SRM Global, the hedge fund that is the largest investor in Northern Rock, joined an army of the nationalised bank's small shareholders yesterday in pressing ahead with their legal action against the Government for compensation.

SRM and the UK Shareholders Association have filed an application for a judicial review of the terms offered to shareholders by the Government after it took the Rock into public ownership in February.

After months of preparation, aggrieved Rock investors are preparing to use European human rights legislation and an array of case law to argue that the nationalisation of the bank was illegal and effectively amounted to “misappropriation” or state theft of privately owned assets.

The Government is expected to respond within the next two months. If it rejects the review, all parties will head for the courts.

“You don't go into litigation lightly and you don't sue the Government lightly,” one shareholder said yesterday.

The shareholders have argued that the terms of the Government's compensation plan for Rock investors are “factually and intellectually dishonest”.

The Government presumed the Rock was unable to continue as a going concern and was in administration, they argue. The shareholders say that the bank was solvent, citing the Rock's ability to draw on emergency funding from the Bank of England.

RAB Capital, another hedge fund that is the second-largest Rock holder, has hired lawyers at Nabarro. Legal & General Investment Management, an institutional owner, has declared itself an interested party, which means it may join the case at a later stage.

The Treasury is being advised by Slaughter and May, the City solicitors, and Lord Grabiner QC. The Treasury, charged with protecting taxpayer interests, has consistently argued that nationalising the Rock was its only available alternative and the best way to recoup loans extended by the Bank.

SRM is taking advice from White & Case, the Anglo-US legal giant.

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