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Royal Scottish Assurance v. Scottish Equitable (No.2 The Lifetime Security Plan Action) [2005] ScotCS CSOH_8 (14 January 2005)

OUTER HOUSE, COURT OF SESSION

[2005] CSOH 8

OPINION OF LORD BRACADALE

in the cause

ROYAL SCOTTISH ASSURANCE

Pursuers;

against

SCOTTISH EQUITABLE

(No. 2: THE LIFETIME SECURITY PLAN ACTION)

Defenders:

________________

Pursuers: Keen, Q.C., A. Young; Brodies, W.S.

Defenders: Tyre, Q.C.; R. Clancy, Q.C.; Burness, W.S.

14 January 2005

Introduction
[1] This case came before me on procedure roll on the third plea-in-law for the defenders. It is closely associated with another action between the same parties arising out of the Flexible Mortgage Plan ("FMP"). In both cases the pursuers were represented by Mr Keen QC and Mr Young, and the defenders by Mr Tyre QC and Mr Clancy QC. In the present case the defenders moved me to dismiss the action or, in any event, to exclude certain averments from probation. The pursuers moved for a proof before answer.

[2] The defenders are the successors to the Scottish Equitable Life Assurance Society ("the Society"). The pursuers were created as a joint venture between The Royal Bank of Scotland Group plc ("RBS") and the Society. In 1989 the pursuers were created in order to launch a range of life insurance and pension products.

[3] Within the establishment of the pursuers there were three interested parties: the pursuers, RBS and the Society. The parties entered into written agreements in connection with the new venture. There were two main agreements. The first of these, the Master Agreement, was primarily concerned with the allocation of shares in the new company and does not feature in the present case. The second agreement was the Reinsurance Agreement which was entered into in July 1990. This agreement features significantly in the present case.

The Reinsurance Agreement
[4] The Reinsurance Agreement is production 6/1. The terms which are of significance for the purposes of the present case are those which relate to the services which the Society undertook to provide to the pursuers. Clause 3 deals with the appointment of the Society to provide specified services and is in the following terms:

"(A) The Company hereby appoints the Society to provide the Specified Services during the continuance of this agreement and for so long as may be required to comply with Clause 10(F) of the Master Agreement all on the terms and conditions hereinafter set out.

(B) The Society hereby accepts the foregoing appointment.

(C) The Society shall take all reasonable steps to provide the Specified Services to the Company in the same quantity, quality and calibre as the Society provides the services comprised therein to its own policyholders.

(D) The Company shall provide such information to and co-operate fully with the Society to enable it to provide the specified services including (without prejudice to the foregoing generality) the prompt provision by the Company of such information to the Society as it shall request to enable it to carry out any of the specified services and the Company shall give its prompt and accurate attention to such instructions as the Society shall give it in connection with the performance of any of the specified services".

The Specified Services are defined in considerable detail in Clause 1.

The Lifetime Security Plan
[5] In article 5 of condescendence, the pursuers aver that RBS and the pursuers had no experience or expertise in the provision of insurance services. RBS had identified the Society as a well regarded provider of financial services which principally sold policies to independent financial advisers. RBS envisaged that the pursuers would re-brand a limited range of the Society's products which would then be marketed to existing customers of RBS. In about late 1989 and the early 1990s, the Society was considering the introduction of a Unit Linked Whole of Life Policy ("ULWOL"). The pursuers expressed interest in the development of their own ULWOL product. The Society developed its own ULWOL product, which was eventually marketed as "Passport for Life", alongside a similar ULWOL product for the pursuers. The pursuers' ULWOL product was launched as a "Lifetime Security Plan" ("LSP") on 3 June 1991. The LSP product was principally designed to provide a level of life cover on a flexible basis at a reasonable cost. The basic structure of LSP was that policyholders would pay premiums which would be used to purchase units within one or more of the pursuers' investment funds. Units would then be cashed in to meet the cost of the life insurance cover and other expenses of administering the LSP product. The LSP was marketed by the pursuers to three principal categories of customers. It was marketed as a flexible lifetime policy for families; as a policy suitable for business protection of key personnel; and for Inheritance Tax planning.

[6] It is further averred that LSP was intended to be a flexible product where the policyholder could opt for different benefits such as critical illness cover and permanent health insurance. The policyholder could opt for standard or maximum life cover. Standard cover was designed so that the premium payable would remain constant until the policyholder's 85^th birthday, provided that the unit growth of 7.5% was achieved. Maximum cover was designed so that if the appropriate unit growth rate was achieved, no increases in premium would be required until after the first review on the fifth anniversary of the policy. Policyholders also had the option to have fixed levels of premium and sum assured or escalating levels of premium and sum assured. The policyholder who wished to have escalating levels of premium and sum assured, could elect whether the rate of escalation should be in line with the National Average Earnings index or by a fixed percentage. An LSP could be written on a single life or on joint lives. On joint lives, policyholders could elect whether the policy became payable on either the first or the second death.

[7] In Article 7 it is averred that the Society was responsible for the design of the LSP product and of the business systems necessary to operate LSP. The Society drafted the conditions of LSP. The Society's actuaries carried out the profit testing of LSP and prepared premium quotation tables for the pursuers' sales force. The Society designed the actuarial basis underpinning the calculation of premiums. The Society produced the premium calculations which were built into the main frame computer system. The software for laptops replicated the premium calculations from the main frame. The Society's administration department carried out the administration of these policies including the arranging of underwriting and the issuing of policy documentation.

[8] It is averred that in about 1998 the pursuers carried out a migration exercise whereby insurance business was transferred from the Society to NDF. As part of the migration process, the pursuers' actuarial department started in January 1999 to put together a review process for the LSP policies in order that NDF could build a computer programme to carry out future five yearly reviews of the LSP customers. Whilst testing the proposed review system on some sample policies in about February 1999, it became apparent that the premiums for many of the policyholders would have to double to provide the benefits proposed. The increase in premium was far greater than might have been expected from the fact that a lower assumed investment return was being used to calculate the future premiums. Further analysis revealed that there was a substantial shortfall in the investment funds of the policyholders.

[9] The pursuers aver that the Society made a total of five errors with respect to calculation of premiums. These are specified in each of articles 8 to 12. The pursuers claim damages in both contract and delict.

The first error: escalation
[10] In Article 8 it is averred that the Society made an error in calculating the premiums by failing to make proper provision in cases where the policyholder wanted escalation of premium and sum assured. The pursuers aver that as a result the premiums were too low to provide for the cost of the escalating life cover and the sum assured. The defenders' position is that this allegation is misconceived. The defenders' position is that in making the necessary calculation the actuaries used a series of reasonable and acceptable calculations and that there was no breach of contract or delictual duty. For the purposes of the procedure roll debate, the defenders accepted that providing for escalation was something which fell within the scope of the specified services. The defenders submitted that the pursuers' case based on an error with respect to escalation fails on the grounds of relevancy and specification.

The second error: Rating
[11] In Article 9 it is averred that the Society failed to reflect the effect of rating in the premium paid by policyholders. If a policyholder had health problems or a high risk occupation which would increase the risk of early death the policyholder would be rated with the result that an additional percentage would be applied to the mortality charge. It is averred that a higher premium would have been required to achieve the objectives of the policy. The pursuers say that the same premium was collected for rated cases as for any other case not involving rating. The pursuers aver that the cost of life cover from rated cases was higher causing more of the units purchased to be used up, resulting in a shortfall.

The third error: the single age equivalent
[12] This arose in the case of joint life policies and is dealt with in Article 10. The pursuers aver that LSP could be taken out on a joint life basis with the life cover being payable on the first or second death. It is averred that the Society used a series of single equivalent age approximations to calculate the premium payable by the policyholders on such policies. It is averred that the single equivalent age approximations used by the Society were insufficiently accurate for either standard or maximum cases. Solely for the purposes of the procedure roll debate, it was accepted by the defenders that selection and use of single age equivalent did fall within the specified services. It is averred that the Society used the same formula for maximum cover and standard cover cases despite an analysis carried out in January 1991 which suggested that different formulae should be used as the existing formulae understated the premium in maximum cover cases. The analysis revealed that the formula did not provide a sufficiently accurate approximation for either standard or maximum cover cases. The risk charges which were deducted from the policyholder's fund were based on the actual ages of the policyholders. The risk charges actually deducted were higher than that assumed in the premium calculations. The understatement of the premiums paid by the policyholders was up to 10% of the correct charge. This resulted in the premium paid on many policies being too low to achieve the objective of the policies. The defenders' passport for life product adopted the same single equivalent age formula as those used for LSP.

The fourth error: Inheritance Tax planning
[13] In Article 11, it is averred that the Society designed the standard cover LSP product to operate until the policyholder reached the age of 85 years. Assuming that an investment return of 7.5% was obtained on the units purchased by the policyholder, the policyholder's funds would be able to meet the cost of the life assurance charges until age 85 years. At age 85 years the fund was designed to reduce to zero. It is averred that this design feature created significant problems for policyholders who lived beyond 85 years since they could obtain further cover only at prohibitively expensive rates. The LSP product with this design feature was unsuitable as an Inheritance Tax planning vehicle. The Society knew that the pursuers were intending actively to market LSP for Inheritance Tax planning. A memo from the ULWOL Implementation Team meeting on 8 January 1991 referred to an Inheritance Tax guide which was being written. The RSA actuarial meeting on 4 February 1991 which was attended by the Society's actuaries, noted that most of the sales pressure was in respect of Inheritance Tax plans. The Society did not advise the pursuers of the consequences of this design feature for policyholders wishing Inheritance Tax protection, of which consequences the pursuers were not aware. The Inheritance Tax brochures which were signed off by the Society's compliance and legal departments, did not draw attention to the fact that the fund would reduce to zero at age 85 and was therefore unsuitable for Inheritance Tax planning. The Society's actuaries who reviewed the brochures as part of the technical advice directly relating to the marketing of the product range did not advise the pursuers of this feature of the product. It is averred that it would be normal for a life assurance company which intended to use the policy for Inheritance Tax purposes to design their life cover with a zero fund being targeted for the extremity of life such as age 105 or 110 years.

The fifth error: critical illness cover
[14] In Article 12 it is averred that in calculating the premium to be paid by the policyholders, the pursuers and, in particular, the pursuers' sales force, relied upon tables and software produced by the Society. These tables and software showed the premium applicable for particular ages with set levels of life cover. The tables and software only provided plans without critical illness cover or with critical illness cover equal in amount to the life cover. The Society had assumed that if a policyholder requested a level of critical illness cover other than equal to the life cover, the premium could be calculated by interpolation from the tables and software provided. The Society provided an interpolation formula which was inaccurate and resulted in the quoted premiums being too low.

Submissions and discussion
[15] Counsel for the defenders invited me to sustain the pursuers' third plea-in-law and to dismiss the case. Counsel attacked the pursuers' case based on breach of contract and delict. An additional argument was advanced with respect to the alleged error relating to Inheritance Tax planning. In addition, counsel for the defenders attacked the basis on which the pursuers had quantified their claim.

Contractual Case
[16] Mr Clancy on behalf of the defenders pointed out that the pursuers' contractual case as set out in Article 13 was virtually identical to the case in the FMP action. Accordingly, he adopted the arguments which had been advanced in the FMP case.

[17] In the course of the hearing in the FMP case I was referred to the case of The Bank of Scotland v Dunedin Properties 1998 SC 657. The case had been referred to by counsel for the pursuers in support of the proposition that I could have regard to the factual matrix in forming a view on the proper construction of clause 3(C). Here, Mr Clancy drew support from it for the proposition that the starting point of interpretation of a commercial contract was that the Court should ask what was the ordinary meaning of the words used. Mr Clancy submitted that the pursuers were trying to put a gloss on what was otherwise a clear provision defining the standard of performance by reference to services actually provided by the Society to its own policyholders. The search for a commercially sensible construction did not take precedence over the search for the ordinary meaning. The commercially sensible construction point was at its highest a neutral concept in the present case. In any event, said Mr Clancy, the defenders argue that it makes commercial sense to contract to provide services to an equivalent standard, which might be higher or lower than the general duty to take reasonable care. It would make no sense for the Society to offer services at a different standard. The Society had 49% of the shares. The Society had an obvious and direct interest to provide an acceptable service to the pursuers and to its own policyholders. The pursuers were coming to the venture without relevant experience. They had identified the Society as a well regarded provider and required them to provide services of the same quantity and calibre as that provided to their own policyholders.

[18] In reply Mr Young submitted that the literal meaning was not always the correct approach. He submitted that in this case it could not be said that the ordinary meaning of the words favoured either the pursuers or the defenders. Mr Young submitted, first, that when looking at a commercial contract one is trying to arrive at a commercially sensible construction. One endeavours to see what the reasonable businessman would have meant by the words used. Second, evidence of surrounding circumstances is often relevant when construing a commercial contract. These two strands were inter-linked because, if seeking to ascertain what a businessman would have meant, it would be necessary to know about the background circumstances, the background to the contract, the business purpose of the contract, and how commercial men would construe it. In support of these propositions Mr Young referred to a passage in the opinion of Lord President Rodger in Bank of Scotland v Dunedin Properties at page 661E-F and to the cases of Mannai Investment Co Ltd v Eagle Star Life Assurance Co ltd [1997] AC 749, and Charter Reinsurance v Fagan [1997] AC 313.

[19] Mr Tyre suggested what was said by Lord Hoffman in Charter at page 391 did not detract from the principle that words should be given their ordinary meaning. All Lord Hoffman was saying was that regard must be had to the context. In the present case, there was no reason to give words anything other than their ordinary meaning. He referred to a passage in the speech of Lord Mustill at page 388A-D.

[20] While the requirement to look at surrounding circumstances, as developed in Bank of Scotland v Dunedin Properties and the Mannai case did represent the modern approach to contractual interpretation, it did not mean that in every case the Court had to defer a proper construction until after evidence had been led. It was not necessary here.

Discussion
[21] In the opinion which I issued in the FMP case I expressed the following view:

"[32] I was invited by the defenders to dismiss the action as irrelevant. In addressing that question it is important to bear in mind the passage in the speech of Lord Normand in Jamieson v Jamieson 1952 SC (HL) 42 at page 50:

'The true proposition is that an action will not be dismissed as irrelevant unless it must necessarily fail even if all the pursuers averments are proved. The onus is on the defender who moves to have the action dismissed, and there is no onus on the pursuer to show that if he proves his averments he is bound to succeed.'

[33] It is clear that a central issue in the question of relevancy of the pursuers' case in contract is the construction to be placed on clause 3(C) of the Reinsurance Agreement. If the construction for which the defenders contend is correct, the pursuers, in order to plead a relevant case, would require to set out the Specified Services which were rendered by the Society to the pursuers, together with the services which were rendered to their own policyholders and identify any differences. They would require to demonstrate that these differences indicated that the service provided to the pursuers was inferior in quantity, quality and calibre. It is manifest that the pursuers have not pled their case in this way. Accordingly, if the construction contended for by the defenders is correct, the pursuers' case in contract is irrelevant.

[34] While I do not consider that it is appropriate to reach a concluded opinion at this stage, I am inclined to the view that the construction of clause 3(C) for which the defenders contend is open to powerful criticism.

[35] The defenders' position is that the duty of care owed by the Society to the pursuers is to a subjective standard. This would represent a departure from the normal standard required by the law. In addition, it would be an implied term in a contract for service that services would be carried out with reasonable care in the circumstances. The subjective standard would be a departure from such an implied term. On the other hand, the court would give effect to such a term if the terms of the contract made it clear that that was the intention of the parties. The question arises whether the parties have so agreed.

[36] In my opinion the first difficulty which lies in the way of the literal construction advanced by the defenders is the question of what standard of care the Society was obliged to exhibit to its own policyholders. In the absence of any suggestion to the contrary, that may be assumed to be the normal contractual standard of exercising reasonable skill and care. Production 7/14 comprises the PIA Rules. These Rules contain Statements of Principle which are intended to form a universal statement of the standards expected by the regulatory authority. Principle 2 states:

'A firm should act with due care, skill and diligence.'

There seems to me at this stage to be considerable force in the submission of the pursuers that the objective standard of care owed by the Society to its own policyholders would become the measure of the duty owed to the pursuers rather than the subjective standard of what the Society actually did with respect to its own policyholders.

[37] The subjective construction may also give rise to difficulties in the operation of business. First, the practice of the Society could vary from year to year. This would make for an unpredictable regime throughout the life of the contract. It would be surprising if a party such as the pursuers would enter into a contract designed to run over a lengthy period of time which included a clause as to the standard at which service was to be supplied which was unpredictable and subjective. Second, it is difficult to see how, in the context of a commercial contract, the pursuers could ascertain what standard the Society was actually exhibiting to its own policyholders.

[38] A further difficulty which may arise as a result of the application of a subjective standard is that it may not be an easy task to compare what the Society did with respect to its own policyholders and the service it provided to the pursuers. This was illustrated in the course of the pursuers' submissions. In article 8 the pursuers set out their averments with respect to the policy charge error. It is averred that in the FMP the policy charge was increased from time to time. In answer the defenders aver that the policy charge for their comparable product the Mortgage Link was never increased. Counsel for the pursuers' raised the question as to the point at which any comparison could be made.

[39] A further way to test the construction for which the defenders contend is to explore the extent to which it may lead to unreasonable or absurd results. In Schuler v Wickman Machine Tools, to which I was referred, [Schuler v Wickman Machine Tools [1974] AC 235] Lord Reid at page 251E said this:

'The fact that a particular construction leads to a very unreasonable result must be a relevant consideration. The more unreasonable the result the more unlikely it is that the parties can have intended it, and if they do intend it the more necessary it is that they shall make that intention abundantly clear.'

Upon a subjective interpretation, if, in a particular case, the Society provided a poor performance to its own policyholders, the pursuers receiving the same performance would have no remedy because all they would be entitled to would be the same service as was actually provided to the Society's own policyholders. Furthermore, the Society's own policyholders would have a remedy but the pursuers would not. These would certainly seem to be odd results. Again, if the Society treated sections of its own policyholders differently, the question could arise as to which standard the pursuers could look in seeking compliance by the Society with the terms of clause 3(C). In my opinion, in the light of these considerations, the construction for which the defenders contend may give rise to unreasonable results."

[22] Nothing in the further discussion of the cases would lead me to alter these views. I agree with the pursuers that the aim is to find the commercially sensible construction. The ordinary meaning may be a satisfactory means to get there but may not necessarily be so. In Mannai Investment Co Ltd v Eagle Star Life Assurance Co Ltd at page 771A-C Lord Steyn said:

"In determining the meaning of the language of a commercial contract and unilateral contractual notices, the law therefore generally favours a commercially sensible construction. The reason for this approach is that a commercial construction is more likely to give effect to the intention of the parties. Words are therefore interpreted in the way in which a reasonable commercial person would construe them. And the standard of the reasonable commercial person is hostile to technical interpretations and undue emphasis on niceties of language."

In my opinion it is legitimate in this case to have regard to the context in which the agreement was made. In the same case at page 779F Lord Hoffman said:

"In the case of commercial contracts, the restriction on the use of background has been quietly dropped. There are certain special kinds of evidence, such as previous negotiations and express declarations of intent, which for practical reasons which it is unnecessary to analyse, are inadmissible in aid of construction. They can be used only in an action for rectification. But apart from these exceptions, commercial contracts are construed in the light of all the background which could reasonably have been expected to have been available to the parties in order to ascertain what would objectively have been understood to be their intention: Prenn v Simmonds [1971] 1 WLR 1381, 1383. The fact that the words are capable of a literal application is no obstacle to evidence which demonstrated what a reasonable person with knowledge of the background would have understood the parties to mean, even if this compels one to say that they used the wrong words. In this area, we no longer confuse the meaning of words with the question of what meaning the use of the words was intended to convey."

[23] There was some discussion as to whether it was appropriate to use the word "subjective" in relation to the construction of clause 3(C) for which the defenders contend. Counsel for the defenders contended that their construction should not be characterised as subjective. However, I noted that in the hearing on the FMP case Mr Tyre had submitted that the parties had expressly chosen not to contract by an objective standard. He suggested that, had that been the intention of the parties, it would have been simple to have imposed an objective standard in the contract. This appeared to imply an acceptance that their construction was a subjective one. While I am of the view that the pursuers' contention that the word "subjective" is properly to be used in that context is correct, I did not find the question of whether a particular label should or should not be applied to be of assistance in exploring what is the proper construction to be placed on clause 3(C).

[24] A number of further arguments were advanced in relation to the LSP case and I must now address these.

Clause 3(C) as an exclusion clause.
[25] In the course of the FMP hearing Mr Keen had advanced the proposition that the defenders were seeking to exclude or modify the implied duty to exercise reasonable skill implied in the contract. The result, if the construction for which the defenders contended was correct, would be that clause 3C would fall to be read as an exclusion clause. The result of that would be that clear words would be required to exclude or limit liability. The wording of clause 3(C) did not clearly exclude or limit liability. In the FMP case the matter was not fully argued and I left it out of account. The question was revisited in the present case. While Mr Young accepted that clause 3(C) was not a classic exclusion clause, he submitted that, since the defenders were arguing for a standard of care which was potentially lower than that normally implied in contract or delict, some form of exclusion of liability was involved. What might be expected under general law was in some way cut back. Clear words would be required to demonstrate some form exclusion. Counsel for the pursuers relied on the following passage in the speech of Lord Diplock in Photo Production Ltd v Securicor Transport Ltd [1980] AC 827 at page 850:

"My Lords, an exclusion clause is one which excludes or modifies an obligation, whether primary, general secondary or anticipatory secondary, that would otherwise arise under the contract by implication of law. Parties are free to agree to whatever exclusion or modification of all types of obligations as they please within the limits that the agreement must retain the legal characteristics of a contract".

[26] Counsel for the defenders disputed this. The situation was very far removed from that in the Photo Production Ltd case. In the Photo Production Ltd case the standard of service was not expressly described in the contract; reliance was placed on an implied duty. The contract was a standard form contract as opposed to the arms length contract between two commercial bodies as in the present case. In addition, the clause was an exclusion clause properly so called. In the present case, there was an express provision with respect to the standard of service and an issue as to what that meant. In these circumstances Lord Diplock's words have no bearing. In any event the pursuers had not pled their case on the basis that Clause 3(C) is the equivalent of what would be an implied provision.

[27] Mr Tyre questioned the use of the word "modify" by Lord Diplock. The word was not used in any of the other speeches. Mr Keen submitted that Lord Diplock's analysis was on all fours with the definition of an exclusion clause in the Unfair Contract Terms Act 1977, Sections 3 and 13.

[28] In my opinion to say that the construction for which the defenders contend requires clause 3(C) to be read as an exclusion clause is a somewhat strained approach. It is not an exclusion clause in the ordinarily understood meaning of that term. I am satisfied that the present case can be distinguished from the Photo Production Ltd case. In that case the standard of service was not expressly described in the contract. In my opinion, where, as here, two parties enter into a commercial contract in which an attempt is made to identify a particular standard at which services are to be provided, the proper approach is to examine the clause in the light of the rules of construction already considered. I do not find it helpful as an additional consideration to attempt to regard the term as requiring to be read as an exclusion clause. In my opinion Mr Tyre was correct to say that no unusual approach to construction was required.

IHT planning (contract case)
[29] Counsel for the defenders advanced an additional point with respect to the pursuers' case on Inheritance Tax planning. In Article 13, at pages 42- 43, it is averred that the Society knew or ought to have known that the LSP standard cover product was to be marketed as a whole of life policy which would be suitable for Inheritance Tax planning. They knew or ought to have known that if the standard cover product was designed so that a zero fund resulted at age 85 years, it would not be suitable for use as an Inheritance Tax planning policy. It is further averred that in the exercise of reasonable skill and care, it was the duty of the Society to design the LSP standard cover policy on the basis that the value of the policyholder's fund would not be projected to zero until age 105 or 110 years. Alternatively, it was their duty to draw to the attention of the pursuers that a standard cover policy was an unsuitable vehicle for Inheritance Tax planning. As I understood it, Inheritance Tax planning in this context meant using the proceeds of the policy to fund Inheritance Tax liability.

[30] The defenders took issue with the proposition that they had designed the standard cover LSP product to operate until the policyholder reached age 85 years. The defenders' position was that the pursuers designed the policy and they are responsible for its features. In any event, the product specification contained reference to this feature. The pursuers' senior staff must have been aware, they having approved it. The design of the product as a whole and design with respect to this particular feature did not fall within the scope of the Specified Services in the Reinsurance Agreement. There was no provision in the definition of Specified Services imposing an obligation on the Society to design the policy as a whole, far less this particular feature of it. With respect to the second duty, there was no contractual provision imposing an obligation on the Society to draw this feature of the policy to the pursuers' attention. It would be necessary for the pursuers to point to a provision in the Specified Services in respect of which particular acts or omissions were said to arise. Counsel for the defenders submitted that the averments with respect to the Inheritance Tax issue should not be allowed to proceed to probation.

[31] Mr Young submitted that the duty to design the product fell within the Pre-Sales Services, which were part of the Specified Services. In addition, that duty, and the duty to warn, fell within the Specified Services as "the provision of technical advice relating to the Product Range and the marketing thereof". The Society had been told how the product was going to be marketed and this was part of the technical advice which should have been given. Thus, both duties could be linked back to the Specified Services in the Reinsurance Agreement.

[32] Mr Tyre submitted that the pursuers' position appeared to be that they had been told that the fund would reduce to zero at age 85 years but they claimed that that did not convey to them that it made it unsuitable for Inheritance Tax planning. That, said Mr Tyre, was an astonishing proposition. Once the pursuers were told that there was a zero fund at age 85 years, it followed that there were not going to be any funds available to fund the liability if the policyholder died after the age of 85 years. Mr Tyre submitted that the provision of pre-sales services had nothing to do with design. Further, it was not technical advice to point out that a zero fund at age 85 years will not provide a fund after that age. The Society was not required to give advice as how to market a product. Therefore, the parts of the contract said to justify these averments were not applicable and there was no duty.

[33] In clause 1 of the Reinsurance Agreement at page 8 "the Specified Services" are defined as meaning Policy Services and General Insurance Services under certain exclusions. Policy Services include Pre-Sales Services. At page 7 of the Reinsurance Agreement Pre-Sales Services are defined as follows:

"the provision of the technical information (including any necessary computer software produced from the Society's hardware) to prepare a benefit illustration by the Company in respect of a prospective Policy including (without prejudice to the foregoing generality) any calculations or legal content or information (including the terms of the prospective Policy) which requires to be included therein but excluding (for the avoidance of any doubt) the provision by the Society of any equipment or hardware for use (out-with the premises for the time being of the Society) in the preparation of such a proposal".

At pages 9-10 the definition of Specified Services includes "the provision of any technical advice relating directly to the product range and the marketing thereof".

While I have some sympathy with the criticisms of this aspect of the pursuers' case, I am unable, without having heard evidence, to hold that these duties cannot be brought within the scope of the Specified Services and that consequently these averments are irrelevant. Accordingly, I shall allow this aspect of the case to proceed to probation.

The Delictual Case
[34] Counsel were agreed that in the present case the same considerations that arose in the FMP case were relevant and adopted their respective submissions made in the hearing in that case. Mr Clancy suggested that the same considerations which applied to the contractual case with respect to Inheritance Tax planning applied in the delictual case.

[35] For the reasons set out in the opinion which I issued in the FMP case I am unable to say that the pursuers' averments setting out the delictual case are irrelevant and they should accordingly be allowed to proceed to probation.

Quantum
[36] In article 15 the pursuers aver that they were subject to the regulatory regime of the Financial Services Act 1986 ("the 1986 Act") and the Insurance Companies Act 1982 ("the 1982 Act"). They were subject to regulation by the PIA, which was the successor to LAUTRO, and were bound to obey the Rules of the PIA. Under the 1982 Act the Treasury had certain functions in relation to insurance companies and could require a company to take such action as appeared to the Treasury to be appropriate to protect policyholders against the risk that the company may be unable to meet the policyholders' reasonable expectations ("PRE"). For completeness, it should be noted that the 1982 Act was repealed by the Financial Services and Markets Act 2000 and the concept of PRE has now been abandoned. The functions of the Treasury were contracted out to the FSA. The FSA became the principal regulatory authority and incorporated the functions of the PIA.

[37] Article 16 sets out the history of the dealings between the pursuers and the regulatory authorities. In September 1999 the pursuers notified the FSA about the various problems which had come to light in relation to the operation of LSP. The FSA insisted that an independent firm of actuaries should audit the pursuers' product. It is averred that the FSA has confirmed that the pursuers will require to compensate policyholders of LSP on the basis that there has been a breach of policyholders' reasonable expectations and that action is required to make good these expectations. The FSA advised the independent actuaries appointed by the pursuers that a similar compensation scheme to that agreed in relation to FMP required to be put in place for LSP. The scheme approved by the FSA is then set out, as a result of which it is averred that a lump sum had been paid into the policyholders' unit fund. In addition, averments are made as to the way in which former policyholders who had surrendered their policies, and policyholders whose policies had lapsed, were to be compensated.

[38] The first argument advanced by the defenders was the same as that advanced in the FMP action. Mr Clancy submitted that the pursuers' case that they could recover damages from the defenders on the basis that the pursuers' policyholders were entitled to damages from the pursuers for breach of contract was irrelevant. The pursuers' pleadings were defective because the pursuers had failed to identify in their pleadings how and why individual policyholders had a valid claim for contractual damages against the pursuers. The pursuers could not seek to recover damages from the defenders on that basis. There was, said Mr Clancy, an important additional consideration in relation to the LSP case. In the FMP case the pursuers had adopted the position that the FSA was holding a gun to their head. They averred that there was an imminent threat of direct and calamitous enforcement action by the FSA if the pursuers did not agree to the contractual damages for the policyholders. In the LSP action the pursuers were not offering to prove that these conditions prevailed. There was no suggestion of enforcement action by the FSA.

[39] On behalf of the pursuers Mr Young submitted that the starting point was to recognise that the pursuers have had to pay compensation which was insisted upon by the FSA and that payment of compensation flowed from the breach of contract by the defenders. In his submission the pursuers were not required to set out the precise basis but could simply rely on the sums that the FSA insisted that they should pay. In a similar approach to that taken in the FMP case, the FSA insisted that a compensation scheme be put in place.

[40] The argument that there was no reference to a Notice of Requirements in the LSP case ignored the fact that this case followed the FMP case and the pursuers knew what had happened in that case; they were aware that the FSA had taken a very strong line.

[41] For the reasons which I set out in the FMP case, it is, in my opinion, open to the pursuers to prove that they acted reasonably in obeying the requirements of the regulatory authority. While a threat of regulatory action was not imminent in the LSP case, this case did follow the FMP case and it would be reasonable for the pursuers to expect that a similar strong line would be taken by the regulatory authority. Accordingly, I reject this argument advanced by the defenders.

[42] A further argument on quantification advanced by counsel for the defenders had been foreshadowed in paragraph 4 of the Note of Arguments for the defenders. It was submitted that the basis upon which the pursuer had calculated loss, and agreed with the FSA to compensate policyholders, was fundamentally flawed. There was an important distinction between FMP and LSP policies. FMP policies were designed to produce a fixed sum on maturity sufficient to pay off a loan after 25 years. In the case of LSP policies there was no equivalent expectation. The contract was for life assurance. Life cover was provided for the duration of the policy. In the pursuers' case there was an illegitimate comparison between the FMP and the LSP cases. Mr Clancy quoted from Paragraph 4:

"The pursuers had failed to appreciate that LSP is different from FMP for the purpose of compensation because understatement of premiums does not result in any loss to the policyholder. LSP is a whole life policy where the target fund is an amount which, together with future premiums is sufficient to provide the death benefit contracted for, unlike FMP where a specific sum is targeted at a specified term and the policyholder's benefit is the maturity amount whether greater or less than the targeted sum. The contract for LSP is for a defined benefit to be payable on death at any time."

Later, paragraph 4 continued:

"The proper approach to quantification of loss so far as this claim is concerned is to assess whether or not, on the basis of current information and expectations, not restricted to the five matters which comprised the claims in this action, the pursuer will be unable to provide the benefits contracted for by policyholders without providing funds additional to those collected by way of premiums (after allowance for the pursuers' expected profit) and if so by how much it will fall short. Unless and until the pursuers' claim is quantified in this manner, it is irrelevant, and the action should be dismissed."

[43] Mr Tyre cited the example of a policyholder who was, say, 78 years old. It would not be open to the pursuers to say, "Sorry, we have run out of money, there is not enough aside to keep you insured for the next seven years". The pursuers would have to carry the remaining loss. Thus, there would be no loss to the policyholder at all. Any loss is a loss suffered directly by the pursuers who would have received less in by way of premiums than they ought to have done. This is not how the claim was framed. If no payment to the policyholders was required, the pursuers' averments were patently wrong and they have pled an irrelevant claim. They should have approached the measure of loss in a different way.

[44] On behalf of the pursuers, Mr Young submitted that the correct way to approach the question of compensation was by reference to what the FSA had insisted on. The question of damages was a question of fact. General principles may be applied but no single method of computation is necessarily the only method. In support of these propositions both Mr Young and Mr Keen referred to Haberstich v M'Cormick & Nicholson 1975 SC 1. This was a professional negligence case. In the present case there was breach of contract with respect to the provision of expert services. It could not be said at this stage that the defenders' approach was the only way to work out what the damages were.

[45] In addition, counsel for the defenders submitted that the Court could not at procedure roll stage determine what the correct method of computation of damages was. It would be only after hearing evidence that the Court would be in a position to determine what was the most appropriate way to calculate the loss.

[46] The general principle to be applied in quantifying a claim for damages for breach of contract is stated by the Lord President Emslie in Haberstich at page 6 in the following passage:

"When damages are claimed for breach of contract it is the aim of the law to ensure that a person whose contract has been broken shall be placed as near as possible in the same position as if it had not (Gloag on Contract, 2^nd ed., 690; Chaplin v Hicks [1911]2KB 786)".

Both the Lord President and Lord Cameron (at page 11) quoted the passage from Hadley v Baxendale 1854 9 Exch 341 at page 354:

"Where two parties have made a contract which one of them has broken, the damages which the other party ought to receive in respect of such breach of contract should be either such as may fairly and reasonably be considered arising naturally, i.e. according to the usual course of things from such breach of contract itself, or such as may reasonably be supposed to have been in the contemplation of both parties at the time they made the contract, as the probable result of the breach of it."

[47] The next point to note is that the question of damages is a question of fact to be resolved by the application of the basic principle and that each case will depend on its own facts and circumstances (Haberstich, Lord President, at page 10). I accept that that does not mean that the Court must allow proof of a claim for loss which is patently irrelevant. Where the Court is satisfied that the basis upon which the pursuer has measured loss is irrelevant the Court should either dismiss the action or issue an opinion in principle and give an opportunity to amend, as was suggested by Mr Tyre.

[48] Next, there may be more than one basis for claiming damages (Haberstich page10). In my opinion the particular basis upon which in their pleadings the pursuers seek to rely must be tested against the general principle. It seems to me that it may be open to the pursuers to prove that they acted reasonably in obeying the requirements of the regulatory authority against a background in which, in the earlier FMP case, they had faced the prospect of a Notice of Requirement backed by criminal sanctions. Furthermore, it may be open to them to prove that it was reasonable for them to bear in mind that they were licensed by the regulatory authority, and that consequently there might well be risks to their commercial future if they continued to defy the regulator authority.

[49] On the other hand it would be open to the defenders to establish that the approach taken by the regulatory authority was wrong and that the pursuers should have mitigated their loss by challenging, and persisting to challenge, the approach being taken by the regulatory authority. It would be open to the defenders to prove that a different basis for quantifying loss was correct. The defenders make averments as to mitigation of loss in answer 16. Mitigation of loss is a question of fact and the onus is on the defenders (McGregor on Damages, 17^th edition, paragraphs 7-016 and 7-019).

[50] For these reasons I reject the submissions of the defenders that the pursuers' claim for loss is irrelevant.

[51] In paragraph 5 of the defenders' Note of Argument it was argued that the pursuers' claim is irrelevant in so far as it contains elements in relation to surrendered and lapsed policies. It was argued that in the event of a policyholder ceasing to pay premiums, the surrender value should represent the premium payments allocated plus unit growth, less any mortality and other charges deducted from the unit fund to date. On surrender the policyholder will have broken the contract and should receive no more than the value on the foregoing basis, which would result in no loss to the policyholder. Equally, no relevant basis was stated for compensating policyholders who have allowed their policies to lapse.

[52] The pursuers relied on the averments in article 16, page 52C-E as to the steps taken with respect to surrendered policies and the requirements of the FSA with respect to lapsed policies.

[53] In my opinion, for the same reasons as those for which I have already held that the pursuers' general approach to quantification cannot be said to be irrelevant, these particular aspects of the pursuers' case cannot be said to be irrelevant and I shall allow them to proceed to probation.

[54] In relation both to project costs and tax relief the same submissions as those made in the FMP case were advanced. For the reasons set out there I am of the opinion that the defenders' complaint of lack of specification with respect to the sum of £5.9 million for project costs in dealing with the compensation investigation and administration is well founded. Accordingly, unless more specification were forthcoming I would not allow that head of claim to proceed to probation. In my opinion the complaint of counsel for the defenders on the matter of tax relief is also well founded.

Decision
[55] For the reasons set out above I shall repel the defenders' third plea-in-law and allow a proof before answer. I have, as requested, expressed my opinion on the question of loss relating to the project costs. In addition, I have, as requested, expressed my opinion on the issue of the absence of averments as to tax relief. The case will be put out by order in order to deal with these matters. I shall reserve the question of expenses meantime.