Darling set to compensate Rock investors

Treasury ready to offer compensation if bank is nationalised; Fears of costly litigation threat
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The Government accepts that it will almost certainly have to compensate Northern Rock shareholders to minimise the threat of messy litigation if it nationalises the bank.

The Chancellor, Alistair Darling, reiterated yesterday that his priorities in settling the crisis were the taxpayer, consumers and financial stability. But with 180,000 angry small shareholders in danger of losing money and aggressive hedge funds threatening to sue, the Government is understood to be ready to offer some compensation to investors.

Ministers are desperate to head off a legal battle with SRM Global and RAB Capital, Northern Rock's two biggest shareholders, which have both said they will not accept nationalisation. They told Northern Rock's extraordinary shareholder meeting on Tuesday that their legal advisers said the Government would break European Union human rights law if it took control of the bank for less than its true worth.

The funds, which have built up a combined 18 per cent stake in the bank, argue that it is worth about £4 a share. Northern Rock's shares closed at a new low of 68p yesterday but that still valued the bank at about £286m. The Government would want to minimise the payout.

One option for the Government would be to have compensation decided by an independent arbitrator whose decision would be legally binding. Accountancy firms regularly act as arbitrators in disputes between shareholders but the method is not thought to have been used for a nationalisation before.

Nick Wood, a corporate recovery partner at accountants Grant Thornton, said valuing the bank would be very difficult but the use of an arbitrator could work in the Government's favour. "I can't see that it is worth anything because if the Government takes away the support it is bust. The Government could say let's do it that way and the independent valuation would come in at next to nothing and the Government would say, 'That's what you are going to get.'"

Mr Wood said it would be impossible for the Government to separate small, long-term shareholders from hedge funds that took speculative stakes after the bank's shares slumped in September when Bank of England support was announced.

The Treasury declined to discuss compensation for shareholders but has always said that all options remain open in seeking a resolution of the Northern Rock affair.

The bank's chairman, Bryan Sanderson, said on Tuesday that he expected to propose a private sector solution to the Treasury and the other authorities by the middle of February, taking the bank right up to the Government's 12 February deadline. The bank has been in talks with Sir Richard Branson's Virgin Group and Olivant, an investment firm, since October.

The bank and its advisers have been waiting to hear the contents of a Goldman Sachs review of funding options ordered by the Government. It is now said that there will be no set date for the report to be handed over and that Goldman will give continuing updates to the Government, which will inform other parties regularly.

The Chancellor and Gordon Brown are increasingly prepared to discuss nationalisation publicly but still hope to avoid the measure and secure some kind of private-sector deal. The Government is growing impatient with the drawn-out sale process for Northern Rock and is ready to step in to impose its own solution – including nationalisation – if all other options are exhausted.