Britain’s most lucrative train franchise is on the brink of failure, leaving the Government facing a £1 billion hole in its rail budget.

National Express is in talks with the Department for Transport about the future of its East Coast line operation, which has been hit hard by the recession and is incurring heavy losses.

The company is contracted to pay the Government £1.4 billion over seven years for the franchise. But now it hopes to persuade the department not only to let it off the rest of the charge, but also to pay the company to carry on running the trains.

The Government wants to avoid the impression that it is bailing out a private company and fears that, if it agrees to the deal, other train companies would also demand new terms. Stagecoach is in dispute with the DfT about how much it is due to pay next year for the South West Trains franchise. Arriva is also facing heavy losses on its CrossCountry line. Both insist that they will honour their financial commitments to the ministry, but they may take a different view if National Express secures a favourable deal.

A ministry source dismissed reports that a deal with National Express had been approved in principle, saying the company could be stripped of its two profitable rail franchises — East Anglia and c2c — if it defaulted on its East Coast payments.

“There is a cross-default clause in the contract which we could invoke if they stopped paying. They could not only lose all their franchises but would leave a bad impression which might affect future franchise competitions,” the source said.

However, ministers may decide that accepting the terms proposed by National Express would cost the taxpayer less in the long run than allowing the franchise to collapse and seeking another company to run it. Either way, the Government will have to revise sharply downwards its projections for income from franchises over the next six years. It will either have to cut investment in the rail network — possibly by cancelling expansion and electrification of key lines — or increase the subsidy.

Ministers are considering abandoning the plan announced in 2007 to make passengers pay a much higher proportion of the costs of the railway. The Government said then that the contribution made by passengers would rise from 50 per cent of total costs in 2007 to 75 per cent by 2014.

Norman Baker, the Liberal Democrat transport spokesman, said: “If the Government bails out National Express it will give the green light to every other train company to go to the DfT with a bowl asking for more money. What is the point in having a system that claims to hand risk to the private sector but the minute companies get into trouble they are rescued with taxpayers’ money?”

Richard Bowker, the chief executive of National Express, told The Times: “We are having discussions with the DfT which include the impact of the recession on the East Coast franchise. Today we are meeting all our obligations for that franchise.”

Asked if National Express would still be meeting them tomorrow, he said: “I am not going to get into what I am sure would be a very interesting discussion.” He implied that National Express should not be expected to pay the price for failing to predict the recession. “I don’t think anybody in May or June 2007 [when National Express agreed the East Coast contract] saw the depth or ferocity or pace of this recession coming.”

National Express reported yesterday that underlying revenue growth at East Coast had fallen to 0.3 per cent in the first three months of this year. It refuses to discuss passenger numbers. The company had based its franchise bid on the assumption that revenue would grow by 10 per cent every year until 2015.

Douglas McNeill, transport analyst at Blue Oar Securities, said: “The DfT has to weigh up the choice between principle and hard cash. If they hold National Express to their franchise terms, the risk is that the company may decide to hand back the franchise and the retendering would be done on much less generous terms for the taxpayer.”

National Express, which also runs buses and coaches, employs 43,000 people worldwide, 16,000 of them in Britain. It made 750 people redundant recently.

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