The Standard Life Assurance Co Re [2007] ScotCS CSOH

OUTER HOUSE, COURT OF SESSION

[2007] CSOH 137

OPINION OF LORD NIMMO SMITH

in the petition of

THE STANDARD LIFE ASSURANCE COMPANY

Petitioner;

for

Sanction of a Scheme under Part VII of the Financial Services and Markets Act 2000

________________

Counsel: for petitioner, Sellar Q.C. and Mrs Munro; for SLLC Ltd, Mrs Munro; for Standard Life plc, F Thomson

Solicitors: Dundas & Wilson

9 June 2006

Introduction
[1] This is an application under section 107 of the Financial Services and Markets Act 2000 ("FSMA"). The petitioner ("the Company") is a mutual insurance company which is now incorporated under the Standard Life Assurance Company Act 1991 ("the Act"). Its constitution is contained in the Act and regulations adopted pursuant to the Act with effect from 26 April 2005. The Company's head office is at Standard Life House, 30 Lothian Road, Edinburgh.

[2] The Company is a "UK authorised person" for the purposes of FSMA, having been granted permission by the Financial Services Authority ("the FSA") under Part IV of FSMA to carry on long term insurance business in the United Kingdom falling within classes I, II, III, IV, VI and VII set out in Annex 11.1 to the Interim Prudential Sourcebook for Insurers.

[3 ] In this application, the Company seeks an order sanctioning an insurance business transfer scheme ("the Scheme") within the meaning of section 105 of FSMA. The Scheme provides for the transfer of the Company's long term business, as carried on in certain States within the European Economic Area ("EEA"), to SLLC Limited (which, upon the Scheme becoming effective, will be renamed Standard Life Assurance Limited ("SLAL") and which is referred to as such in the Scheme and in this Opinion). The Company's long term business as carried on in certain jurisdictions outside the EEA will be transferred by separate schemes in accordance with the relevant local laws ("the Associated Schemes").

[4 ] SLAL is a private limited company incorporated under the Companies Act 1985. Its registered office is also at Standard Life House, 30 Lothian Road, Edinburgh. Its directors are referred to in the application as "the SLAL Board". SLAL is also an authorised person for the purposes of FSMA. It has permission under Part IV of FSMA to carry on long term insurance business within classes I, III, IV, VI and VII set out in the said Annex 11.1 to the Interim Prudential Sourcebook for Insurers. It has not sought authorisation to carry on long term insurance business within class II (which comprises contracts of insurance to provide a sum on marriage, the formation of a civil partnership or the birth of a child).

[5 ] SLGC Limited is a private company limited by shares, with its registered office also at Standard Life House, 30 Lothian Road, Edinburgh. Prior to publication of the prospectus in connection with the Flotation referred to in paragraph [7] below, SLGC Limited will re-register as a public company under the name Standard Life plc ("SL plc"). It is referred to as such in the Scheme and in this Opinion.

[6 ] SL plc is also a party to the Scheme. In particular, SL plc will provide the compensation payable under the Scheme to certain members of the Company in respect of the loss of their membership rights ("Demutualisation Entitlements"). The Demutualisation Entitlements will take the form either of ordinary shares in SL plc ("the Demutualisation Shares") or their cash equivalent.

[7 ] Subsequent to the demutualisation under the Scheme ("the Demutualisation"), but on the same day, SL plc will issue further ordinary shares ("the IPO Shares") to investors as part of its flotation on the London Stock Exchange ("the Flotation"). The Flotation is conditional upon the Scheme becoming effective. The Demutualisation and the Flotation (together with the parallel transfers pursuant to the Associated Schemes) form a composite transaction (collectively referred to in this Opinion as "the Transaction").

[8 ] The Company and its subsidiaries are referred to in the Petition as "the Present SL Group". After the Transaction, and certain related transfers of subsidiaries, SL plc will be the parent company of a new group of companies, which will include SLAL as a wholly-owned subsidiary of SL plc.

[9 ] In these circumstances, and acting through its directors ("the Directors"), the Company makes this application. This Court has jurisdiction in respect of this application in terms of sections 107(3)(a) and 107(4)(b) of FSMA.

[10 ] Section 111 of FSMA provides.

"(1) This section sets out the conditions which must be satisfied before the court may make an order under this section sanctioning an insurance business transfer scheme or a banking business transfer scheme.

(2) The court must be satisfied that -

(a) the appropriate certificates have been obtained (as to which see Parts I and II of Schedule 12);

(b) the transferee has the authorisation required (if any) to enable the business, or part, which is to be transferred to be carried on in the place to which it is to be transferred (or will have it before the scheme takes effect).

(3) The court must consider that, in all the circumstances of the case, it is appropriate to sanction the scheme."

[11 ] On the date which this Opinion bears, I have decided, after considering inter alia the reports referred to below and the written and oral submissions of counsel, to grant the application. I have been addressed, and been satisfied, about numerous issues. In particular, I have been satisfied about the matters set out in section 111(2)(a) and (b) of FSMA, and I consider, as provided by section 111(3), that, in all the circumstances of the case, it is appropriate to sanction the Scheme. Counsel has asked me to consider writing this Opinion on one issue alone, because of its novelty and possible interest to practitioners in this field. Although I am under no obligation to do so, to I have decided to write it, but for some time pressure of other judicial business has delayed the task. I make no apology for extensive use of material derived from some of the documents before me, all of which appears to me to be of a high standard and at least as well expressed as anything I could write myself.

The Mortgage Endowment Promise
[12 ] The material in this passage is derived from the Petition. On or about 28 September 2000, the Company issued the Mortgage Endowment Promise ("the Promise") to certain holders of mortgage endowment policies resident in the United Kingdom and Ireland. The holders of policies to which the Promise applied are hereinafter referred to as "MEP Policyholders" and the policies as "MEP Policies". The Promise was introduced to allay the concerns of MEP Policyholders about the extent to which the maturity payments on their MEP Policies might fall short of their target values.

[13 ] The terms and conditions of the Promise are to be found in various documents, notably in letters sent to the MEP Policyholders. In the course of the ten-day period commencing 4 October 2000, a letter was sent by the Company to all MEP Policyholders which stated, so far as material:

"We promise that your endowment plan will meet its targeted value at maturity, provided the future earnings on the assets in which your policy is invested are on average at least 6% each year (after tax).

The Promise is subject to the future growth in Standard Life's capital being enough to allow us to set aside regular provisions to meet any possible shortfalls. Standard Life is financially very strong and the Company is confident that future investment earnings will be sufficient to provide any necessary support ...

Between October 2000 and March 2001, even if we have already sent you a review, we will send you a personalised update showing exactly how the Promise will affect your plan. The full details of conditions attaching to the Promise will also be outlined to you with your plan update."

The condition contained in the first sentence of the second paragraph of this letter - namely, that the Promise was subject to future growth in the Company's capital being sufficient to allow the Company to set aside regular provisions to meet any payments due under it - is hereinafter referred to as "the Capital Growth Condition".

[14 ] As part of the first plan review for each MEP Policyholder after the issue of the letter referred to above, a further letter was sent to those MEP Policyholders ("the Non Top Up MEP Policyholders") resident in the United Kingdom whose policies were then projected to achieve their target amounts, even if their plans earned on average less than 6% per annum (after tax) from the date of that letter to maturity. That letter stated, so far as material:

"We also wrote to you in October about the introduction of the Standard Life Mortgage Endowment Promise. The Promise is designed to help keep our customers' plans on track to pay the target amounts when they mature. Your plan update shows that your plan is currently on track to pay the target amount. As your plan requires earnings of less than 6% each year you do not need the Promise."

Also at that time, a further letter was sent to those MEP Policyholders ("the Top Up MEP Policyholders") resident in the United Kingdom whose policies were then projected to achieve their target amounts only if their plans earned on average a return in excess of 6% per annum (after tax) in each remaining year to maturity. That letter stated, so far as material:

"[The Promise] means that your plan will meet its targeted value at maturity, provided the future earnings on the assets in which your plan is invested are on average at least 6% each year (after tax).

Even if the future earnings on the assets in which your plan is invested fall below 6% on average, we will top up your plan at maturity to reduce the impact of any shortfall. The maximum amount of your potential top up will be [£X]."

This maximum amount (the "Maximum Top Up") was calculated by deducting from the target amount the projected maturity value of the policy as at that time, on the assumption that the assets in which the policy was invested earned 6% per annum (after tax) from then until maturity. That letter also stated the Promise to be subject to certain further conditions (namely, that the MEP Policy had to remain invested in either the With Profits Fund or the Company's Managed Fund (or both); all premiums should be paid on the MEP Policy; neither the premium amount nor the term of the MEP Policy had to be altered; and the MEP policy had neither to be surrendered nor assigned absolutely, except on divorce).

[15 ] The application of the Promise to the MEP Policyholders resident in Ireland was based upon the same principles, but the relevant information was conveyed to the vast majority of them in August 2004 and amplified in January 2005. The information communicated to these policyholders, together with that contained in the letters referred to above, is referred to generically in the Petition as "the First Review". The expressions "Non Top Up MEP Policyholders" and "Top Up MEP Policyholders" are to be read as extending to the relevant MEP Policyholders resident in Ireland accordingly.

[16 ] It is averred in the Petition that the Company believes that the legal effect of these letters was thus to divide the MEP Policyholders into two categories: (a) the Non Top Up MEP Policyholders, being those whose policies, as at the First Review, were projected to achieve maturity values equal to or greater than their target values, assuming annual growth of 6% (after tax) from the First Review to maturity; and (b) the Top Up MEP Policyholders, being those whose policies, as at the First Review, were projected to fall short of their target values, assuming annual growth of 6% (after tax) from the First Review to maturity. There are, it is averred, reasonably estimated to be approximately 417,000 Non Top Up MEP Policies and approximately 620,000 Top Up MEP Policies.

[17 ] The Company promised, subject to the satisfaction of the Capital Growth Condition, to pay MEP Policyholders in both categories any shortfall ("the Shortfall Amount") between the actual maturity value of a MEP Policy and its target value as identified in the First Review if the average investment return on the assets in which the MEP policy was invested in the period from September 2000 to maturity equalled or exceeded 6% per annum (after tax). This is referred to in the Petition as "the 6% Per Annum Test". If the 6% Per Annum Test was not satisfied, the Company promised, subject to the fulfilment of the Capital Growth Condition, to pay the Top Up MEP Policyholders the Maximum Top Up or, if less, the Shortfall Amount.

[18 ] The Company has operated the Promise on the basis that "capital" means, broadly, the excess, as at 2000, of its assets over its liabilities as assessed on the regulatory basis then in force. In particular, the Company has taken the Capital Growth Condition to require there to be growth in that capital sufficient to fund payments under the Promise. As explained further in paragraphs [27] to [33] below, the Company has been advised by both Scottish and English leading counsel that this was a reasonable interpretation to adopt and was consistent with the interpretation preferred by leading counsel, but that, given the uncertainty of the wording of the Promise, other reasonable interpretations were possible.

[19 ] The Company's capital, assessed on the above basis, was approximately £10.5 billion in 2000. The Company's capital is less now than it was then. In each of the years 2000, 2001, 2002 and 2003 the Company nonetheless set aside provisions in respect of future payments under the Promise as a matter of commercial prudence. As at 31 December 2005, those provisions ("the Existing Provisions") were valued at £460,000,000.

[20 ] In October 2004 the Company made an announcement ("the 2004 Announcement") to the effect that the Capital Growth Condition (as the Company has interpreted it) had not been met, that it was unlikely to be met in the foreseeable future and that, while this remained the case, it would be inappropriate to make further provisions for payments under the Promise.

[21 ] The 2004 Announcement also stated that, so long as the Company was satisfied that it was fair and prudent to do so, the Company intended that the Existing Provisions would be used to make payments on the maturity of Top Up MEP Policies under the Promise. This was confirmed to Top Up MEP Policyholders in letters subsequently written to them. In the case of Top Up MEP Policies which matured up to 31 December 2005, it was stated that those MEP Policyholders would receive the Maximum Top Up. Thereafter, the proportion of Maximum Top Ups payable to Top Up MEP Policyholders was to be "smoothed down" over a two-year period to the proportion considered affordable out of the remainder of the Existing Provisions. The relevant letters written to the holders of Top Up MEP Policies maturing after 31 December 2007 informed those policyholders that they could expect to receive in the region of 40 to 60 per cent of the Maximum Top Up, payable out of the Existing Provisions. However, the relevant MEP Policyholders were also informed that, if the financial condition of the Company should deteriorate further, future payments could be reduced, possibly to zero.

[22 ] The terms and conditions of the Promise did not explicitly provide how the Company should react in the circumstances described above. Indeed, the ambiguity of the Capital Growth Condition entailed inevitable uncertainty about how the Company should have reacted. The Company sought therefore to do what it considered to be fair in those circumstances. The Company has, since then, operated the Promise in accordance with the 2004 Announcement.

[23 ] The Capital Growth Condition, and its application to setting aside of provisions for future payments under the Promise, are, it is averred, open to different interpretations. There would be significant difficulty if the Capital Growth Condition were not clarified so as to establish how it should operate following the Demutualisation. When the Scheme becomes effective, the capital and organisational structure of the present SL Group will change significantly. The Capital Growth Condition has, therefore, to be modified so far as concerns its application within SLAL. It is important in the interests of all policyholders that this should be done in a way which is not open to different interpretations, and also because continuing uncertainty might adversely affect the Flotation.

[24 ] For these reasons, the Scheme includes a reconstitution of the Promise which is intended to ensure that it will operate within the new capital structure in a way which is fair to all policyholders and removes uncertainty. An account of the relevant provisions of the Scheme is given below, at paragraphs [41] to [44]. First, however, I shall set out what the Company has to say about its interpretation of the Promise.

The interpretation of the Promise

The Company's interpretation
[25 ] The Company's clear position is that its obligations under the Promise cannot be transferred to SLAL without modification. There are said to be a number of reasons for this. First, as it stands, the Capital Growth Condition is predicated upon growth in the capital of the mutual entity. But the Transaction will redistribute the capital of the mutual entity (in as much as a material part of the Present SL Group will not, ultimately, be retained within SLAL); and SLAL, in any event, will be subject to a range of duties and obligations as a proprietary company which differ from those to which the Company is subject as a mutual. Secondly, the meaning and effect of the Promise is inescapably uncertain. The Company cannot realistically contemplate the Transaction unless such uncertainty is resolved, since it will inevitably discourage the introduction of new capital by outside investors in the context of the Flotation. In any event, continuing uncertainty is in the interests neither of the Company nor its policyholders. The Scheme provides an opportunity for addressing that uncertainty, which is a desirable objective in itself.

[26 ] For these reasons, the Company says that it regards the reconstitution of the Promise as a matter of practical necessity. It fully accepts, however, that any such reconstitution must take account of existing rights and expectations under the Promise, so far as these can be ascertained with any reasonable confidence. It therefore sought the advice of leading Counsel in England and Senior and Junior Counsel in Scotland (collectively, "Counsel"). As is apparent from the following summary of that advice, Counsel took the view that there was no obviously correct interpretation of the Promise and Capital Growth Condition, and that virtually every aspect of the latter raised significant interpretive difficulties.

The advice of counsel
[27 ] Counsel advised that the Promise was a unilateral obligation governed, in all cases and notwithstanding the governing law of the underlying policy, by Scots law. Broadly speaking, Counsel considered that the Company had adopted, and acted upon, a reasonable interpretation of the Promise but that, given the ambiguity of its wording, other reasonable interpretations were possible. Counsel did not, however, consider that the Promise was so vague as to be void for uncertainty. Their opinion was that to avoid the whole Promise on that basis would be to relieve the Company of an obligation which, although conditional, it plainly intended to assume; while to avoid the Capital Growth Condition for uncertainty (assuming severability) would fundamentally alter the nature of the Promise, creating a guarantee in place of the conditional obligation the Company intended.

[28 ] Specifically, Counsel considered that a Court would seek to identify a commercially sensible and workable meaning, in accordance with the ordinary principles of contractual interpretation: see, in particular, Investors Compensation Scheme Limited v West Bromwich Building Society [1998] 1 WLR 896 at 912H, per Lord Hoffmann; Bank of Scotland v Dunedin Property Investment Company Limited 1998 SC 657. The starting point must always be the language in which an obligation is actually expressed. However, the true meaning of the language used may be illuminated by the "factual matrix" in which the obligation was entered into and, more broadly, by reference to the general commercial purpose of the Promise read as a whole.

[29 ] On an application of those principles, Counsel were satisfied that the central purpose or aim of the Promise as a whole was plainly to provide meaningful reassurance for customers concerned about whether their endowment policies would achieve their targeted values on maturity; but that, equally plainly, the primary if not the only purpose of the Capital Growth Condition was to protect the Company's capital base in 2000 from material erosion at the expense of non-MEP Policyholders in the event that future capital growth should prove insufficient to fund payments under the Promise.

[30 ] Specifically, in Counsel's view, the preferable (in the sense of "least unsatisfactory") interpretation of the Capital Growth Condition was that it required the Company to determine, in each year of assessment, whether the aggregate of actual growth in capital since 2000 (which might be, and indeed was, negative) and projected growth to 2020 was sufficient to allow a regular provision to be made without bringing about a situation in which, in 2020, its capital base would be less than its 2000 level by reason of making Promise payments out of capital. Counsel considered that relying simply on actual growth, year on year, could produce arbitrary and unfair results for policyholders, and imprudent results for the Company, if growth over a period of years should fluctuate. In their view, an interpretation which produced such results could not be regarded as the preferable interpretation if an alternative were available.

[31 ] If the Capital Growth Condition, thus interpreted, was satisfied in any year of assessment, the Company was obliged both to set aside the regular provision and to make appropriate Promise payments on plans maturing in that year. If, in any year of assessment, the Capital Growth Condition was not satisfied, the more probable legal position was that the Company was relieved of any obligation to set aside a further provision in that year, but was nonetheless required to apply existing provisions to making Promise payments on policies maturing in that year (albeit, conceivably, at reduced amounts).

[32 ] The interpretation of the Capital Growth Condition set out above was broadly consistent with the approach actually adopted by the Company. The Company's capital in 2000, assessed on the regulatory basis then in force, was approximately £10.5 billion. The Company took the Capital Growth Condition to require there to be sufficient growth in that capital (i.e. £10.5 billion) to fund payments under the Promise in the sense of being able to set aside regular provisions for future payments.

[33 ] Counsel emphasised that theirs was not the only possible or reasonable interpretation. In that regard, it is necessary to note that the FSA took a materially different view of the Capital Growth Condition, having also taken the advice of leading Counsel in London. The FSA has provided the Company with only a summary of that advice. It considers its preferred interpretation to be the more persuasive, and has requested that the Court be fairly informed of its view of the meaning of the Capital Growth Condition.

The FSA's interpretation
[34 ] On the basis of the summary of its legal advice, the Company understands the main elements of the view taken by the FSA to be as follows. The Promise takes effect as a variation of the contracts of insurance between the Company and the relevant policyholders. It therefore imposes enforceable contractual obligations on both the Company and the affected policyholders. The FSA accepts that the meaning of the Capital Growth Condition is difficult to discern. The FSA considers (and the Company does not dispute this) that the Capital Growth Condition requires the Company to assess, on an annual basis, whether growth in its capital has been "enough" to allow it to set aside regular provisions for payments under the Promise.

[35 ] The objective of the Capital Growth Condition, as the FSA interprets the contemporaneous documentation, was to ensure that the Company was not required, in 2000, to make an upfront provision for the full cost of the Promise. The Company fully accepts that the Capital Growth Condition had that effect, but contends that its primary purpose was, rather, to protect the level of its capital as at the time the Promise was made. For this reason, as noted above, the Company interprets "growth" as meaning, by implication, "projected growth". Since the FSA does not accept that the Capital Growth Condition had the primary purpose for which the Company argues, the FSA does not accept that it is necessary to imply the word "projected" into the Capital Growth Condition.

[36 ] On the FSA's interpretation, the Company is required, in each year of the life of the Promise, to assess whether its capital has grown, since the last such review, sufficiently to allow it to set aside a provision for the cost of the Promise. Growth, in other words, is assessed from one year to the next, not by comparing growth projected from the year of assessment with the capital position of the Company in 2000. This is perhaps the most important difference between the FSA's interpretation and that of the Company.

[37 ] It is the FSA's view that the Company must then assess whether growth in its capital since the previous review has been "enough" to allow it to set aside a provision in that year. The Capital Growth Condition plainly confers a discretion on the Company to decide whether growth in any given year has been enough, but, as the FSA interprets it, it also establishes a framework within which the discretion is to be exercised. Where a provision has been made, that provision will continue to be available to meet Promise payments due on policies maturing in any given year even if, in that year, the Capital Growth Condition is not satisfied. In other words, the fact that the Capital Growth Condition is not satisfied in any year (or, in the Company's judgment, there has been insufficient growth in capital to allow a provision to be set aside) does not mean that the obligation to make payments under the Promise is disapplied. In any event, the FSA's clear view, taking account inter alia of the Company's conduct after the Promise was made, is that the Company is now precluded from releasing existing provisions. The FSA's view is that, on their interpretation, the practical likelihood is that the Capital Growth Condition would be more easily (or more often) satisfied than on the interpretation adopted by the Company.

[38 ] The FSA agrees that there are other, equally plausible ways of interpreting the Capital Growth Condition, beyond those advanced by the Company and the FSA, and that the Court may prefer some other such interpretation. As to that, the Company is clearly of the view, as more fully explained below, that the Court is not required to form any definite view of what the Promise and Capital Growth Condition presently mean for the purposes of determining this application.

[39 ] Notwithstanding its differences with the Company as to the interpretation of the Capital Growth Condition, the FSA has indicated, having considered the Scheme as a whole, that it does not object to the proposed reconstitution of the Promise contained in the Scheme. It considers that the Company could have asked the Court to sanction a reconstitution of the Promise cast in a number of other ways, but that the model chosen is within the range of fair and reasonable possibilities.

[40 ] For completeness, it should be noted that the Company also took the advice of Irish leading counsel as to the interpretation of the Promise. It underlines the intrinsic uncertainty of the Promise that Irish leading counsel took a view different from (and far more favourable to the Company than) those of Counsel and of the FSA. There has also been a recent determination by the Irish Financial Services Ombudsman which takes a broad view of the meaning and effect of the Capital Growth Condition.

The relevant provisions of the Scheme
Parts 9 and 17
[41 ] Part 9 of the Scheme provides as follows:

"9. Mortgage Endowment Policies; Mortgage Endowment Promise

9.1 At and with effect from the Effective Time:

(A) SLAL shall, subject to paragraph 9.2, assume the obligations of SLAC arising in respect of the Promise;

(B) the terms and conditions applicable to the Promise, and the nature and extent of SLAL's obligations thereunder, shall be revised and clarified in the manner set out in, and determined solely by reference to the provisions of, Schedule 4 (Mortgage Endowment Promise);

(C) SLAL's obligations in respect of the Promise shall be allocated to the With Profits Fund in accordance with paragraph 17.2(C); and

(D) without prejudice to paragraphs 9.1(A), 9.1(B) and 9.1(C), the Promise shall, in all respects, be applied and operated in accordance with the provisions of Schedule 4 (Mortgage Endowment Promise).

9.2 Every person who is a holder of an MEP Policy shall, at and with effect from the Effective Time, become entitled as against SLAL to the rights, benefits and powers in respect of the Promise as are specified in Schedule 4 (Mortgage Endowment Promise). Such entitlement shall be in substitution of any rights, benefits and powers which the relevant person may have had against SLAC if and to the extent arising in respect of, or otherwise attributable to or connected with, the Promise."

Part 17 of the Scheme provides inter alia as follows:

"17. Allocation of liabilities

17.1 At and with effect from the Effective Time, all Transferred Liabilities and Demutualisation Costs, excluding those Transferred Liabilities allocated to the Non Profit Fund or the Shareholder Fund pursuant to paragraph 17.2(L)(ii) and 17.4 respectively, shall be allocated to the With Profits Fund.

17.2 Without prejudice to the generality of paragraph 17.1, the Transferred Liabilities allocated to the With Profits Fund shall include: ...

(C) all liabilities attributable to the Promise, as applied and operated in accordance with paragraph 9 and Schedule 4 (Mortgage Endowment Promise); ..."

Schedule 4
[42] The provisions of Schedule 4 to the Scheme are complex. It is sufficient for present purposes to take the following summary from the written submissions of counsel. In formulating its proposals for the reconstitution of the Promise, the Company has sought to achieve certainty in a manner which is fair to all policyholders, whether or not eligible to receive payments under the Promise. In assessing the fairness of its proposals, the Company has had regard to differing expectations which may have resulted, in the past, from differing interpretations of the Promise. It has also had regard to the views of the FSA and of the Independent Expert. The views of the Independent Expert are set out more fully below, at paragraph [47].

[43 ] The Scheme provides for the Promise to be operated, following the Demutualisation, in accordance with its Schedule 4. Schedule 4 provides that the amount of any payment under the Promise shall be determined by reference to certain objective formulae based on rates of investment return. Those rates are described as the "Target Rate", the "Accelerated Rate", the "Payment Reduction Rate" and the "Payment Cessation Rate". Each of these rates has been calculated for each of a number of "Calculation Periods". Each Calculation Period begins on 1 October 2005. Each ends on 31 December in one of the years from 2006 to 2020, such that there are, in general, a total of 15 Calculation Periods over the lifetime of the Promise as reconstituted by the Scheme. These rates have then to be compared with the "Actual Rate" which, as more fully described in paragraph [44] below, comprises the actual rate of investment return earned by SLAL on its with profits assets.

[44 ] The rates of investment return are defined as follows:

Target Rate: the average rate of investment return on assets backing its with profits business that the Company, as a mutual, would have had to achieve over the relevant Calculation Period to support a reasonable expectation that, by 31 December 2020, its capital would exceed its capital as at September 2000 by an amount sufficient to fund payments under the Promise. The Target Rates have been calculated in accordance with consistent and prudent assumptions about the likely experience of the Company, were it to continue as a mutual, to the end of 2020.

Actual Rate: the average annual rate of investment return on assets backing the asset shares of the policies in the With Profits Fund of SLAL post-demutualisation, determined for each Calculation Period within three months of the end of that period. If the Actual Rate for that period equals or exceeds the Target Rate, a MEP Policyholder whose policy matures in the period between determination of the Actual Rate for the relevant Calculation Period and the determination of the Actual Rate for the following Calculation Period will receive one of two amounts depending on whether the 6% Test is satisfied (which is to say, whether the assets attributable to the policy have earned an average net return of 6% per annum or more in the period between 28 September 2000 and its maturity date). Where the 6% Test is satisfied, the MEP Policyholder (whether a Top Up MEP Policyholder or a Non Top Up MEP Policyholder) will receive the full Shortfall Amount required to be added to the maturity proceeds of his policy in order to meet its target value as determined by the Company and communicated to the MEP Policyholder shortly after the Promise was made. Where the 6% Test is not satisfied, the Non Top Up MEP Policyholder will receive nothing and the Top Up MEP Policyholder will receive the lesser of (a) the Shortfall Amount and (b) the Maximum Top Up communicated to him shortly after the Promise was made.

Accelerated Rate: for any Calculation Period (other than the two final Calculation Periods), the Target Rate applicable to the Calculation Period expiring three years earlier. Necessarily, therefore, it will be lower than the Target Rate for the current Calculation Period. Where it is determined, in respect of a particular Calculation Period, that the Actual Rate exceeds the Accelerated Rate but is lower than the Target Rate, MEP Policyholders whose policies mature between that determination and the determination of the Actual Rate for the following Calculation Period will receive Top Ups increased by an amount depending on whether the assets attributable to the policy have satisfied the 6% Test in the period between 28 September 2000 and its maturity date. If so, the MEP Policyholder (whether a Top Up MEP Policyholder or a Non Top Up MEP Policyholder) will receive a proportion of the Shortfall Amount. If not, Top Up MEP Policyholders (but not Non Top Up MEP Policyholders) will receive a proportion of the Maximum Top Up. In either case, the proportion will lie between "the Basic Amount" (as more fully described in the following paragraph) and the Shortfall Amount or, as the case may be, the Maximum Top Up calculated by reference to where the Actual Rate lies between the Target Rate and the Accelerated Rate. The Accelerated Rate therefore serves as a "smoothing mechanism" designed to prevent undue fluctuation from year to year in the payment of Top Ups. It is also intended to give some weight to the FSA's interpretation, and to the practical likelihood that, on that interpretation, the Capital Growth Condition would have been more easily satisfied.

Basic Amount: an amount which broadly equates to the amount that the Company could have afforded to pay to a Top Up MEP Policyholder out of the provisions which have already been set aside for the Promise. It is therefore intended to be broadly consistent with the intimation given to MEP Policyholders in the 2004 Announcement, as explained in paragraph [21] above. In practical terms, the formulation prescribed will mean that Top Up MEP Policyholders will continue to receive the Basic Amount by way of a Promise payment, subject to increase if good investment returns on the underlying with-profits assets are achieved but subject also to decrease in the circumstances described in the two following paragraphs. Non Top Up MEP Policyholders will be treated similarly, but only if the 6% Test is satisfied in the period between 28 September 2000 and the maturity date of the relevant policy.

Payment Reduction Rate: the rate of investment return on the assets backing the Company's with profits business which, had it continued as a mutual, would have reduced its capital to 110% of the Company's prescribed solvency margin (known as the "Capital Resources Requirement" or "CRR") at the end of the relevant Calculation Period.

Payment Cessation Rate: the rate of investment return on the assets backing the Company's with profits business which, had it continued as a mutual, would have reduced its capital to 100% of CRR.

[45 ] Where either the Payment Reduction Rate or the Payment Cessation Rate is triggered, SLAL's financial position would have deteriorated to such an extent that the interests of non-MEP Policyholders might be prejudiced even if Promise payments were to be restricted to what is affordable out of provisions already set aside for the Promise. If, in respect of any Calculation Period, the Actual Rate is less than the Payment Reduction Rate but more than the Payment Cessation Rate, Promise payments will be reduced below the amount payable in terms of the 2004 Announcement but will not cease entirely. If the Actual Rate in any Calculation Period is equal to or less than the Payment Cessation Rate, Promise payments will not be made unless the Actual Rate in respect of a subsequent Calculation Period should exceed the Payment Cessation Rate for that period.

[46 ] The Company regards the inclusion of these rates in the Scheme as consistent with the terms of the 2004 Announcement. In particular, Schedule 4 has been drafted so as to ensure that, as a rule, MEP Policyholders will receive a certain minimum amount on the maturity of their policies, being an amount broadly equivalent to what they would have received pursuant to the 2004 Announcement.

Report of the Independent Expert
[47] Mr M Arnold FIA ("the Independent Expert") was instructed by the Company to report pursuant to section 109 of FSMA in the capacity of on the terms of the Scheme. His appointment was approved by the FSA, which also approved the form of his report. He interpreted his instructions and terms of reference, which included rules on expert evidence, to require him to consider primarily the likely effects of the Scheme on the policyholders of the Company and also the terms of the compensation which members will receive for loss of their membership rights. He took into account inter alia the report of the Company's With Profits Actuary and Actuarial Function Holder. His report, dated 11 April 2006, contains the following passage (in which the expression "the MEP Proxy" is used to refer to the provisions of Schedule 4 to the Scheme, summarised at paragraphs [43] and [44] above, whereby the capital growth condition of the Promise will be replaced with alternative measures by reference to which the basic amount will be varied):

"The MEP Proxy

4.106 There are two distinct strands in the assessment of the MEP Proxy: first, the legal analysis of the status and interpretation of the MEP and, secondly, the comparison of the financial consequences of the MEP Proxy with those of the MEP.

4.107 The original MEP wording has been the subject of legal analysis and debate. It is not within my area of expertise to comment upon the analysis though I have taken it into account in reaching my conclusions. It is, however, fair to say that all of the advice received has pointed to uncertainty in the interpretation of the MEP. The approach being proposed by the Company represents an outcome which reflects a balance between the different interpretations capable of being given to the MEP, particularly the capital growth condition, as set out in the letters describing the MEP which have been issued to MEP policyholders.

4.108 It is noted that there is no change to the maximum amount payable under the MEP in respect of Top up MEP policies if the 6% pa condition is not satisfied (i.e., the maximum top up amount), or to all MEP policies if it is satisfied (i.e., the Shortfall Amount).

4.109 The principal elements which are relevant to my assessment of the comparison of the financial consequences of the MEP Proxy with those of the MEP are:

i. The interpretation of the capital growth condition to which the MEP is subject, both in respect of both the starting financial position and the measure of improvement to trigger a provision being made; and

ii. The circumstances in which provisions previously made may be released and consequently payments under the MEP suspended.

4.110 These have the following practical applications:

i. The capital position should be measured on a regulatory basis (since the realistic basis was not relevant at the time the MEP was made);

ii. The initial capital position against which the MEP should be measured is the disclosed regulatory position when the MEP was made (i.e., regulatory basis free assets of £10.5 billion);

iii. Improvements in the capital position should be measured from the initial capital position taking into account past and projected future experience; and,

iv. Provisions under the MEP, once made, can only be released in extreme adverse circumstances where to continue to meet the MEP would be unsustainable.

4.111 As noted above, there is legal uncertainty in each of the points referred to in 4.108 above and other interpretations could have been applied.

4.112 The capital growth condition in the MEP is dependent on the financial position of the Company and, since the future capital position of SLAL, the successor life company, will clearly be different from, and be influenced by factors not present within the Company, it has been necessary to find a practical approach that produces a fair result. The inclusion of the MEP Proxy in the Scheme has been necessary for this reason and it is self-evidently desirable, if it can be achieved, for the MEP Proxy to be both unambiguous and fair to all policyholders.

4.113 The capital position of the Company has been subject to many influences since 2000 and would have continued to be in the future in the absence of the Scheme. A significant influence has been the interaction of the terms of the in force business with economic conditions and investment performance as well as the capital requirements of transacting new business. However, one of the main determinants in the developing capital position is the rate of investment return earned on the Company's assets and it would have been a natural step in 2000 to have considered the minimum rate of investment return which would have been required to maintain or improve the financial position as its then level. Accordingly, I believe that adopting such a measure now is consistent with the original intentions of the MEP.

4.114 In practice, the calculations to achieve the investment measures used in the MEP Proxy have been undertaken from 30 September 2005, which allows for the MEP Policies in-force and the financial condition of the Company at that time. The financial condition at 30 September 2005 has been determined excluding the capital raised by the Company since 2000 as subordinated debt and subordinated members' accounts.

4.115 The actual rate of return calculations will be updated on 30 September each calendar year. The rate of return will be measured on the assets backing the asset shares of the with profits policies in the WPF [With Profits Fund] rather than on all the assets of the WPF. The use of this subset of the assets has been justified as being consistent with the capital growth condition in the MEP. In any event, I believe that it is appropriate to ignore assets backing non-profit business and the assets of the Estate which will possibly be invested differently from the assets backing asset shares and could produce anomalous results (e.g., if assets were held to hedge specific liabilities).

4.116 The derivation of the so called Target Rates set out in 3.48 has been broadly based on the principles set out in 4.109 and incorporate best estimate assumptions on the likely development of the business of the Company as an on-going mutual open to new business. I have considered the assumptions which have been used to effect the calculations (as further described in the report of the Actuarial Function Holder), and believe that they are appropriate.

4.117 The Company has sough to ensure that the MEP Proxy is fair to all policyholders and balances the interests of MEP policyholders against those of with profits policyholders generally. The principles set out in 4.109, whilst consistent with the legal advice received by the Company, are not the only basis upon which to interpret the MEP. To take account of the uncertainty as to the meaning of the MEP the Accelerated Rates set out in 3.48 have been introduced. These have the effect of grading increases or reductions to the proportion of the maximum top up amount or the maximum shortfall amount (as the case may be) which will become payable under the MEP. This was not an explicit feature of the MEP but I believe that avoiding sudden significant changes is desirable in the operation of the MEP and may have represented how, in practice, provisions set aside under the original MEP would have been applied.

4.118 The MEP Proxy now also includes lower rates of return which formalise when the MEP provision would cease to be held and therefore when payments under the MEP would be suspended. In particular, this follows the general intention expressed in the 2004 announcement. The lower limits proposed are at levels where regulatory concern could be expected at the financial condition of the Company and I believe that they have been chosen reasonably in that context.

4.119 As explained in 3.46 above, under the MEP, the maximum amount payable varies, depending upon whether, or not, the 6% pa condition is satisfied and, in the case of the Non Top Up MEP policyholders is only payable if the 6% pa condition is satisfied. This means that in the MEP Proxy, the rate of return will reflect the specific asset pool in which the policy is invested (and may also reflect the effects of differential returns if a durational asset matching regime is adopted). This calculation will be continuously updated and MEP policyholders will be informed of the rate of return shortly before the maturity date of their policy.

4.120 The Applicable Proportion of maximum shortfall amounts for the MEP will be fixed from 30 September 2020 (by which time some 94% of Top Up MEP policies and 97% of Non Top Up MEP policies will have matured) at the higher of the Applicable Proportion applicable immediately prior to that date or the average rate for the 3 years prior to that date. This is not a feature of the MEP but it is a desirable addition to protect both MEP Proxy holders and with profits policyholders.

4.121 Distributions that may be made from the Estate to enhance benefits under policies qualifying for a MEP payment will reduce the potential payments under the MEP. I believe that this approach is fair as there was never any intention that the MEP should be more than a "safety net" and therefore that it should result in payments that exceed the maximum shortfall amount.

4.122 In summary, I conclude that the proposed restatement of the MEP is fair to policyholders who are eligible for payments and maintains an equitable balance between the interests of policyholders who could benefit under the MEP and all other policyholders."

Report by Paul W Hally, WS, Reporter for the Process
[48 ] Mr Paul W Hally WS ("the Reporter") was appointed by the Court, in the First Order pronounced by it, to perform the duties of the Reporter for the process. His remit was to report on the correctness and sufficiency of the facts set out in the Petition and the regularity of the whole procedure. His report, dated 6 June 2006, contains the following passage:

"12. The Promise

12.1 The Petition states that on or about 28 September 2000, the Company issued the Mortgage Endowment Promise (the 'Promise') to certain holders of mortgage endowment policies resident in the UK and Ireland. The holders of policies to which the Promise applies are referred to as 'MEP Policyholders'. The terms of the Promise and matters pertaining to its subsequent operation are set out in Statement 4.8 of the Petition.

12.2 The Petition states that, without modification, the Capital Growth Condition (as defined in the Petition) could not readily be transposed, as part of the Demutualisation, to the new corporate framework of SLAL and the New SL Group. Your Reporter would draw your Lordship's attention to Statement 8.13 of the Petition which summarises the reasons why the Company is seeking to restate the terms of the Promise in accordance with, and as more fully set out in, Schedule 4 of the Scheme (the 'Proxy'). A summary of the Proxy and illustrations of the effect of the Proxy are set out in Part 5 of the Circular.

12.3 In your Reporter's view a wide discretion is conferred upon the Court in considering the appropriateness of insurance business transfers under Part VII of FSMA. Section 112(1) of FSMA states that, 'if the court makes an order under section 111(1), it may by that or any subsequent order make such provision (if any) as it thinks fit ...with respect to such incidental, consequential and supplementary matters as are, in its opinion, necessary to secure that the scheme is fully and effectively carried out'. [emphasis added by Reporter]

12.4 In Re Lincoln Assurance Limited, unreported, 6 December 1996, Rattee J held obiter that, inter alia, terms of a scheme which did not themselves provide for any transfer of insurance business from one company to another could only be sanctioned if, they 'were indeed necessary to secure that the scheme of transfer should be fully and effectively carried out'. This implies that the scheme proper can do nothing more than effect the relevant transfer of insurance business with any wider objectives requiring to be achieved through the medium of supplementary orders.

12.5 However, a more flexible view of what could be accomplished through the medium of a scheme and the test of 'necessity' was taken by Knox J in the earlier case of Re Hill Samuel Life Assurance Limited; Re Ambassador Life Co Limited [1998] 3 All ER176. This approach was endorsed in In the matter of Consolidated Life Assurance Company Limited, unreported, 11 December 1996, Re Hill Samuel Life Assurance Limited, unreported, 10 July 1995, Re Sun Life of Canada Assurance Company, unreported, 21 September 1999, Re Allianz Cornhill Insurance plc and another company [2005] All ER (D) 346 and Re Norwich Union Linked Life Assurance Limited [2005] BCC 586.

12.6 In Re Norwich Union Linked Life Assurance Limited, Lindsay J held, obiter, that, inter alia, an insurance business transfer scheme provided it results in a transfer of business may also contain and effect other matters which might otherwise have been considered as incidental or supplementary to or consequential upon the transfer. Lindsay J also held, obiter, that, 'there are good reasons, if the proponents of a scheme from the outset see the need for a given supplemental provision, that it should be included within the scheme itself ... In that way policyholders have a four-fold protection; the supplemental provision comes within the purview of the FSA, it is reported on by the appointed Independent Expert, is explained to members and is required to obtain the sanction of the Court as being "appropriate"'.

12.7 The Promise forms part of the insurance business that the Scheme would transfer. As stated in the Petition and the Circular, the Capital Growth Condition cannot readily be transposed to the new corporate framework without modification and hence, a reconstitution of the Promise is necessary to ensure that the transfer is able to take proper effect. Your Reporter respectfully submits that the inclusion of the Proxy in the Scheme offers policyholders the four-fold protection referred to by Lindsay J in Re Norwich Union Linked Life Assurance Limited as set out in paragraph 12.6 above.

12.8 Consequently, in your Reporter's view, the Court has jurisdiction to approve the Proxy in the body of the Scheme itself by virtue of the order sanctioning the Scheme made under section 111(1) of FSMA. It is, of course, a matter for your Lordship to determine whether or not it would be appropriate for the Court to exercise its jurisdiction in this manner.

12.9 Accordingly, your Reporter understand that Counsel for the Company will address your Lordship on the Promise, the Proxy, the Court's jurisdiction to sanction the Proxy as part of the Scheme pursuant to section 111(1) of FSMA and the appropriateness of exercising that jurisdiction."

Submissions of Counsel
The general legal definition of a "scheme"
[49] As a matter of the general law, "scheme" has a wide meaning. In the present context, the term denotes, essentially, a contract the predominant purpose of which is to effect one or more of the transfers referred to in section 105(1)(a)-(c) of FSMA, but which need not be limited to such a transfer and whose contents, to that extent, are left at large for the parties to determine: see in particular Re Norwich Union Linked Life Assurance Limited [2005] BCC 586 at 590 C-H, per Lindsay J ("Norwich Union").

[50 ] At paragraph 12.6 of his report, the Reporter describes the decision of Lindsay J in Norwich Union as obiter so far as it concerns the meaning of "scheme". This may be strictly so. It is, nevertheless, entirely consistent with an earlier line of authority developed in the Companies Court (a line that is largely unreported, and which deals with the meaning of "scheme" as that term appeared in the immediate statutory predecessor to section 105(1), namely paragraph 1(1) of Schedule 2C to the Insurance Companies Act 1982, as amended ("Schedule 2C")).

[51 ] Whereas in Re Lincoln Assurance Limited, 6 December 1996 (unreported) ("Lincoln Assurance"), Rattee J had taken the narrow view that a scheme as such could do nothing more than effect the relevant transfer or transfers of insurance business (with any wider objectives requiring to be achieved through the medium of supplementary orders), subsequent decisions endorsed the more flexible view of what could be accomplished through the medium of a scheme taken by Knox J in the Re Hill Samuel Life Assurance Company Limited, 10 July 1995 (unreported) ("Hill Samuel"): see, in particular, Re Consolidated Life Assurance Company Limited, 11 December 1996, unreported, per Harman J ("Consolidated Life"); Re Hill Samuel Life Assurance Limited [1998] 3 All ER 176 especially at 179 a-c, per Rimer J ("Hill Samuel Life"); and Re Sun Life of Canada Assurance Company, 21 September 1999, unreported, per Neuberger J ("Sun Life of Canada"). It is upon this wider and more flexible line of authority that Lindsay J relies in Norwich Union.

[52 ] It is significant to note that no demutualisation scheme involves the simple transfer of an insurance business and nothing more. Each of them, by definition, also involves the removal of membership rights. In contrast to the position in, for example, Australia, South Africa and Canada, a transfer scheme is the only procedure not involving private legislation whereby a demutualisation can take place and is, in effect, intended to obviate the need for private Acts of Parliament in such circumstances among others: see the discussion of Park J on this point in Re WASA International UK Insurance Company Limited [2003] 1 BCLC 668 at 674.

[53 ] Authority apart, a further reason for adopting a broad interpretation of the term "scheme" is that, if such an interpretation were not adopted - so that a scheme might only include provisions directly related to the transfer of the insurance business - it would not be possible to build future protections for transferred policies into the scheme. In fact, however, every demutualisation scheme sanctioned by this Court under section 105 of FSMA and, previously, under Schedule 2C, has included such protections, as has every such scheme sanctioned by the Companies Court. Furthermore, as the Reporter notes at paragraphs 12.6-12.7 of his report, under reference to the decision of Lindsay J in Norwich Union, "if the proponents of a scheme from the outset see the need for a given supplemental provision,... it should be included within the scheme itself. ... In that way policyholders have a four-fold protection: the supplemental provision comes within the purview of the FSA, it is reported on by the appointed Independent Expert, is explained to members and is required to obtain the sanction of the Court as being 'appropriate'."

[54 ] Finally, the width of the Court's power to "transfer" a long term insurance business is clearly demonstrated by the decision of the First Division in Re Empire Guarantee and Insurance Corporation Limited ("Empire Guarantee") 1911 SC 1296, which concerned the power of the Court under section 13 of the Assurance Companies Act 1909 to sanction an arrangement inter alia for the transfer of an assurance business. The Court sanctioned a scheme in which the with-profits policies of the transferor were, in legal terms, cancelled, in exchange for the issue by the transferee of new non-profit policies.

[55 ] It is to be noted that section 13 of the 1909 Act is a statutory predecessor of the present section 105 of FSMA, being replaced by section 11 of the Insurance Companies Act 1958, which in turn was replaced by section 26 of the Insurance Companies Amendment Act 1973 (which contained the first specific statutory reference to an "insurance business transfer scheme"). The 1973 Act was replaced, unamended so far as presently material, by the Insurance Companies Act 1982 and subsequently by FSMA.

[56 ] In addition to these authorities on the general meaning of the term "scheme" as it appears in section 105(1) of FSMA, there is also express authority in relation to Schedule 2C to the effect that a party other than the transferor and transferee of the relevant long term insurance business may be a party to a scheme. In this Court, the parent company of the transferee was a party to the scheme for the transfer by the Scottish Provident Institution: see Scottish Provident Institution v Shore 2003 SLT 73. In the Companies Court, the schemes for the transfer of the insurance business of Friends Provident and Norwich Union both involved companies which were to become the parent of the transferee and the shares in which were to be used as member compensation under the schemes (which is to say that both companies were in exactly the same position as SL plc under the present Scheme). In each case, as is the position with SL plc in the present case, it was necessary for the new parent company to be a party to the scheme since the scheme provided for the issue by that company of membership compensation. In the analogous context of schemes of arrangement between a company and its members under what is now section 425 of the 1985 Act, another person may, and frequently does, become a party to the scheme: see for example Singer Manufacturing Company Limited v Robinow 1971 SC 11. The analogy with Companies Act schemes is developed further below.

[57 ] If the broad meaning of "scheme" identified above is correct, then the present Scheme is plainly within that meaning, notwithstanding its inclusion of certain unique features. The competency of the inclusion in the Scheme of two particular features - namely the power to amend or vary policies (which is not unique to the present Scheme) and the reconstitution of the Promise (which is) - is specifically considered below.

Competency of aspects of the Scheme
[58 ] Counsel submitted that an assessment of the competency of the Scheme gives rise to two specific questions, over and above the general considerations canvassed elsewhere in counsel's submissions. The first is whether the Scheme can competently provide for the direct amendment of policies transferred pursuant to it. The second is whether the Scheme can competently reconstitute the Promise in the manner described above.

[59 ] The view expressed to the Company by the FSA is that the Promise itself takes effect as a variation of the relevant policy contracts. The FSA therefore regards the power to amend policies and the power to re-constitute the Promise as one and the same.

Power to amend policies
[60 ] The power to amend policies applies to unit-linked policies and also, conceivably, to policies securing the benefits payable under occupational pension schemes. The competency of providing such a power in a scheme is well-established, both under FSMA and its predecessors: see the authorities cited at paragraphs [49] to [51] above, which, as well as elucidating the meaning of "insurance business transfer scheme", also accept as valid powers to amend or vary policies in various ways. In particular, Norwich Union is a direct, and recent, precedent under Part VII of FSMA, in so far as it involved a complex variation of the transferred policies under which the transferor, on completion of the transfer, became a party to the policies and liable to provide certain of the policy benefits. In this Court, the Part VII Scheme for the transfer of the business of Lloyds TSB Life to Scottish Widows plc provided for the future variation of with-profits policies so that they would become non-profit policies. Under Schedule 2C, Hill Samuel involved a similar power to vary with-profits policies, and also a power to amend unit-linked policies closely akin to that contained in the present Scheme. Also under Schedule 2C, Sun Life of Canada involved a similar power to amend unit-linked policies. In this Court, the schemes for Scottish Widows, Scottish Life and Scottish Provident all contained similar powers to close funds and so amend unit-linked policies. In particular, the scheme by Lloyds TSB Life for the transfer to Scottish Widows plc provided for certain with-profits policies to be changed into non-profits policies.

[61 ] In the cases heard in the Companies Court before Norwich Union, the capacity of a scheme to amend or vary policies (or, to put the matter another way, the competency of the inclusion in a scheme of a power to amend or vary) was based on paragraph 5(1)(e) of Schedule 2C to the 1982 Act or, following FSMA's entry into force, its section 112(1)(d). In Norwich Union, Lindsay J held that, if a matter is "necessary to secure that the scheme is fully and effectively carried out", it must be capable of forming part of the scheme (and accordingly need not be provided for separately and brought into effect by way of a supplementary order). This is consistent with the precedents in this Court.

[62 ] The approach taken in Norwich Union is entirely consistent with the width to be accorded to the term "scheme" as a matter of statutory interpretation. In particular, it appears that where the term is used, the legislature intends that it should be generously construed, inter alia so as to obviate any need for private Acts of Parliament as a means of effecting a transfer: see on this point the discussion of Park J in Re WASA International UK Insurance Company Limited [2003] 1 BCLC 668 at 674. The width of the matters that may be provided for by way of private legislation may therefore give some indication of the width of the concept of a "scheme" for the purposes of Part VII of FSMA. Specifically, a power to amend or vary may be seen as exemplifying the width of the concept of a Part VII scheme (as to which, see further Empire Guarantee). That width is necessary to enable schemes to operate in their practical commercial context.

[63 ] The competency of the inclusion in a scheme of a power to amend or vary policies is distinct from the question whether it is appropriate, in terms of section 111(3) of FSMA, to sanction a scheme including such powers. The latter question is considered in greater detail below.

Reconstitution of the Promise
[64 ] The foregoing discussion of the competency of the inclusion in the Scheme of powers to amend or vary policies is equally relevant to the question whether the Scheme may competently provide for the reconstitution of the Promise. There is one salient difference between the two issues in as much as the authorities cited refer only to the amendment or variation of policies, whereas the Promise is, in legal terms, an obligation distinct from individual policies. That distinction is not, however, material, since the Promise is not only part of the business of the Company which is to be transferred but also forms part of the Company's contractual relationship with the MEP Policyholders. Thus in commercial, if not legal terms, the Promise is so close to the MEP Policies as effectively to form part of them.

[65 ] Discrete issues arise in relation to the competency of the inclusion in the Scheme of the reconstitution of the Promise. The first is whether, notwithstanding the width of the concept, a scheme may embody what amounts to a compromise of existing rights. The second is whether, before the Court can proceed to decide whether it would be appropriate to sanction a scheme, it must first reach a concluded view as to the content of policyholders' existing rights where, as here, this is uncertain.

[66 ] Before one can properly address these issues, however, it is necessary to describe in detail the actions the Company has taken in relation to the Promise and the advice it has received as regards the proper interpretation of that Promise. That advice acknowledged, and the Company accepts, that the present meaning of the Promise - or more specifically, of the Capital Growth Condition - is unclear in several, very material, respects. Others, in particular the FSA, have taken a different view as to the meaning of the Promise and the Capital Growth Condition. In formulating its proposals for the reconstitution of the Promise, the Company has based itself primarily on the legal advice it has received but has also sought to reflect the inherent uncertainty and scope for difference of views.

Competency of the reconstitution of the Promise
[67 ] Given the general width of the concept of an "insurance business transfer scheme" within the meaning of section 105 of FSMA, there is no reason in principle why such a scheme should be able to contain a power to amend or vary a policy but not to amend or vary an obligation such as the Promise. This is particularly so when it is difficult, to say the very least, to see how the Promise could be transferred to SLAL without modification. In practical terms, if the Scheme cannot competently reconstitute the Promise, the Transaction will not proceed further.

[68 ] There is a further reason why the Scheme should be held capable of reconstituting the Promise. The reconstitution may be seen as analogous to a "compromise" or "arrangement" between the Company and the MEP Policyholders. Those concepts are expressly referred to by section 425 of the Companies Act 1985 in the context of schemes between a company and its members or creditors. As explained in the following paragraph, a transfer scheme under the insurance companies legislation closely resembles, and has always closely resembled, a Companies Act scheme. In general, therefore, the Court should apply similar principles to both types of scheme. In particular, for the reasons given in the following paragraph, the Court should adopt the same approach as it would adopt in relation to a Companies Act scheme in considering the competency of that part of an insurance business transfer scheme which is, in effect, a compromise or arrangement in relation to rights of uncertain content.

[70 ] Section 26 of the 1973 Act became, without amendment, section 42 of the consolidated Insurance Companies Act 1974. The Insurance Companies Act 1982 was in materially identical terms to the 1974 Act, and was the legislation in force when Re London Life Association Limited ("London Life"), unreported, 21 February 1989, was decided. Hoffmann J's discussion in that case of the statutory history demonstrates clearly that the fundamental nature of an insurance business transfer scheme did not change between 1909 and 1982, despite significant changes to the procedural requirements for sanction of such a scheme.

[71 ] There is nothing to suggest that either Schedule 2C or the present Part VII of FSMA was intended to change the nature of an insurance business transfer scheme. Were it otherwise, the continuing reliance placed by the courts on London Life when considering whether to sanction a scheme (as more fully explained below) would be difficult to understand.

[72 ] Section 105(5) to (7) of FSMA provides, significantly, that if the scheme involves a compromise or arrangement in terms of section 427A of the Companies Act 1985, sections 425 to 427 of that Act shall have effect in relation to it.

[73 ] There is direct Commonwealth authority which expressly refers to insurance business transfer schemes as "analogous" to the equivalent of section 425 schemes of arrangement: see Ex Parte Liberty Life Association of Africa Limited [1976] 1 WLD 58 at 68, per Boshoff J; Re NRMA Limited; Re NRMA Insurance Limited [2000] NSWSC 82 at paragraph 29, per Santow J (citing Hoffmann J in London Life).

[74 ] As previously explained, the precise content of the rights of MEP Policyholders is uncertain. The Company has proceeded, both in its operation of the Promise and Capital Growth Condition to date and in the reconstitution of the Promise as embodied in the Scheme, on the basis of a particular interpretation of the Promise. It has been advised that this interpretation was a reasonable one to adopt, but that other reasonable interpretations exist. The question therefore arises whether, before the Court can proceed to decide whether it is appropriate to sanction the Scheme, it must first attempt to reach a concluded view as to the content of policyholders' rights.

[75 ] In Axa Equity & Law Life Assurance Society plc v Axa Sun Life plc ("Axa") [2001] 2 BCLC 447 Evans-Lombe J, having summarised the principles stated by Hoffmann J in London Life (which are set out in full at paragraph [89] below), held, at page 469:

"It seems to me to follow from the above ... that the court, in arriving at its conclusion [whether it is appropriate to sanction the scheme] should first determine what the contractual rights and reasonable expectations of policyholders were before the scheme was promulgated and then compare those with the likely result on the rights and expectations of policyholders if the scheme is put into effect."

This dictum may be taken to imply that the Court, in exercising its discretion under section 111 of FSMA, must indeed take a view as to what the contractual rights and reasonable expectations of policyholders actually were before it can decide whether policyholders, or a class of policyholders, will be adversely affected by the Scheme. Specifically, in the present situation, it implies that this Court must identify the precise content of MEP Policyholders' rights before it can satisfy itself as to the fairness of the provisions of the Scheme which reconstitute the Promise.

[76 ] In the Company's submission, however, this Court is not required, before it can exercise its discretion to sanction the Scheme, definitively to determine the prior rights and expectations of policyholders where these are unclear and where the Scheme consciously seeks to embody some compromise of those rights.

[77 ] Taken in its proper context, Axa is not authority for such a proposition: it did not involve any dispute as to the rights of policyholders, and the matter was not canvassed in argument. Furthermore, in the context of schemes of arrangement under section 425 of the Companies Act 1985, it is quite clear that the Court is not required to reach a concluded view on a legal question to which the answer is uncertain before it may competently sanction the scheme. The Court need be satisfied only that the content of the rights which are the subject of the scheme of arrangement is unclear; if it is so satisfied, the question for the Court is whether the proposed solution to that lack of clarity is a reasonable one: see in particular Edinburgh Railway Access and Property Company Limited v Scottish Metropolitan Assurance Company ("Edinburgh Railway Access") 1932 SC 2 at pages 9 to 10, per Lord Sands; Caledonian Insurance Company Limited v Scottish American Investment Company Limited 1951 SLT 23; Palmer's Company Law at paragraph 12.009.

[78 ] There is a further reason for the view that this Court is not required to form a concluded view as to the content of existing rights before considering whether to sanction a scheme, which relates to the nature of the process Parliament has prescribed for testing the fairness of such schemes. A scheme under Part VII of FSMA is subject to the scrutiny of an Independent Expert. The FSA has a right to object if it considers aspects of the scheme to be unfair. Ultimately, the scheme requires to be approved by the Court itself, and policyholders who wish to object to a scheme are entitled to enter that process and be heard. However, the overall nature of the process is not such as to allow for the resolution of a complex dispute of law and fact. In the present case, the true interpretation of the Promise could not be determined without proof and, inevitably, significant delay. In any event, the determination, once made, would not remove the need to reconstitute the Promise for the purposes of its application after the Demutualisation. To hold that it is necessary to identify that true interpretation as a pre-condition of the exercise of the Court's jurisdiction under section 111 of FSMA would, in the Company's submission, cut across the whole purpose of the procedure prescribed by the legislature in Part VII of FSMA.

[79 ] For these reasons, the Company submits that this Court may competently form a view as to the fairness of the Scheme, including those provisions relating to the Promise, without first trying to reach a decision as to the content of MEP Policyholders' existing rights.

The Substantive Test for Sanction of the Scheme
[80 ] In addition to satisfaction of the jurisdictional and procedural requirements already identified in counsel's submissions, the Court must also consider that "in all the circumstances of the case, it is appropriate to sanction the scheme" (section 111(3) FSMA).

[81 ] Neither Schedule 2C nor any of the earlier statutory predecessors of Part VII FSMA expressly required that the Court should consider it "appropriate" to sanction a scheme. However, the introduction of this test in section 111(3) merely codifies the law as it had previously been developed in the context of applications under Schedule 2C: see, in particular, the principles identified by Hoffmann J (as he then was) in London Life and summarised by Evans-Lombe J in a application under FSMA in Re Allied Dunbar Assurance Limited ("Allied Dunbar") [2005] 2 BCLC 220 at paragraph 13 as follows:

"(1) The 1982 Act [as does section 111 of the Act] confers an absolute discretion on the court whether or not to sanction a scheme but this is a discretion which must be exercised by giving due recognition to the commercial judgment entrusted by the company's constitution to its directors.

(2) The court is concerned whether a policyholder, employee or other interested person or any group of them will be adversely affected by the scheme.

(3) This is primarily a matter of actuarial judgment involving a comparison of the security and reasonable expectations of policyholders without the scheme with what would be the result if the scheme were implemented. For the purpose of this comparison the 1982 Act [and the Act] assigns an important role to the independent actuary [now the independent expert] to whose report the Court will give close attention.

(4) The FSA by reason of its regulatory powers can also be expected to have the necessary material and expertise to express an informed opinion on whether policyholders are likely to be adversely affected. Again the court will pay close attention to any views expressed by the FSA.

(5) That individual policyholders or groups of policyholders may be adversely affected does not mean that the scheme has to be rejected by the court. The fundamental question is whether the scheme as a whole is fair as between the interests of the different classes of persons affected.

(6) It is not the function of the court to produce what, in its view, is the best possible scheme. As between different schemes, all of which the court may deem fair, it is the company's directors' choice which to pursue.

(7) Under the same principle the details of the scheme are not a matter for the court provided that the scheme as a whole is found to be fair. Thus the court will not amend the scheme because it thinks that individual provisions could be improved upon."

On an application of these criteria, and for the following reasons, it is appropriate to sanction the Scheme.

[82 ] In the first place, the Court must exercise its discretion whether or not to sanction the Scheme "giving due recognition to the commercial judgment entrusted by the company's constitution to its board". The Board took the decision that the Scheme and indeed the Transaction as a whole was in the best interests of the Company's members and policyholders after a comprehensive review of other options in a changed and changing commercial environment. The Board has reviewed that decision in light of the approaches which have been recently made to the Company, but remained (and remain) of the view (having taken appropriate financial advice from Lazards) that the interests of members and policyholders are best served by proceeding with the Transaction. The Board's judgment has been comprehensively endorsed by the members voting at the SGM.

[83 ] Secondly, whether a policyholder or other interested person will be adversely affected by the implementation of the Scheme is "primarily a matter of actuarial judgment involving a comparison of the security and reasonable expectations of policyholders without the scheme with what would be the result if the scheme were implemented. For the purpose of this comparison, the 1982 Act and FSMA assign an important role to the independent actuary (now the independent expert) to whose report the court will give close attention". The Independent Expert's assessment of the Scheme, as set out in his report, focuses on the security of policyholder benefits; the need to treat customers fairly and to ensure that their reasonable expectations are met; and on the overall equity of the proposal, including the proposed allocation of Demutalisation Entitlements. In that regard, the Independent Expert considers it necessary to ensure that security for all policyholders will not be materially adversely affected by implementation of the Scheme; that all policyholders will be treated fairly, and that, in particular, the reasonable benefit expectations of with-profits policyholders will continue to be met; and that members are adequately compensated for the loss of their membership rights.

[84 ] The Independent Expert's principal conclusions are as follows:

· SLAL will be sufficiently capitalised to enable it to meet its business plans and to maintain an adequate level of cover for its capital requirements;

· SLAL's financial strength will not be significantly different from that of the Company at the date on which the Scheme becomes effective, and will remain sufficient to ensure adequate security for transferred policies;

· The benefit expectations of with-profits policyholders will not be adversely affected by the implementation of the Scheme;

· The Scheme will not have an adverse effect on the benefits arising under non-profit and linked policies, nor will it adversely affect the fair treatment of non-profit and linked policyholders;

· The proposed re-statement of the Promise is fair to policyholders who are eligible for payments under the Promise, and maintains an equitable balance between the interests of policyholders who could benefit from the Promise and all other policyholders;

· The proposals in relation to the allocation of Demutualisation Entitlements are fair to all members and consistent with the approach adopted in previous demutualisations.

[85 ] These conclusions are consistent with those of the With Profits Actuary, whose report considers the effect on the Company's members and policyholders of the arrangements to be made in connection with the Demutualisation and Flotation. His principal conclusions are as follows:

· The demutualisation proposals are in the interests of policyholders and members.

· There will be no adverse effect on the reasonable benefit expectations of any policyholder.

· There will continue to be a high level of security for policyholder benefits.

· The proposed re-statement of the Promise is fair.

· The proposed arrangements for compensating Eligible Members for the loss of their membership rights are fair.

[86 ] The Company has involved the FSA in the development of all aspects of the Scheme, in particular the proposals in relation to the Promise. The FSA has confirmed that it has no objection to what is being proposed in the Scheme.

[87 ] The Independent Expert and the With Profits Actuary have both formed the view that the provisions of the Scheme will operate fairly as between different classes of policyholder. There is no evidence that any individual policyholder or group of policyholders will be adversely affected to any material extent by the implementation of the Scheme. Even if there were such evidence, the Court would still be entitled to sanction the Scheme, provided it were satisfied that the Scheme as a whole was fair.

[88 ] With specific reference to the fairness of the proposed reconstitution of the Promise, the Company submits, on the basis of the approach adopted by the First Division in Edinburgh Railway Access (see above, at paragraph [85]), that the reconstitution is appropriate, particularly when considered in the context of the Scheme and the Transaction as a whole. This is for the following broad, and interrelated, reasons.

[89 ] First, the meaning and effect of the Capital Growth Condition are intrinsically unclear. The interpretive difficulties to which it gives rise have been fully described at paragraphs [25] to [40] above. That lack of clarity generates uncertainty - on the part of MEP Policyholders, as to what their entitlements under the Promise are or might be; and on the Company's part, as to what its future exposure is likely to be. Such uncertainty is in the interests of nobody. The reconstitution of the Promise can therefore be seen as desirable in itself.

[90 ] The Company cannot, realistically, approach the Transaction without seeking to resolve this uncertainty. In particular, that uncertainty would inhibit the introduction of outside equity capital in the Flotation, and (relatedly) could adversely affect the ability of SL plc to pay dividends in the future.

[91 ] In any event, if the Scheme becomes effective, the Promise will have to operate within a significantly different capital structure. For this reason also, the Company regards modification of the Promise as a matter of practical necessity.

[92 ] The inherent uncertainty of the Promise, and the practical consequences which would flow from that if it went unmodified, satisfy in part the approach adopted in Edinburgh Railway Access. The remaining consideration relates to the reasonableness of what is proposed. In that regard, the Company submits that the reconstitution of the Promise contained in the Scheme is a reasonable one, and for the following reasons.

[93 ] First, the Independent Expert makes no criticism of the proposed reconstitution. His approach is as set out above, at paragraph [47]. Secondly, the report of the With Profits Actuary and Actuarial Function Holder is similarly supportive of the fairness of the proposed reconstitution of the Promise. Having discussed the Promise and the provisions in the Scheme for its reconstitution, the With Profits Actuary concludes:

"I believe that the proposed re-statement of the Promise is fair to policyholders who are eligible for payments under the Promise, and maintains an equitable balance between their interests and those of other policyholders."

[94 ] Thirdly, despite the difference of opinion already described, the FSA has indicated that it does not object to the proposed reconstitution of the Promise and, in particular, that it considers the reconstitution to fall within the range of fair and reasonable options open to the Company.

[95 ] Although counsel's submissions have addressed the reconstitution of the Promise as a separate issue, it must be emphasised that, while this may be useful for analytical purposes, it is ultimately inappropriate. The reconstitution of the Promise is part of the Scheme. This Court is concerned with the fairness of the Scheme as a whole, and as part of the Transaction.

[96 ] The fact that the reconstitution of the Promise forms an integral part of the Scheme and the Transaction explains why it would have been wholly inappropriate (even if theoretically possible) for the Company to have attempted to effect the reconstitution of the Promise by way of a section 425 scheme between the Company and the Promise Policyholders.

Conclusions

[97] I accept the submissions of counsel in their entirety. It would serve no useful purpose to elaborate on them, so I shall simply present my conclusions in summary form:

(1) The term "scheme" in FSMA has a wide meaning and, in the present context, denotes, essentially, a contract the predominant purpose of which is to effect one or more of the transfers referred to in section 105(1)(a)-(c) of FSMA, but which need not be limited to such a transfer and whose contents, to that extent, are left at large for the parties to determine: see paragraphs [49] to [56].

(2) The present Scheme is plainly within this meaning of "scheme", notwithstanding its inclusion of certain unique features: see paragraph [57].

(3) The Scheme can competently provide for the direct amendment of policies transferred pursuant to it: see paragraphs [60] to [62]

(4) The Scheme can competently reconstitute the Promise in the manner described above. The Scheme may embody what amounts to a compromise of existing rights. The Court is not required first to reach a concluded view as to the content of policyholders' existing rights where, as here, this is uncertain: see paragraphs [64] to [87].

(5) In all the circumstances of the case, it is appropriate to sanction the Scheme, having regard, in particular, to the following considerations:

(a) The Board took the decision that the Scheme and indeed the Transaction as a whole was in the best interests of the Company's members and policyholders after a comprehensive review. The Board's judgment has been endorsed by the members voting at the SGM: see paragraph [90].

(b) The Independent Expert has concluded that security for all policyholders will not be materially adversely affected by implementation of the Scheme; that all policyholders will be treated fairly, and that, in particular, the reasonable benefit expectations of with-profits policyholders will continue to be met; and that members are adequately compensated for the loss of their membership rights: see paragraphs [91] and [92].

(d) The FSA has confirmed that it has no objection to what is being proposed in the Scheme and that it considers the reconstitution to fall within the range of fair and reasonable options open to the Company: see paragraphs [94] and [102].

(e) There is no evidence that any individual policyholder or group of policyholders will be adversely affected to any material extent by the implementation of the Scheme: see paragraph [95].

(f) The proposed reconstitution of the Promise is appropriate and reasonable, having regard to the interpretative difficulties to which it gives rise and the consequent practical necessity of its reconstitution, and when considered in the context of the Scheme and the Transaction as a whole: see paragraphs [88] to [103].

	[Home] [Databases] [World Law] [Multidatabase Search] [Help] [Feedback]
	Scottish Court of Session Decisions
You are here: BAILII >> Databases >> Scottish Court of Session Decisions >> The Standard Life Assurance Co Re [2007] ScotCS CSOH_137 (09 June 2007) URL: http://www.bailii.org/scot/cases/ScotCS/2007/CSOH_137.html Cite as: [2007] ScotCS CSOH_137, [2007] CSOH 137

Scottish Court of Session Decisions