Government rescue bid for Northern Rock could be illegal under EU law, Brown is warned

Insiders at the bank expressed concerns over whether the Prime Minister's contingency plan to rescue it will pass EU rules governing illegal state aid.

Legal experts on European competition law expressed similar fears.

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Alastair Gorrie, competition partner at law firm Orrick, said: 'It could be problematic for the Government.

'There is no obvious exemption (to the rules).

'Opponents of nationalisation could claim that no private sector investor would behave in this way (buy a failed business) and that it is propping up the business, thereby distorting competition.'

The Government is thought to have an army of lawyers trying to find a way through the minefield. It would have to pass an Act of Parliament in order to take the Rock into Government control.

But Stephen Hamilton, competition lawyer at Mills & Reeve, believes it may be able to achieve similar results by forcing the bank into administration.

That could be followed by a sell-off of the business and its assets, with any proceeds being returned to the state's coffers.

He added: 'The Government would have to tread very carefully should it decide to take any steps towards nationalisation because an incorrectly managed process could be in breach of European law and could lead to litigation and significant shareholder activism.'

The Conservatives announced they would vote against emergency legislation to nationalise the stricken bank.

Moves to take the ailing bank into public ownership - at a reported cost to taxpayers of £50 billion - could even be derailed in the Lords if enough crossbench peers join the opposition.

The prospect of a showdown in Parliament follows a series of signals that Chancellor Alistair Darling is serious about nationalisation within weeks unless there is a last-minute rescue.

Some observers believe nationalisation will - at least temporarily - add more than £50 billion to the national debt, with £26 billion already lent to the bank and a similar amount committed to guaranteeing savers' deposits.

It emerged at the weekend the Treasury has appointed the former boss of Lloyd's insurance market, Ron Sandler, to run the bank if it is nationalised.

Senior Conservatives said they were almost certain to vote against any Bill to take the troubled bank into public ownership.

David Cameron said yesterday nationalising Northern Rock would be "the most complete humiliation and failure for the Government".

An ally of shadow chancellor George Osborne said: "I cannot see the Conservative Party supporting a Bill for nationalisation."

Mr Darling's office accused the Tories of putting taxpayers' money and depositors at risk.

The Chancellor's spokesman said: "The Government has made clear it wants to do its best for depositors and taxpayers. All options are on the table. To rule anything out at this stage is irresponsible."

Legislation could be steamrollered through Parliament in a few days - but such speed is usually only possible where there is all-party support.

Labour has an overall majority in the Commons but would be vulnerable to an ambush in the Lords where the crossbenches contain many former City grandees.

Mr Darling told a committee of MPs last week that nationalisation was his last resort. The Treasury will decide this week whether to pursue a possible new finance deal drawn up by investment bank Goldman Sachs.

NO EASY SOLUTION BUT PLENTY OF RISK

NATIONALISATION - the compulsory sale to the Government of the bank's shares - would require primary legislation and would hold ministers directly responsible for the company.

The biggest headache might be lawsuits from shareholders, but the Treasury believes investors would have no case because owning shares is always risky.

ADMINISTRATION is an alternative that would see a quick "pre-packaged" sale of the business and assets with the proceeds going to meet the debt to the taxpayer.

But administration would mean a fire sale of assets and its mortgage book and heavy job losses in the North-East.