Sir Richard Branson was on the brink of realising his dream of running the National Lottery last night after current operator Camelot was left on the sidelines in the race to win the new licence.

In a bombshell announcement, the National Lottery Commission said it was not satisfied that either of the rival bids was good enough to secure outright victory.

But it has given Sir Richard's People's Lottery bid a month to resolve outstanding issues and said it hoped to award it the coveted licence by the end of next month.

The Virgin tycoon has pledged not to take a penny out of the People's Lottery other than cover expenses - unlike Camelot which has made millions in profits and has been hit by rows over "fat cat" salaries.

Camelot was ruled unfit to run the Lottery for a second time, despite the success of the game's first six years, because of problems with its software supplied by US firm GTech, said commission chairwoman Dame Helena Shovelton.

Concerns with the People's Lottery centred on its ability to provide refunds to players if the draw was declared void.

Dame Helena said: "Both bids have many merits. But they also had important failings. We are disappointed about that, but we would fail in our statutory duty if we granted a seven-year licence based on either bid in its present form."

She told a London news conference the Camelot bid fell down because it was felt problems with the software raised questions about the "propriety" of the bid.

The Commission drew particular attention to a software fault which was corrected secretly by GTech, in breach of established software change control procedures.

The fault, which had been in place since the beginning of the Lottery and was finally rectified in July 1998, resulted in an overcharge to retailers and errors in the distribution of the prize fund. Winners may have been underpaid by about £1 to £3, Dame Helena said.

These concerns, the Commission said, led it to conclude that Camelot, due to its involvement with GTech, was not a proper and fit body to run the National Lottery for a second term.

Added to this stinging criticism came the revelation that Camelot could also face fines over breaches of its licence during the past six years that it has been running the game.

Dame Helena continued: "We propose to negotiate with the People's Lottery and hope that we can reach a satisfactory solution within the deadline we have set of one month from today."

But the People's Lottery also faced concerns over its ability to provide refunds to players if the draw is declared void. The Commission was not satisfied that an additional £50m contingency fund, needed in the event of low revenues or unforeseen costs, had been provided.

Discussions concerning this fund will form the basis of the negotiations.

Camelot, which employs around 800 workers, could be back in the running if the negotiations with the People's Lottery fail.

Camelot's chief executive designate, Dianne Thompson, said: "We were concerned about what happened with GTech, but some very stringent procedures were put in place to make sure it didn't happen again."

She said the consortium was considering making an appeal.

The Virgin boss, who had been stranded on his Caribbean island of Necker by a hurricane, was last night on his way back to Britain.

"We have always said we could deliver much more for good causes and are happy that the Commission has acknowledged that," he said.

"I am hopeful that we can finally deliver to the people of Britain the Lottery they want."

l More than £420m has been awarded in grants in the North-East region since the National Lottery started.

Life's a Lottery - Page 1