LAW REPORT 21 July 1995: Investors' claims may be limited to 'fair compensation'

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Regina v Investors Compensation Scheme Ltd, ex parte Bowden and another; House of Lords (Lord Keith of Kinkel, Lord Browne-Wilkinson, Lord Lloyd of Berwick, Lord Nicholls of Birkenhead and Lord Steyn) 13 July 1995

In assessing the compensation payable under the Financial Services (Compensation of Investors) Rules 1990, to investors who had lost money on unsound "home income plans", Investors Compensation Scheme Ltd had a discretion, not only to exclude claims altogether, but also to reduce the amounts of those claims it allowed, in order to provide what it considered fair compensation.

The House of Lords by a majority (Lord Steyn dissenting) allowed an appeal by ICS against the decision of the Court of Appeal ([1994] 3 WLR 1045) and restored the decision of the Queen's Bench Divisional Court, on 16 February 1993, refusing an application by the investors, Arther Edwin Bowden, Philip Haring and Mrs Margaret Jeanne Weyell, for judicial review of a decision of ICS, communicated on 7 August 1992, as to the compensation to which they were entitled under the 1990 Rules following the failure of "home income plans" taken out by them with authorised investment advisers.

Michael Beloff QC and Richard McManus (Wilde Sapte) for ICS; Nicholas Strauss QC and Neil Kitchener (Barnett Sampson) for the investors.

Lord Lloyd said that in the late 1980s a large number of home-owners were persuaded to enter into so-called "home income plans" advertised by financial advisers. In essence, a home-owner would take out a loan for 50 per cent of the value of his home, secured by mortgage. The loan would be invested in a single-premium equity-linked investment bond. The interest on the mortgage would be rolled up with the capital. It was assumed that the bond would increase sufficiently in value so as to provide the investor with a regular income by the sale of units in the fund, at the same time ensuring the mortgage loan and accumulated interest did not exceed two-thirds of the current value of the house.

The scheme was viable so long as house prices and the equity market continued to rise and mortgage interest remained low. But as soon as any of these three elements started to move in the wrong direction, the scheme was doomed.

The consequences could be illustrated by Mr Haring's case. In 1989 he and his wife invested in a "retirement income plan" advertised by Fisher Prew-Smith, whereby they mortgaged their home and invested the loan in an equity-linked fund. They subsequently withdrew a monthly "income" by selling units in the fund, which they spent on holidays and improved living standards.

By the autumn of 1990 alarm bells were ringing. On 8 November 1990 Fisher Prew-Smith were suspended by Fimbra (Financial Intermediaries, Managers and Brokers Regulatory Association). On 16 September 1990 they went into liquidation.

The Harings' mortgage debt then amounted to pounds 136,678 but the value of their equity-linked bond was only pounds 69,969, a shortfall of pounds 66,982. The Harings had also spent pounds 1,177 on having accountants, stockbrokers and solicitors rearrange their affairs.

They and other investors caught in the same trap applied to ICS, which had been set up under section 54 of the Financial Services Act 1986. ICS accepted they were entitled to compensation under the 1990 Rules. The question was how it should be assessed.

It was accepted that the basic measure of compensation should be the difference between the outstanding loan and the value of the bond at the relevant date, but ICS said the sums received by investors by way of "income" should be deducted, and that the claim for professional fees should be limited to pounds 500.

The investors argued that they were entitled to the amount they would have recovered in a successful action against the investment advisers, had they been good for the money.

The 1990 Rules provided by rule 2.04:

(1) The basic compensatable claims are claims for property held and claims arising from transactions

which remain uncompleted at the quantification date, and an application for compensation relating to any other claim is to be met only where [ICS] consider that this is essential in order to provide fair compensation to the investor.

The investors conceded that the second half of this rule contained a limiting provision but argued that the discretion conferred on ICS was restricted to excluding claims altogether.

His Lordship could envisage no sensible commercial reason why that should be so. The language fitted better with a broad discretion to include within the definition of a compensatable claim either the claim as a whole or those elements of it that ICS considered essential to provide fair compensation and exclude those that did not.

Nor could it be said that ICS's decision to disallow the sums already received as income was one that no reasonable public authority, exercising the functions imposed by the 1986 Act and 1990 Rules, could have reached.

As to professional costs, the decision to impose a "cap" of pounds 500 was reasonable in the circumstances.

Paul Magrath, Barrister

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