MI6 rocks Lyell's hopes: Scott inquiry told in camera that Attorney General was warned against Matrix Churchill trial

MI6 OFFICERS warned the Attorney General's office to call off the prosecution of three Matrix Churchill executives for breaching arms embargoes to Iraq because they were working for the intelligence services.

The disclosure threatens to wreck the chances of the Attorney General, Sir Nicholas Lyell, rescuing his career when he gives evidence to the Scott inquiry next week. It will also come as a severe blow to John Major's attempts to revive Tory party morale.

Sir Nicholas, 55, is battling for his political life. He promised a fight- back after being savaged at the inquiry into the export of arms-related equipment to Iraq by Michael Heseltine, President of the Board of Trade, but the new disclosures make his position more difficult.

The Independent has learnt that MI6 officers have told the Scott inquiry in camera about their warnings. That evidence has yet to be published, but it was corroborated by a senior Whitehall source who said MI6 expected the Attorney General's office to tell Customs and Excise to halt the prosecution before it got to court.

'The Attorney General's office was told by MI6 that the case would compromise their contacts. They thought the Attorney General's office would warn Customs that if they did not drop it, it would collapse in court, which is what happened,' said the source.

The Attorney General's office said last night: 'He will answer all the questions that Lord Justice Scott puts to him. One would not comment on a matter relating to the intelligence service but that is not intended to indicate that there is anything there. It is speculative.'

Lord Justice Scott is expected to question Sir Nicholas closely about his responsibility to oversee Customs prosecutions. He is known to be planning to argue that he should not have stepped in and halted the trial because governments should not be seen to interfere with prosecutions brought by a supposedly independent Customs and Excise.

The Attorney General issued a statement defending his role after the damaging evidence to the inquiry by Mr Heseltine, one of the ministers who reluctantly signed a public interest immunity (PII) certificate, after advice by Sir Nicholas.

The PIIs challenged the disclosure to the court of secret ministerial papers, which revealed an alleged ministerial cover-up over a change in the export rules, and the fact that MI6 was using Matrix Churchill executives to gather vital information on Saddam Hussein's capability in the Gulf war. Defence ministers shared MI6's anger at the decision by Customs and Excise to go ahead with a case which risked sending innocent men to prison.

Malcolm Rifkind, the Secretary of State for Defence, who has become embroiled in the case after signing a PII certificate, is also said to be deeply unhappy about the way the warning by MI6 appeared to be ignored by the Attorney General's office.

Lord Justice Scott, who is due to report on his inquiry in the late summer, is expected to criticise the system which led to the directors of the machine tool company being prosecuted for breaching the arms embargo during the Gulf war.

The Matrix Churchill men supplied the Iraqis with weapons-making equipment while MI6 and ministers knew that they were, at the same time, supplying Britain with secrets. 'They were holding board meetings in Baghdad. It was very risky for them to be exposed in this way,' said one source.

The inquiry looks likely to damage the Prime Minister as he attempts to lift the Conservative Party's morale after the expected wave of Tory defeats in May's local elections, the European elections in June, and a string of by-elections.

Cabinet ministers believe the report is almost certain to lead to resignations from the Government, unless those under threat have been dismissed by Mr Major in a July reshuffle. Kenneth Clarke, the Chancellor, has given a commitment to resign if criticised in the report, but he is not expected to be at risk. William Waldegrave said he would consider his position if he is criticised. Ministerial colleagues think Sir Nicholas will be forced out before the end of the year.