Ministers are preparing to pay substantial compensation to a senior military commander in the new Libyan government who was abducted and sent to Libya at the request of Colonel Gaddafi eight years ago.
Abdelhakim Belhaj is suing both the security services and the British Government for complicity in his illegal rendition and alleged torture. He claims he was rendered from Bangkok to Libya by the CIA acting on information supplied by MI6 and was tortured while in prison in Libya.
The Commissioner for the British Indian Ocean Territory is also being sued for complicity in the alleged rendition. The law firm Leigh Day & Co said yesterday it had filed legal papers against the Commissioner after Mr Belhaj claimed he was rendered to Libya via Diego Garcia in 2004.
A letter from an MI6 officer, found in the aftermath of Gaddafi's overthrow, refers to Abdelhakim Belhaj's rendition to Libya. It congratulates the Libyans on the "safe arrival" of the "air cargo". Successive UK governments have denied complicity in rendition or torture. But, faced with the prospect of an embarrassing court case, MI6 and ministers are thought to have concluded that Mr Belhaj's legal action should be settled.
It is believed to be one of the cases that led the Justice Secretary Ken Clarke to propose new rules allowing some civil cases which involve evidence from the security services to be heard in secret. However the plans, which have provoked strong criticism, would be unlikely to be in force in time to affect the case.
Yesterday the BBC claimed Mr Belhaj's original rendition was given ministerial approval. The Metropolitan Police is investigating the allegations.
Sir Malcolm Rifkind, chairman of the Intelligence and Security Committee, described the case as "very worrying" and said his committee would be investigating once police inquiries were complete. "I think one's entitled to be extremely uneasy because, if he was rendered to Libya and if the UK intelligence agencies and the UK Government were involved, that is not only contrary to the policy the British Government has pursued for a long number of years, but also to the assurances that were given to the Intelligence and Security Committee and to Parliament as a whole," he said.
Jack Straw was the Labour Foreign Secretary in 2004 when the rendition took place but, in an interview last year, he said: "We were opposed to unlawful rendition. We were opposed to any use of torture. Not only did we not agree with it; we were not complicit in it and nor did we turn a blind eye to it."
Mr Belhaj was one of the leaders of the forces that helped overthrow Muammar Gaddafi. But in 2004, he says, MI6 had discovered that he was in Malaysia and about to head for London in the hope of obtaining political asylum. MI6 informed its foreign intelligence partners, and as a result Mr Belhaj was intercepted in Bangkok and rendered to Libya.
A letter from the senior MI6 officer, Sir Mark Allen, to Gaddafi's intelligence chief, Moussa Koussa, was found last year in the rubble of Koussa's headquarters, which were bombed by Nato. As well as congratulating the Libyans on the arrival of the "cargo", it points out "the intelligence was British".
Mr Belhaj claims that, during four years in prison, he was interrogated by agents from countries including the UK and US.
In 2010, David Cameron established a Detainee Inquiry into "whether Britain was implicated in the improper treatment of detainees, held by other countries, that may have occurred in the aftermath of 9/11".
However, the inquiry was put on hold in January 2012 after the Metropolitan Police announced it was investigating Mr Belhaj's claims.