In the company’s most recent annual report, auditors warned there was “material uncertainty” about its ability to survive without support promised by the UK Government.
The legal quandary has gummed up efforts to support Harland & Wolff and thrown the company’s future into doubt – as well as its ability to deliver a £1.6bn supply ships contract for the Royal Navy.
It has also caused a rift within the Government, with officials in the Treasury under Chancellor Jeremy Hunt understood to be holding the line in the face of pressure from the defence, business and Northern Ireland departments, led respectively by Grant Shapps, Kemi Badenoch and Chris Heaton-Harris.
One government defence source said there were “differing opinions” on the legal risk and that lawyers were “working on that at the moment”.
Mr Shapps, the Defence Secretary, and his officials argue that building the three Royal Navy supply ships on time and on UK soil is a national imperative.
There are also concerns about the political implications of leaving Harland & Wolff to its fate in Northern Ireland, where the devolved government was only recently restored following two years of fraught negotiations.
However, Treasury officials are said to be convinced that approving a support package for the company in its current form would leave the Government open to legal challenge.
Under the proposed support package announced in December, the Government will guarantee £200m of private loans to Harland & Wolff under the export finance loans regime.
Unusually however, ministers have proposed to underwrite 100pc of the company’s borrowings rather than the usual 80pc, meaning taxpayers would be on the hook for the entire sum if the loan turns sour.
In a letter to UK Export Finance, ISSG warned that providing the loan guarantee to Harland & Wolff would flout subsidy control laws and competition rules. The letter was also sent to members of the government including Ms Badenoch, the Business Secretary.
Stuart Reid, chief executive of ISSG, wrote: “The prospect of such subsidy gives rise to serious concerns for ISSG, as a ferry provider which offers an essential service in a remote part of the UK, but also more generally as a matter of subsidy control law.
“We respectfully remind the Government that in granting a subsidy, it would be necessary to demonstrate that the proposed subsidy is an appropriate and necessary form of state intervention to address an identified market failure or equity rationale.”
On Friday, Harland & Wolff insisted that the ferry venture was separate to the rest of its business and would not benefit from any state support.
A spokesman said: “These issues have not been identified to us as a barrier to securing the [loan] guarantee.
“Harland & Wolff’s Scilly assets are being financed through a separate arrangement with a different bank and are happening independently of the [government]-backed loan.”
The legal issue has reared its head after ISSG chose a French company, Piriou, to build two new ferry vessels, rejecting a bid by Harland & Wolff.
Just weeks before that decision was formally announced, Harland & Wolff announced plans to launch its own rival ferry service in the Scilly isles.
It then made a takeover bid for ISSG two months later, which was rejected.
ISSG has previously said that choosing Harland & Wolff for the ferry contract would have been “too much of a risk” due to the company’s financial situation and its lack of recent experience building ships.
Harland & Wolff, which was bought out of administration by its present owners for £6m in 2019, has been attempting to mount a turnaround after struggling for some time.
It has partnered with Spanish state-owned shipbuilder Navantia to deliver a £1.6bn contract to build three fleet solid support (FSS) warships for the Royal Navy.
But the company’s collapse would be an embarrassment for the Government and put hundreds of jobs at risk, after Mr Shapps this week claimed the UK had just entered a “golden age of shipbuilding”.
An ISSG spokesman said “The UK has strict laws around subsidy control and state aid. We would fully expect the Government to enforce these rules.”.
A government spokesman said: “No decision has been made and nothing is off the table – we are exploring all options to support Harland & Wolff”.