The saga continues.
I got my hands on a new machine fresh windows install, brand new installation of ArcGIS 10.1 SP1 with 64 bit background geoprocessing and like magic the error returned! This time though I found something. When I was running the geoprocessing tools and was giving me the error, I was running on a Basic license, so I closed arc, changed to Advanced License and this time NO error occurred. I closed arc, switched back to Basic ran the tool and no more error. This appears to be a solution but only if you have access to Advance. Not sure how you would get around it if you didn't have access to an Advanced License.
cheers