MP whose death sparked poll was suing the MoD

Embarrassment for Brown as Glenrothes's late incumbent was denied compensation for the 'asbestos' cancer that killed him

The Labour MP whose death forced the latest by-election to threaten Gordon Brown's premiership was suing the Government over its refusal to pay compensation for the illness that killed him.

John MacDougall, the former MP for Glenrothes, launched a court action against the Ministry of Defence (MoD) last November after the Government turned down his request for a £300,000 payout. Mr MacDougall believed his lung cancer was contracted as a result of working at the Royal Naval dockyards in Rosyth in the 1960s and 1970s when he was exposed to asbestos.

The disclosure that Mr Brown's government blocked the payment will be acutely embarrassing for the Prime Minister, who paid tribute to Mr MacDougall at his funeral last week. Mr Brown described the illness as the "cruel legacy" of Mr MacDougall's exposure to asbestos in the dockyards during his youth.

Yesterday, the Scottish National Party (SNP) selected its candidate for the by-election at Glenrothes, bordering Mr Brown's own constituency. Labour, which has not yet chosen a candidate, described the SNP as "ghouls" and accused them of campaigning in the constituency before the terminally ill Mr MacDougall passed away earlier this month.

Mr Brown is expected to call the by-election in the second week of September, despite fears of another reverse at the hands of the SNP, to prevent defeat damaging his hopes of an autumn relaunch.

The by-election must be held within three months. It was originally expected that Labour, defending a fragile-looking 10,000 majority, would delay setting a date for the election for as long as possible in the hope of an improvement in the party's fortunes. But now it is expected that Labour will officially move for an early date, in a re-run of the decision to get the Glasgow East by-election out of the way before MPs started their summer holidays.

An opinion poll by ComRes for The Independent on Sunday showed Mr Brown's party failing to make significant inroads into the Tories' hefty lead. Labour has picked up one point since last month, but still trails the Tories by 21 per cent, with a general election less than two years away.

Mr Brown dismissed speculation that he would be deposed before the end of the year and insisted that he was still the man to rescue Britain from economic turmoil. During interviews yesterday on his trip to the Beijing Olympics, he proclaimed Britain's ability to withstand an economic downturn, and rejected claims that the Foreign Secretary, David Miliband, was preparing a bid to replace him. The PM, asked by Sky News if he was confident that he would still be in a job by Christmas, replied: "Of course."

John Park, a member of the Scottish Parliament and a long-term Brown ally, and Mark Hood, the local councillor, are believed to be in the running for the Glenrothes seat. But the IoS understands that John McTernan, a former aide to Tony Blair who is now working for the Secretary of State for Scotland, Des Browne, is also considering entering the race.

Mr McTernan would be a controversial candidate, as he ran Labour's unsuccessful Scottish parliamentary election campaign last year, and was quizzed by police over "cash-for-honours" allegations. He represents a significant strand of opinion within the Labour Party calling for a more aggressive "attack strategy" against the SNP, which has been in the ascendancy in Scotland since Alex Salmond became First Minister last summer.