Kaupthing is suing the Government over its handling of the stricken Icelandic bank's UK subsidiary in a legal action bankrolled by the Icelandic Government.

Lawyers for Kaupthing, formerly Iceland's largest bank, will file a lawsuit at the High Court in London today attacking the way in which Britain forced Kaupthing Singer & Friedlander into administration on October 8 last year. The lawsuit, which has the “full support” of the Icelandic authorities, including financial backing, comes after weeks of threats from Reykjavik.

Iceland took control of Kaupthing on October 9, the day after Kaupthing Singer & Friedlander was put into administration, and Reykjavik blames Britain for the collapse of the group. The action, prepared by Weil, Gotshal & Manges, an American law firm, will take the form of a judicial review, which allows individuals or businesses to challenge government decisions. Northern Rock shareholders are using the same process to question the Government over its nationalisation of the mortgage lender.

Kaupthing's case is expected to focus on whether the Government's actions over Kaupthing Singer & Friedlander were allowed under the Banking (Special Provisions) Act 2008, the emergency legislation that was passed after the failure of Northern Rock. If the High Court finds that the Government acted unlawfully over Kaupthing Singer & Friedlander, it could set the stage for a separate multibillion-pound compensation case from Kaupthing.

The Government, which acted on the recommendation of the Financial Services Authority, said that the move was necessary to protect British depositors and was within its powers.

The Icelandic Government had previously hired lawyers to investigate bringing its own lawsuit directly against the UK. Yesterday, however, Geir Haarde, the Prime Minister, said that it had a better chance of success if it backed Kaupthing's case.

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