in formal logic) from a conditional.
Now, these two statement each contain a SUFFICIENT and NECESSARY condition. In short, sufficient on the left, necessary on the right. In other words, ~WP is sufficient to tell us ~L, and L is sufficient to tell us WP.
So what is the flaw in the CONCLUSION??
The (flawed) conclusion states that it follows, or that we can INFER, that:
"... where the police are well paid there will be good legal system ..."
In other words, "If WP then L, " ... which is NOT a valid inference. In that FLAWED inference, WP would be a sufficient condition!!! In other words, we CANNOT infer that a well paid force is SUFFICIENT to provide us with a good legal system. It's the other way around ... if we have a good legal system, we MUST have a well paid force! So answer choice (D) correctly describes the problem!
Hope that helps!
Oh, and two additional side notes:
1) Some folks will have seen "if/then" statements written as L --> WP, which is perfectly correct and a useful shorthand. This is NOT the same as causality, and sometimes we DO use arrows to denote causality, so just don't mix them up!
2) If you had trouble translating the first piece of evidence, try an intermediate translation of "... there cannot be a good legal system UNLESS the police ARE well paid ..." (which should make sense, I hope). Then you can ALWAYS form the "if/then" by crossing out the "cannot" and the "unless" and drawing an arrow in the direction of causality. Little LSAT trick that sometimes comes in handy!!