Thanks Tanu - yes I see what you mean, however, I am still confused by the help text. The following statements seem to contradict each other:
"if the Fixed Frame option is selected, the frame size will remain fixed, and as legend items are added or removed, they will adjust to fit inside."
and
"Instead of resizing legend item elements to fill the frame; font size, default patch size, and gap measurement values will be used as maximum values. After the entire frame is taken up using these values, legend items will begin to drop."
The first implies that the items will adjust to fit inside the legend as more are added - this is what occured in the example you showed. The second implies that the font sizes etc remain fixed, and items will drop out as more are added, which is what occurs in my example. The help text is not clear about when each behaviour occurs.
Just experimenting with adding different layers I think the answer is that the text does not scale when a map service is added - it only scales when a standard desktop layer is added to the map.
To test this I chose two of our map services. I opened the two mxds used to create them and grouped the layers in each and exported them to a lyr file - so I had two desktop layers replicating the map services.
See the attached images - the first two show what happens when the desktop layers are added to the legend with fixed frame ticked on. When the second layer is added the text and patch size is scaled down so that all items fit.
[ATTACH=CONFIG]27073[/ATTACH]
[ATTACH=CONFIG]27074[/ATTACH]
The second two show what happens when the same thing is done for the corresponding map services. There is no scaling and the items drop off the legend.
[ATTACH=CONFIG]27075[/ATTACH]
[ATTACH=CONFIG]27076[/ATTACH]
As far as I can see, this means that the "fixed frame" option can not be used in a web application/geoprocessing service application.