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SECOND DIVISION, INNER HOUSE, COURT OF SESSION

Lord Justice Clerk

Lord Nimmo Smith

Lord Kirkwood

[2006] CSIH 47

A2271/01 and A2613/01

OPINION OF THE LORD JUSTICE CLERK

in the

RECLAIMING MOTIONS

in the causes

ROYAL SCOTTISH ASSURANCE plc

Pursuers and Respondents;

against

SCOTTISH EQUITABLE plc

Defenders and Reclaimers:

_______

For pursuers and respondents: Keen, QC, ARW Young; Brodies

For defenders and reclaimers: Tyre, QC, Clancy, QC; Burness, LLP

11 October 2006

Introduction
[1] These are reclaiming motions by the defenders against interlocutors of Lord Bracadale dated 14 January 2005 in two actions of damages. In each action the Lord Ordinary repelled the defenders' plea to relevancy and appointed proof before answer.

[2 ] In 1989 the pursuers were created as a joint venture between the Royal Bank of Scotland Group plc (RBS) and the Scottish Equitable Life Assurance Society (Scottish Equitable). Scottish Equitable's part in the joint venture was to provide technical expertise in the development and administration of life assurance products that would be marketed by RBS. RBS, Scottish Equitable and the pursuers, then known as RBS Life, entered into a Master Agreement dated 12 December 1989 relating to the establishment, ownership and operation of the pursuers. On 12 February 1990 the pursuers assumed their present name. The defenders are the successors of Scottish Equitable.

[3 ] Part 1 of the Schedule to the Master Agreement set out the provisions of a Reinsurance Agreement entered into in July 1990. Clause 3 of the Reinsurance Agreement provides as follows:

"(A) The Company [sc the pursuers] hereby appoints the Society [sc the defenders] 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."

Clause 1(A) defines "Specified Services" as meaning "Policy Services" and "General Insurance Services," subject to two specific exclusions. The second of these is an exclusion of

"any services arising directly or indirectly from, or in connection with, the sale and marketing of the Product Range including all sales, marketing, advertising and promotional costs and materials (other than the supply of any documentation required in performance of the Pre-Sales Services, New Business Processing Services and Policy Maintenance Services and the provisions [sic] of any technical advice relating directly to the Product Range and the marketing thereof)."

Clause 1(A) defines "the Policy Services" as meaning "Pre-Sales Services, New Business Processing Services and Policy Maintenance Services." "Pre-Sales Services" means inter alia "the provision of the technical information ... to prepare a benefit illustration by the Company in respect of a prospective Policy including ... any calculations or legal content or information (including the terms of the prospective Policy) which requires to be included therein ... " Clause 1(A) defines "General Insurance Services" as meaning the provision of six specific forms of service, the details of which need not concern us.

[4 ] In pursuance of the Reinsurance Agreement the defenders designed a unit-linked endowment policy, known as the Flexible Mortgage Plan (FMP), and a unit-linked whole of life policy, known as the Lifetime Security Plan (LSP). In due course the Financial Services Authority required the pursuers to compensate FMP and LSP policyholders. That is what has led to these actions.

The Flexible Mortgage Plan
[5] The FMP was sold in conjunction with mortgage loans granted by RBS. It was designed to generate a capital fund sufficient to pay off the mortgage on maturity and to provide life cover during the term of the loan for a sum equivalent to the amount of the loan. Since the maturity value of the policy might be insufficient to repay the loan, there were periodic revaluations of the policyholder's units. If it then appeared that the policy would not repay the loan in full, the policyholder had the option of increasing the premiums.

[6 ] The defenders produced the premium rate tables. A key element in the calculation of the premium rate was the assumed rate of growth of the unit fund. The higher the assumed rate, the lower would be the premium. The FMP involved an annual management charge of 1% of the fund, a policy charge to cover administrative costs, and a death benefit funding charge to pay for the life cover. The FMP product specification was attached to a memorandum dated 10 July 1990 by Fiona Craigon, an employee of the pursuers. It provided inter alia that "Assumed rate of unit growth will normally coincide with Royal Bank of Scotland's maximum of 9% pa." This specification was circulated to several of the pursuers' senior staff, including their chief executive, Bill Stewart, who was an actuary and was on secondment from the defenders.

The Lifetime Security Plan
[7 ] Under the LSP premiums were used to buy units in one or more of the pursuers' investment funds. The pursuers marketed the policy as, inter alia, a means of inheritance tax planning. The policyholder could opt for different benefits, such as critical illness cover or permanent health insurance, and for standard or maximum life cover. For standard cover the premium remained constant until the policyholder's 85th birthday, provided that 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. The policyholder could opt for fixed or escalating premiums and sum assured.

The intervention of the regulatory authorities
[8 ] In 1995 the Life Assurance and Unit Trust Regulatory Organisation (LAUTRO) introduced new disclosure rules, known as "hard disclosure," which required insurance companies to provide policyholders with certain information, including illustrations of the expected performance of their policies. In preparing for hard disclosure, the pursuers found that in most FMP policies the premiums in force would be insufficient for the loans to be repaid at maturity. The pursuers aver that their investigations showed that the defenders had made three specific errors which caused the pursuers to sustain the losses that are sued for.

[9 ] LAUTRO was succeeded by the Personal Investment Authority (PIA). On 19 June 1998 the PIA wrote to the pursuers stating that there appeared to be evidence that the pursuers had failed in their obligation to ensure that all information given to investors was fair, clear and not misleading. The PIA took the view that the pursuers appeared to have failed to ensure that their business was conducted with due skill, care and diligence in compliance with Statement of Principle 2 of the Financial Services Authority (FSA). It set out proposals for the compensation of FMP policyholders by the pursuers.

[10 ] In about February 1999 it became apparent to the pursuers that the premiums for many of the LSP policyholders would have to be doubled if the benefits proposed were to be provided. Further analysis showed that there was a substantial shortfall in the investment funds of the policyholders.

[11 ] Under the Insurance Companies Act 1982 (now repealed) the Treasury could require an insurance company to take such action as appeared to the Treasury to be appropriate to protect policyholders against the risk that the company might be unable to meet "policyholders' reasonable expectations" (PRE).

[12 ] The functions of the Treasury were contracted out to the FSA, which became the principal regulatory authority and incorporated the functions of the PIA. In September 1999 the pursuers notified the FSA about the problems that had come to light in relation to LSPs. The FSA required that the pursuers should instruct an independent actuarial audit. It thereafter confirmed that the pursuers would be required to compensate LSP policyholders on the basis that there had been a breach of their PRE and that action was required to make good their expectations. The FSA advised the independent actuaries that a compensation scheme had to be put in place for LSPs similar to that agreed in relation to FMPs. The scheme thereafter approved by the FSA resulted in the payment of a lump sum into the policyholder's unit fund. Former policyholders who had surrendered their policies or whose policies had lapsed were also compensated.

The actions

[13 ] In the first action (the FMP action) the pursuers sue for £44 million. In the second (the LSP action) they sue for £13 million. These sums represent the amounts paid to policyholders under the compensation schemes, together with the associated costs of administering the schemes. The calculation of these sums is specified in the pleadings. In each action the pursuers sue ex contractu and ex delicto.

[14 ] The pursuers aver that their liability to pay compensation resulted from the commission of certain specific errors by the defenders, each of which was a breach of their duty to provide Specified Services to the standard required by clause 3(C) of the Reinsurance Agreement.

The FMP action
Unit growth rate (UGR)
[15 ] The pursuers aver that the defenders requested them to specify the assumed growth rate of the fund to be used by the defenders in calculating the premium rates; that the defenders knew that assumed growth rates for endowment policies were normally determined by the attitude of the lenders; that the pursuers advised the defenders that the investment growth rate should be 9% pa; that both RBS and the pursuers understood that figure to represent a gross rate of return before the deduction of management charges; and that that was in line with the basis on which rates were calculated by LAUTRO.

[16 ] The pursuers aver that, on being advised that the assumed growth rate was to be 9% pa, the defenders' actuaries introduced the phrase "assumed rate of unit growth"; that this phrase has a specific technical meaning; that it would be understood by an actuary to refer to a net growth rate after deduction of management charges, but that it would not necessarily be so understood by others in the insurance industry; that the staff of RBS and the pursuers had no reason to believe that the product specification was inconsistent with RBS's objective of assuming an annual investment growth rate of 9% gross; that in designing the actuarial basis for the premium rate calculations the defenders did not deduct the 1% annual management charge from the specified annual growth rate, so that in assuming a net rate of 9% the defenders were in fact assuming a gross rate of 10% or more; and that as a result premiums for FMP were among the lowest on the market in October 1990. If the pursuers had known of this, they would have instructed that the calculations should assume a net annual growth rate of 8%.

Compounding

[17 ] The pursuers aver that the defenders incorrectly applied the figure of 9% pa. They failed to take into account the effect of compounding. The premium rates were calculated on the assumption that the funds would grow at 1/12th of 9% each month. As a result of compounding, that growth rate equated to an annual growth figure of 9.38%. This too made the premiums lower than they would otherwise have been.

The policy charge

[18 ] The pursuers aver that the FMP policy charge was linked to the Index of National Earnings, and that in designing the actuarial basis for the premium rates, the defenders failed to take account of future increases in policy charges to reflect earnings inflation.

The LSP action

Escalation

[19 ] The pursuers aver that in calculating the premiums the defenders failed to make proper provision in cases where the policyholder opted for escalation of premiums and of sum assured, with the result that the premiums were too low to provide for the cost of the escalating life cover and the sum asssured.

Rating

[20 ] The pursuers aver that the defenders failed to reflect the effect of rating in the calculation of premiums. If a policyholder was rated because of health problems or a high risk occupation, a higher premium was required. The pursuers aver that the same premium was collected for rated cases as for non-rated cases. Since the cost of life cover for rated cases was higher, more of the units bought were used up for this cover, with a resulting shortfall.

The single age equivalent

[21 ] The pursuers aver that in the case of joint life policies the defenders used a series of single equivalent age approximations to calculate the premium. The defenders used the same formula for both maximum cover and standard cover cases, despite an analysis carried out in January 1991 which suggested that that formula understated the premium in maximum cover cases and did not provide a sufficiently accurate approximation for either standard or maximum cover cases. The risk charges deducted from the policyholder's fund were based on the ages of the policyholders. These charges were higher than those assumed in the premium calculations. The premiums paid by the policyholders were understated by up to 10% of the correct charge. As a result the premium paid on many policies was too low to achieve the policy objective.

IHT planning

[22 ] The pursuers aver that the defenders designed the standard cover LSP to run to age 85. On the assumption of an investment return of 7.5% pa on the units bought by the policyholder, the policy fund would meet the cost of the life assurance until that age, at which point the fund would have been reduced to nil. The IHT brochures that were signed off by the defenders' compliance and legal departments did not draw attention to this feature. LSP policyholders who lived beyond that age could obtain further life cover only at prohibitively expensive rates. The LSP was therefore unsuitable as a vehicle for IHT planning. The defenders did not advise the pursuers that the LSP would have these consequences and the pursuers were not aware of them. The defenders knew that the pursuers were intending to market it for that purpose. A memo from a meeting of the Unit Linked Whole of Life Policy Implementation Team held on 8 January 1991 referred to an inheritance tax guide that was being written. The pursuers' actuarial meeting on 4 February 1991, which was attended by the defenders' actuaries, noted that most of the sales pressure was in respect of IHT plans. It would be normal for a life insurance company which intended to use the policy for IHT purposes to design life cover with the fund being targeted to nil at the extremity of life, such as age 105 or 110.

Critical illness cover

[23 ] The pursuers aver that in calculating premiums they relied upon tables and software produced by the defenders which showed the premium applicable for particular ages with set levels of life cover. The tables and software provided only plans without critical illness cover or with critical illness cover equal in amount to the life cover. The defenders had assumed that if a policyholder requested a level of critical illness cover that was not equal to the life cover, the premium could be calculated by interpolation from the tables and software. The defenders provided an inaccurate interpolation formula that produced premiums that were too low.

The grounds of action ex contractu
[24 ] In both actions the pursuers found on clause 3(C). They aver that it creates a general duty in which the defenders failed in certain specified respects. They aver (FMP action, cond 11; LSP action, cond 13) that it was the duty of the defenders to take all reasonable steps to provide the Specified Services to the pursuers in the same quantity, quality and calibre as they provided to their own policyholders; that the defenders were obliged to exercise reasonable skill and care in providing such services; that such skill and care included the taking of reasonable steps to avoid a finding by the regulatory authorities that the policyholders' reasonable expectations had been breached or that the policyholders had been given misleading information; and that in providing the Specified Services the defenders were obliged so to exercise such skill and care that the pursuers would not be found liable by the regulatory authorities to compensate their policyholders.

The grounds of action ex delicto

[25 ] In both actions the pursuers impute liability to the defenders ex delicto in exactly the same respects. The Lord Ordinary heard detailed criticisms of the pursuers' delictual case from the point of view of specification, and a separate criticism of it so far as it was based on Hedley Byrne liability. I need not delve into this aspect of the case. Counsel for the pursuers confirmed to us that the pursuers seek to establish no more than a concurrent and co-extensive liability. Both sides accept that the delictual case stands or falls with the contractual case.

The Lord Ordinary's decision

The FMP action

[26 ] The Lord Ordinary considered that the central issue was the construction of clause 3(C). While he did not consider it appropriate to reach a concluded opinion on the point, he was not satisfied that the wording of clause 3(C) clearly favoured the defenders' construction (paras [34]-[41]). On the contrary, he was inclined to the opposite view; but since the contract was entered into as a joint venture in which the pursuers, the defenders and RBS brought different interests, talents and input, and since the interaction between the parties was complicated, he considered that the precise interpretation to be placed on various contractual terms might depend on the evidence. There might be an issue as to what various persons understood by references to particular services; and there was a factual dispute as to the course of events and the involvement and state of knowledge of various members of the management and staff of the parties. He considered that he could not reach a concluded view on the construction of clause 3(C) until evidence had been led (para [41]).

[27 ] On the pleading point taken by the defenders, he considered that it was not necessary for the pursuers to specify the particular aspects of the Specified Services to which each of the specific duties pled related. It was not possible to say with certainty at that stage that each was not related to the Specified Services. Accordingly, the defenders had failed to show that the pursuers must necessarily fail even if they proved all of their averments (para [46]).

[28 ] The Lord Ordinary accepted that the pursuers' replies to the defenders' averments about the actings of Mr Bill Stewart and the question of the product specification were open to criticism; but he declined, with hesitation, to exclude them from probation on the basis that the defenders were heavily involved in the joint venture, that they designed the FMP and that they were a party to the communications in the development of it. He was not persuaded that the defenders would be materially prejudiced by a lack of notice of certain critical details of the pursuers' case. In the light of these considerations he decided that he could not exclude from probation the averments about which the defenders complained (paras [65]-[66]).

[29 ] On the relevancy of the claim based on the amounts paid by way of compensation to policyholders, he considered that the essential issues were dependent on the facts (paras [89]-[93]).

[30 ] On all of these issues the Lord Ordinary repelled the defenders' plea to relevancy and allowed proof before answer. He directed that on two particular questions of loss relating to project costs and tax relief, on which he expressed a view favourable to the defenders, the case should be put out by order (para [96]).

The LSP action

[31 ] In this action too the Lord Ordinary repelled the plea to relevancy and allowed a proof before answer, and directed that the case be put out by order on the two questions to which I have referred.

The reclaiming motions: submissions and conclusions

The FMP action

(1) The pursuers' failure to plead the contractual basis for the defenders' alleged duties

[32 ] Counsel for the defenders submitted that the pursuers' case on record (cond 11; Opinion, para [43]) was that each breach of duty flowed from clause 3(C), whereas clause 3(C) specified only the standard to which the duties were to be fulfilled. The pursuers had failed to specify which of the Specified Services the defenders were providing when they committed the alleged breaches. The Lord Ordinary had failed to identify which of the pursuers' averments provided, as he put it, some basis for saying that the duties related to the Specified Services (para [46]). The defenders could not prepare properly for a proof in which the issue would be whether services had been rendered to the required standard.

[33 ] Counsel for the pursuers submitted that the defenders' submission was at best a point of specification. It was difficult to see how the defenders would be prejudiced in their preparation for a proof. The quality of the services provided by the defenders was capable of expert assessment. The pursuers averred that each of the three alleged errors affected the premium calculation. The defenders admitted that they were responsible for the calculation. These errors fell within the definition of "Pre-Sales Services." If they were not clearly within that definition, they were certainly arguably so.

[34 ] In my view, this question can be resolved only after proof. The essence of the defenders' argument is that clause 3(C) specifies the standard to which the contractual duties are to be performed rather than the duties themselves, which are to be found in clause 3(A) as defined by clause 1(A). On a fair reading of their pleadings the pursuers contend that all of the alleged errors were made in the performance of the Specified Services and that those services were not provided to the required standard. In my view, it is an excessive criticism of the pursuers' pleadings to say that the defenders cannot know to what specific duty each individual error relates. The pursuers give adequate notice of the errors themselves and of the plea that each constituted a breach of the duty to provide Specified Services to the standard set out in clause 3(C). Whether any individual error was made in the performance of Specified Services and, if so, into which category of those services it fell are questions to be decided on submissions made in the light of the evidence.

(2) Construction of clause 3(C)
[35] Counsel for the defenders submitted that the Lord Ordinary erred in characterising the defenders' interpretation of their contractual obligation as involving a "subjective" standard of performance (para [35]) and in holding that the defenders' interpretation required comparison with a standard that was unpredictable and subjective or difficult to ascertain (para [37]). Clause 3(C) set an objective standard, namely a standard equivalent to that provided by the defenders to their own policyholders. The defenders' construction did not lead to an unreasonable result (paras [36], [39]). The Lord Ordinary should have reached a concluded view on the point. The interpretation of the clause should not be affected by the evidential difficulties that the Lord Ordinary thought that the defenders might have in proving what standard they provided to their own policyholders (para [38]). The pursuers did not specify which facts could have a bearing on the interpretation of clause 3(C) and the Lord Ordinary had not indicated which facts, in his view, those were. None of the factual questions to which he referred (para [41]) could conceivably affect the interpretation of the clause. The dealings between the parties and the state of knowledge or belief of various persons mentioned in the pleadings could be relevant to the construction of clause 3(C) only to the limited extent of establishing the parties' knowledge of the circumstances with reference to which they used the words in the contract (Bank of Scotland v Dunedin Property Investment Co Ltd, 1998 SC 657). The pursuers had not explained whose state of knowledge would be relevant to this point.

[36] The Lord Ordinary further erred by rejecting the defenders' submission that the duty imputed to them amounted to that of guaranteeing that the pursuers would not be found liable by the regulatory authorities to compensate policyholders for the work carried out by the defenders. The defenders' submission made commercial sense in the context of a joint venture in which they had a significant financial interest.

[37 ] Counsel for the pursuers submitted that the construction of clause 3(C) had to be considered against the whole background of the Master Agreement, the nature and structure of the joint venture arrangements and the fact that both parties were members of LAUTRO, and subject to its required standards, at the relevant time. Whether the defenders had complied with the requirements of clause 3(C) should be determined after proof, especially if the interpretation of it was doubtful. In that event, the clause should be interpreted in the light of the background knowledge of the parties at the time and the commercial purpose of the contract (Bank of Scotland v Dunedin Property Investment Co Ltd (supra)). Both parties were closely involved in the whole background circumstances. The defenders' objections to the relevancy should be resolved along with the question under clause 3(C) in the light of a proof before answer.

[38 ] In my opinion, this is the core issue in both actions. It could be resolved at this stage only if the defenders' interpretation of clause 3(C) was so clear-cut that no other interpretation could conceivably be sound. In my opinion, the defenders' proposed interpretation is far from obvious. Before the Lord Ordinary there was a suggestion that the clause prescribed a "subjective" standard of care (cf paras [35]-[39]). That expression is, I think, misleading. It is plain that the clause purports to set an objective test. The question is what the test should be.

[39 ] The defenders' argument would have been stronger if the clause had required the defenders to provide the specified services to the pursuers' policyholders in the same quantity, quality and calibre as they provided to their own policyholders. But instead, the clause provides that those services are to be provided to the pursuers themselves. It is difficult, certainly at this stage, to conclude that whatever services the defenders provided to their own policyholders could simply be provided to the pursuers themselves. It seems obvious that the case based on the UGR error could not be related to any service provided by the defenders to their own policyholders.

Senior counsel for the defenders was constrained to accept that the wording of the clause was not sufficient on its own to yield the meaning for which he contended. He accepted that the wording of the clause was inelegant and that, for it to have that meaning, certain words would have to be added to it by way of a gloss. Since he did not specify what words those would be, we need not consider that point further at this stage. It is sufficient, in my view, to say that when both sides agree, as they do, that the clause is badly drafted, we can at once dismiss the idea that the clause yields a sure and certain meaning that can be found on an examination of the pleadings alone. For that simple reason I consider that this central issue must be decided after proof.

(3) The alleged UGR error

[40 ] Counsel for the defenders submitted that the Lord Ordinary had failed to take account of the agreed fact that the choice of the growth rate was a matter for the pursuers and RBS and not for the defenders. The pursuers had failed to point to any provision in the definition of Specified Services that could include the choice of growth rates in general, or the assumed rate of unit growth in particular. There was no basis in the pleadings for the pursuers' contention that the choice of the growth rate involved technical actuarial input. It was not the provision of "technical information" or any other form of "Pre-Sales Services" under clause 1(A). The product specification called for a 9% pa UGR and that is what the pursuers got. The pursuers' pleadings failed to identify any contractual provision which imposed on the defenders a duty to check with the pursuers whether they wished a rate of 9% net of management charges and/or a duty to warn them that 9% UGR meant 9% net. The alleged duty to use a growth rate of 9% pa before the deduction of management charges was unsupported by any relevant or specific averments of fact and was inconsistent with the rest of the pursuers' case, which was based upon the premise that the pursuers did not know what 9% UGR meant. The passages in the pursuers' pleadings in which they imputed to the defenders specific duties relating to growth rates (viz, all of cond 6; and in cond 11, "It was their duty ... They failed to do so," Reclaiming Print, pp 47C-48B) should be excluded from probation.

[41] Counsel for the defenders also renewed the submission that the pursuers' averments on the UGR error were neither candid nor specific (cf Opinion, paras [47]-[54]). They materially prejudiced the defenders. In answer 6, the defenders gave a clear narrative of when and how the phrase "unit growth rate" came into play. They specified the contemporary documents that referred to it and the persons who saw those documents. These were met by a general denial. The action rested on the dubious propositions (i) that the phrase "rate of unit growth" was introduced into the specification by the defenders, although the pursuers did not aver when, how or by whom that was done; (ii) that none of the pursuers' senior management and no one from RBS who was involved in the project saw the specification or the memorandum that preceded it, or knew what "assumed rate of unit growth" meant, despite the pursuers' own averment (cond 6) that that phrase would be understood by an actuary to refer to a net growth rate after deduction of management charges; and (iii) that Mr Stewart did not know that a 9% pa unit growth rate was being used in the premium calculations. The pursuers had failed to answer the defenders' calls to specify when and by what means the defenders requested them to specify the assumed rate of unit growth; when and by what means the defenders' actuaries introduced that phrase; how the defenders became aware at a meeting on 28 November 1989 that RBS were considering the adoption of a "single maximum acceptable investment growth rate"; and what discussions took place between RBS, the pursuers and the defenders as to the rate of unit growth to be used; and to specify their allegation that they advised the defenders that the "investment growth rate" for FMP should be 9%. These matters were central to the dispute (Gordon v Davidson (1864) 2 M 758, Lord Justice Clerk Inglis at p 768; Bryce v Allied Ironfounders Ltd, 1969 SLT (Notes) 29). The failure of the pursuers to answer the calls prejudiced the defenders through lack of fair notice (Gray v Boyd 1996 SLT 60). For this reason too, the pursuers' averments about the UGR errors should be excluded from probation.

[42 ] Counsel for the pursuers submitted that the defenders' submissions on this point were misconceived. The pursuers' complaint was not about the selection of the percentage rate. The rate was given to the defenders by the pursuers, but on the understanding that it was to be a gross figure. The defenders used it as a net figure in their calculations without clarifying what the pursuers and RBS required. That was arguably within the definition of Pre-Sales Services.

[43 ] The burden of the defenders' submission is that the selection and specification of the growth rate was a matter for the pursuers and not for the defenders and that it was the pursuers who advised the defenders that the growth rate for FMP should be 9% pa. It is agreed that a 9% growth rate was in the product specification. The problem lies in the uncertainty as to what "growth rate" means. The pursuers' pleadings suggest that they saw 9% pa as a maximum, whereas the defenders provided a 9% unit growth rate that represented a true growth rate of over 10%. In my opinion, it is arguable that the adoption of a growth rate given in the product specification, and the consequent fixing of the premium rates, could fall within the provision of "Pre-Sales Services" or "the provision of technical advice relating directly to the Product Range and the marketing thereof" and therefore within the meaning of the Specified Services. One cannot say at this stage that the pursuers' case on this point is bound to fail. What the respective parties understood by the expression "growth rate," and whether the defenders correctly interpreted and carried out the instructions of the pursuers and RBS, are matters that can be resolved only after enquiry.

(4) The pursuers' failure to aver that the defenders knew of the pursuers' interpretation of UGR

[44 ] Counsel for the defenders submitted that the allegations of breaches of duty relating to UGR were irrelevant because the pursuers did not aver that the defenders knew that the pursuers believed that 9% was a gross rate. For this reason too, the pursuers' averments in respect of the UGR error should be excluded from probation. Although the Lord Ordinary rejected that submission (para [67]), he gave no reason for doing so.

[45 ] Counsel for the pursuers submitted that neither of these objections could be decided on the pleadings. Mr Stewart was seconded by the defenders to the pursuers as their chief executive but he remained an employee of the defenders and was paid by them. Although he was an actuary, the pursuers offered to prove that he had no involvement in the discussions about the UGR. Although the defenders averred that the product specification was circulated to him, they did not expressly aver that he knew what it contained. At the relevant time the pursuers did not employ any actuaries and had no expertise in insurance services. The pursuers' pleadings sufficiently averred that the misunderstanding as to UGR arose from a failure by the defenders to clarify what it meant. The defenders admitted that they did not ask the pursuers if 9% UGR was to be gross or net (ans 6, Reclaiming Print, pp 28-29). The defenders would sustain no real prejudice in preparation for the proof. They could lead evidence from the actuary who raised the question of UGR with the pursuers. The defenders knew from their own enquiries that, in the specification of maximum acceptable growth rates, the practice among lenders varied as to whether the rates were gross or net of management charges. The defenders should have appreciated that (Reclaiming Print, p 25A-C), and should have realised that the parties were at cross purposes. In relation to the provision of UGR the defenders were providing Specified Services. The essence of the pursuers' case was not about their giving of the 9% growth rate. It was about what happened to that rate when the defenders received it.

[46 ] In my opinion, this question is so closely bound up with the previous one that it too should be the subject of proof before answer. The meaning of the rate called for in the product specification; the question whether the defenders' UGR complied with it, and the significance, if any, of the growth rate basis adopted by LAUTRO and of the part played by the pursuers' chief executive in the preparation of the FMP are all matters for enquiry.

(5) Quantum

[47 ] Counsel for the defenders submitted that the action was based on the assumption that policyholders were legally entitled to compensation representing the difference between the premiums paid and the premiums that ought to have been charged over the whole term of the policy. This measure of compensation was unsound in law. The concept of policyholders' reasonable expectations was not defined (Re Axa Equity & Law Life Ass Soc plc and Axa Sun Life plc [2001] 1 All ER (Comm) 1010, Evans-Lombe J at para [10]). It gave no indication as to the basis of compensation. Moreover, it was not enough for the pursuers merely to aver that the sum sued for was the amount that the regulatory authority directed them to pay. They must specify the legal basis on which they were obliged to pay it. The correspondence showed that the pursuers themselves did not accept the legal basis on which the authority required them to pay compensation. The Lord Ordinary failed adequately to deal with the first of these submissions (paras [79], [89]-[93]). He erred in saying that the second submission was a submission that the pursuers had failed to mitigate their loss (para [92]). He accepted a proposition for the pursuers (infra) based on Banco de Portugal v Waterlow & Sons Ltd ([1932] AC 452). That case was distinguishable because in the present case there was no proper basis in law for the demand made by the regulatory authority. In any event, the delictual claim, if valid, would entitle the pursuers to damages for past losses only.

[48] Counsel for the pursuers submitted that under the PIA rules a contravention was actionable at the instance of any person who suffered loss. The rules required members to co-operate, to obey the rules and to comply with any order of the Discipline Committee or Tribunal. If there was a failure to comply, the authority could issue a written request to the member concerned to take such action as the Committee thought desirable and could order it to pay compensation or take certain specified actions. That was the regulatory background set out in condescendence 13. In the discussions with the pursuers the FSA insisted on a measure of compensation that extended to the whole term of the policy on the basis of the policyholder's reasonable expectations. That basis underlay the payments that the pursuers were required to make. If the pursuers had not accepted it, the FSA would have served a Notice of Requirements under section 45 of the 1982 Act, which would have prevented them from taking on any new business (cf Reclaiming Print, p 54C-D). The pursuers' case was that they took the FSA as far as they could go, but then had no alternative but to back down. It was arguable that this outcome was in the reasonable contemplation of the parties. Whether or not the pursuers' agreement to pay on the basis laid down by FSA was a reasonable response to the situation depended on the whole facts and circumstances (Banco de Portugal v Waterlow & Sons Ltd, supra). These consequences were foreseeable by both parties as members of the regulatory bodies. Moreover, both parties would know that section 45 of the 1982 Act provided for compensation on the special statutory basis of the policyholder's reasonable expectations. In this case the second rule in Hadley v Baxendale ((1854) 9 Exch 341) would apply. There were no fixed rules as to the appropriate measure of damages. The court could not conclude at this stage that any one particular measure was necessarily the correct one. The issue of quantum was particularly fact-sensitive (Haberstitch v McCormick and Nicholson 1975 SC 1, Lord President Emslie at pp 6-7; 9-10).

[49 ] While the general rules by which damages fall to be assessed are matters of law, the measure of damages to be adopted in any given case is to a great extent dependent on the facts. In my opinion, it is impossible to affirm on the pleadings that the quantification of the pursuers' claim in this case is irrelevant. It is possible that the pursuers could prove that a loss of this kind was foreseeable by the defenders, particularly in the light of their obligations as members of the regulatory bodies and of the provisions of section 45 of the 1982 Act.

[50 ] The pursuers aver that as a matter of commercial reality they had either to compensate policy holders in accordance with FSA requirements or face a statutory Notice of Requirements, with disastrous consequences. In Banco de Portugal v Waterlow & Sons Ltd (supra) the defendants' breach of contract resulted in the circulation of forged notes which the plaintiffs were under no legal obligation to redeem. Nevertheless it was held that, in the emergency created by the breach, the redemption of the notes was a reasonable step for the plaintiffs to take (ibid, Lord Chancellor Sankey at pp 473-474). In the present case, whether the pursuers took all reasonable steps to mitigate their loss and, in particular, whether the payment by them of compensation in accordance with FSA requirements was a reasonable step, are issues for enquiry. In such an enquiry, it may be proved that it was in contemplation of the parties that in the event of a breach of the kind alleged, the pursuers would or might have to pay compensation in accordance with FSA requirements on the principle of policyholders' reasonable expectations. That issue may be relevant to the question whether the measure of damages adopted by the pursuers is sound in law.

The LSP action
[51 ] Counsel made the same submissions as in the FMP action on (i) the question of the pursuers' failure to aver the contractual basis for the duties that they imputed to the defenders; (ii) the proper construction of clause 3(C), and (iii) the general issue of quantum. Counsel for the defenders also raised the following additional points that were special to the LSP action.

(1) The IHT issue
[52] Counsel for the defenders submitted that the Lord Ordinary erred in holding (para [33]) that the question whether the duties imputed to the defenders in respect of IHT were within the scope of the Specified Services was one for proof. The pursuers had not specified to which of the contractual services the alleged breach related. The Lord Ordinary had failed to indicate what evidence would enable the court to determine that issue. The pursuers admitted that they had a product specification for LSP (cond 5). According to the specification, the product was designed on the assumption that the fund would reduce to nil at age 85 in standard cover cases. It was inconceivable that the pursuers' senior management were not aware of that. The matter could be determined without proof, it being obvious that the alleged acts and omissions of the defenders could not fall within the scope of the contractual provisions founded upon by the pursuers (at para [31]). If not dismissing the action, the court should at least exclude from probation the averments in support of this claim (viz, all of cond 11; and in cond 13, "They knew ... planning policy" (Reclaiming Print, pp 42E-43B); and "In the exercise of reasonable skill ... tax planning" (ibid, p 43 C-D)).

[53 ] Counsel for the pursuers submitted that this question, like the question of escalation of premiums, rating and single age equivalents, arose during the provision of pre-sales services. It affected the calculation of the premiums. The IHT point, like the other points, was an aspect of the defenders' provision of technical advice relating directly to the product range and the marketing of it. It was therefore not one of the "excepted services." It was technical advice for which the defenders were responsible.

[54 ] I fail to see how the court could dismiss this element of the claim on relevancy. The pursuers have pled a straightforward case to the effect that the LSP was designed to run out at age 85 when the policy fund was reduced to nil; that inevitably policyholders living beyond that age could obtain further life cover only at prohibitively expensive rates, and that any policy that was to be suitable for IHT purposes would have to provide cover to the extremity of human life. In my view, this question, like those relating to escalation of premiums, rating and single age equivalents, is pre-eminently a matter for enquiry.

(2) Measurement of loss by reference to the sums paid in compensation
[55] Counsel for the defenders adhered to the submissions that they made on this point in the FMP action. They added that in this case, unlike the FMP case, the pursuers did not aver that they were facing the imminent calamity of enforcement action by the FSA. There was no basis for the assumption that the FSA would take the same line in the case of LSPs. Since there were substantial differences between the two products and different allegations of breach of duty in the two cases, the Lord Ordinary had erred in holding that "it would be reasonable for the pursuers to expect that a similar strong line would be taken by the regulatory authority" (para 41). In the absence of averments to that effect, it could not be said that the pursuers offered to prove that the damages claimed fell within either of the rules in Hadley v Baxendale (supra, at p 354) or that their losses were caused by breach of contract rather than by their own decision to accede to the regulator's demands.

[56 ] Counsel for the pursuers submitted that although the LSP was a straightforward life policy, the FSA had nonetheless insisted on compensation based on policyholders' reasonable expectations. The issue of quantum was so fact-sensitive that one could not say that the defenders' suggested approach was necessarily the only correct one. In suggesting that the pursuers had failed to mitigate their loss by challenging the FSA's position on compensation, the defenders correctly saw this as being a mitigation of loss point. That demonstrated the need for proof before answer.

[57 ] In my view, the short question is whether, since the LSP was a different insurance product, the pursuers were under the same compulsion to pay compensation as they were in the FMP cases. The pursuers aver that, although the LSP was a different product, the FSA decided that a compensation scheme similar to that applicable to FMP policyholders should be put in place (cond 16; Reclaiming Print, pp 51-52), and that the pursuers paid compensation in this way in consequence of their being required to do so by the regulatory authority. That, in my view, is a matter for enquiry. The pursuers seek to recover losses suffered by them in having to make good the deficiencies in the policyholders' funds and to pay increased surrender values on those policies that had been surrendered at an undervalue. Again, it is impossible for us, in my opinion, to conclude at this stage that this claim could not conceivably set out a relevant loss.

(3) Basis of quantification where policyholder could sustain no loss
[58] Counsel for the defenders submitted that since an LSP policy paid out the sum assured on death regardless of the level of premiums, it was for the pursuers to explain how the policyholder could suffer loss. Any loss that the pursuers might sustain would be suffered by them directly rather than indirectly by their compensating policyholders. The method of quantification adopted in the settlement with the FSA was not a relevant measure of damages. The Lord Ordinary had erred in holding that that might be one of several means of quantifying the pursuers' loss and in treating the matter as one of failure to mitigate. If the pursuers sustained any loss, it would have to be measured by reference to the defenders' calculations taken as a whole, including features that might have caused premiums to be higher than necessary, rather than by isolating aspects that were said to cause premiums to be unduly low. Only if the case were pled in this way could the court ascertain whether the pursuers had sustained any loss at all.

[59 ] Counsel for the pursuers said that on this as on the previous point, the pursuers' case was that they had contested the FSA's approach to compensation so far as they could, but had had to back down. There was no practical difference on this point between the two actions.

[60 ] In my opinion, the defenders' objection on this point is only another aspect of the basic question whether the amount of compensation paid on a requirement made by the regulatory body can be an appropriate measure of damages. Since I consider, for the reasons that I have given, that that question cannot be resolved without enquiry, I reject the defenders' submission on this point.

(4) Surrendered or lapsed policies
[61] Counsel for the defenders submitted that the Lord Ordinary erred in failing to dismiss the claim to the extent that it related to sums paid or payable to policyholders whose policies had been surrendered or had lapsed (paras [51]-[52]). Counsel for the defenders accepted, rightly in my view, that this point stood or fell with their general submission on the quantum issue. If I am right in the view that I have taken on that issue, we need not consider this point further at this stage.

Disposal

[62 ] Counsel for the defenders moved that in each action we should recall the interlocutor of the Lord Ordinary, sustain the defenders' plea to relevancy and grant decree of dismissal; failing which, we should in each action exclude from probation the specific passages to which I have referred.

[63 ] There is an obvious error in the Lord Ordinary's interlocutor in each action. He repelled the defenders' plea to the relevancy and allowed proof before answer. The appropriate course, since he had decided to appoint a proof before answer, was to reserve the plea to relevancy.

[64 ] Since I consider that the Lord Ordinary was right in both actions in holding that the questions raised by the defenders should be answered after enquiry, I propose that we should recall the interlocutor reclaimed against in each action and substitute an interlocutor reserving the plea to relevancy and of new allowing proof before answer on the whole record. The minor questions of relevancy that the Lord Ordinary directed to be put out by order can be left open meanwhile for parties to settle.

SECOND DIVISION, INNER HOUSE, COURT OF SESSION