Darling's plan to pay off Rock investors

Chancellor Alistair Darling is eager to avoid protracted legal battles with investors who could have seen their holdings in Northern Rock wiped out if ministers decide to take the bank into public ownership.

It marks a change of heart by Darling and Prime Minister Gordon Brown, who have consistently said their priorities in solving the crisis are financial stability, savers and borrowers, and the taxpayer - with shareholders bottom of the pile.

But hedge funds SRM Global and RAB Capital, which together own 18% of Northern Rock, have threatened to sue the Government if it is nationalised. They argue the bank is worth about 400p a share.

While it is highly unlikely Darling will agree to compensate shareholders by anything like as much, the Treasury is ready to compromise.

When the Government nationalised Railtrack, it eventually agreed to pay compensation to shareholders of 262p a share, the market price on the day before the company was put into administration. It followed the threat of a High Court challenge, something the Government wants to avoid this time around.

Shares in Northern Rock crashed to a new low of 52p yesterday before closing down just 1¼p at 68p. They were up ¼p today at 68¼p, valuing the firm at £288 million against £5.3 billion before the crisis struck.

Given the Railtrack model, the Government would be keen to see the share price fall further to minimise the payout to shareholders. Yesterday's tumble followed comments by Brown that nationalisation was very much under consideration, although he also said ministers were still searching for a private buyer.

Although shareholders insist nationalisation would be a disaster for Northern Rock, the fact the Government has accepted it may have to pay compensation represents some sort of victory. It follows Tuesday's extraordinary general meeting in Newcastle where small shareholders joined SRM and RAB to voice their concerns. Philip Richards, head of RAB, said that while just a month or so ago there was little chance shareholders would get anything, they were now being taken seriously.

Goldman Sachs was under growing pressure today to come up with a financial package to push through a sale and stave off nationalisation.

A successful rescue bid by Sir Richard Branson's Virgin Group, Luqman Arnold's Olivant, or a standalone option rests on Goldman raising enough finance to fund a deal.

HOW IT WORKED WITH RAIL

Railtrack, which was founded in 1994 under the Conservative Government to look after railway infrastructure, plunged into administration in October 2001 after an application to the High Court by then Transport Secretary Stephen Byers.

New Labour invited private companies to bid for Railtrack but chose nationalisation instead in 2002 through Network Rail. The Government insisted that it owed shareholders nothing but a revolt followed and, under threat of a challenge in the courts, ministers eventually agreed to pay 262p a share, the stock market price on the day before the company was put into administration.