The rescue of British bank Northern Rock could get bogged down in a legal battle as shareholders criticised the government's handling of the five-month crisis just as a decision nears.
Lawyers for hedge fund SRM Global, the biggest shareholder in Northern Rock, today delivered a report to the government saying the Treasury needed to reassess the criteria it used for rescue proposals, as it had wrongly applied the rules of the European State Aid regime to its emergency funding. For details click on.
The legal move is seen as an attempt to pull the government back from the brink of choosing a consortium led by billionaire Richard Branson's Virgin Group to rescue the bank.
A rival "in-house" proposal led by the bank's management team is less dilutive for existing shareholders and is supported by SRM.
The Treasury has called on both suitors to improve their proposals, including offering the government more money for the guarantee it is providing on the £26 billion borrowed by the bank. The guarantee will allow the loan to be turned into bonds that can be sold to investors.
The government wants up to £200 million from Virgin if it turns round the bank within three years, today's Financial Times reported. The Treasury declined to comment.
Revised offers are due to be submitted on Saturday, according to people familiar with the situation, so the Treasury could make a decision early next week.
Northern Rock's second biggest investor, RAB Capital, is also against the Virgin proposal. RAB and SRM have topped up their holdings this week and combined they now own almost 20 per cent of the shares, almost enough to block the proposal, which requires 75 per cent investor approval.
The high-profile battle for Northern Rock, which became Britain's biggest casualty of the global credit crunch when it was forced to seek emergency funding in mid-September, is becoming increasingly political.
The Treasury's comments that nationalisation currently stood as the best option for taxpayers was seen as a move to put pressure on the suitors to improve their terms. The government has long said it wants a private-sector solution.
SRM's action indicates it would prefer nationalisation to a Virgin rescue. Shareholders are expected to receive little under nationalisation, but SRM is reported to have taken legal advice and wants compensation of the bank's book value if this occurs, or about 400 pence per share.
The in-house proposal, meanwhile, may sweeten its proposal but also has a duty to its shareholders and therefore may not want to be used as a tool to extract a higher offer from Virgin, potentially diluting shareholders further.
The final decision is expected to be taken by prime minister Gordon Brown. European regulators then need to clear the proposal to ensure it doesn't breach state aid rules.