Lloyds Banking Group has pulled out of a large group of investors suing its fellow state-owned bank, the Royal Bank of Scotland, following what City sources allege is "pressure" from George Osborne's Treasury.

Lloyds withdrew its £420m claim from the RBoS Shareholders’ Action Group (RBSAG) - which is taking legal action against Royal Bank of Scotland on behalf of more than 30,000 investors - on Thursday and has instead "warehoused" its claim with law firm, Mishcon de Reya. "This is seen as act of sabotage by Lloyds,” a source at the action group said.

The Treasury is alleged to have been concerned that a high-profile legal spat between two partly state-owned banks would be “embarrassing” and interfere with its plans to return the banks to private ownership. However a Treasury source denied any involvement in Lloyds's decision to pull out of the action group, and sources close to Lloyds said it quit the group because litigation is progressing slowly.

In May 2014, the Sunday Herald exclusively revealed that Lloyds was suing RBS for £420m as part of a wider “group litigation order” lawsuit over RBS's allegedly "misleading" 2008 right issue.

Nine Lloyds investment and insurance entities filed papers in the High Court to sue RBS – Scottish Widows, Scottish Widows Unit Fund, Pensions Management (SWF), Scottish Widows Unit Trust Managers, Clerical Medical Investments Group, Halifax Life, Clerical Medical Management Fund, HBOS Investment Fund Managers and St Andrews Life Assurance. At the time Lloyds said management of these insurance businesses had thought hard about “whether it was in the interests of policyholders to join the legal proceedings and decided that it was”.

The 34,000 claimants in the case, which include retail and institutional investors, allege that RBS, then led by Fred Goodwin, effectively duped them into investing £12 billion in RBS shares just weeks before the Gogarburn-based bank collapsed and needed a £45.5bn taxpayer bailout. Some 85 to 95 per cent of the money the claimants invested was lost.

The claimants allege RBS’s rights issue prospectus was "defective" and contained material mis-statements and omissions. Following eight case management conferences in front of high court judge Mr Justice Hildyard the trial, expected to be the largest civil lawsuit to be heard in the UK next year, will commence in December 2016.

The RBoS Shareholders’ Action Group accuses Lloyds of using "spurious reasons to quit" including claims that the action group lacked "after-the-event (ATE) insurance" and had insufficient funding. The Action Group denies this saying it paid a multi-million premium for ATE insurance last week and has £15.5m of funding in place.

Lloyds agreed to pay some £1.6m to participate in the action group, including a £600,000 upfront fee and its share of litigation funding. But according to the action group the bank has so far paid only £600,000. An action group source said: “Lloyds is withdrawing under clause 12 [of their contract] which allows them to withdraw. If their intention is to genuinely discontinue their claim, we won’t mind as long as they honour their financial commitments to the group”, referring to the £1m sum outstanding. A Lloyds spokesman declined to comment on its financial arrangements with the action group.

“It’s always been a surprise that Lloyds, a part state-owned bank, should wish to be involved in an action group against another majority state-owned bank, and so their wish now to go their own way and to terminate their contract with the action group is not entirely unexpected,” said an action group spokesman.

"This changes nothing in relation to this group's determination to obtain justice for our members, and we are delighted with the progress we are making following the appointment of [the London-based law firm] Signature Litigation."

The RBoS Shareholders' Action group, the largest of the investor groups suing RBS appointed Signature Litigation in August. Another group of investors including Aviva, Legal & General, Prudential/M&G, Standard Life, RSA and the Universities Superannuation Scheme are represented by US law firm Quinn Emanuel Urquhart & Sullivan, with another large group of institutional investors represented by Stewarts Law. Herbert Smith Freehills continues to defend RBS.

The claimants made headway in March, when Mr Justice Hildyard ordered RBS to hand over emails that were first requested in December. These include seven million documents including emails sent and received by Goodwin, RBS’s former head of investment banking, Johnny Cameron, its former finance director Guy Whittaker, and its former chairman Sir Tom McKillop – who are named as defendants alongside the bank in the Action Group’s claim – as the crisis was brewing for RBS in late 2007 and early 2008.

Herbert Smith Freehills has since doubled its fees for defending RBS from an initial £42 million to more than £91 million.

Following a series of earlier share sales to City investors, the Treasury has cut its stake in Lloyds from 43 per cent in 2008 to less than 10 per cent today. The taxpayer’s stake in RBS remains at 73 per cent, after an initial batch of taxpayer-owned shares were sold at a loss in August. Chancellor George Osborne last month unveiled plans for a £2 billion “Tell Sid” style public offering in Lloyds shares.

A spokesperson for the Treasury said: “This is a commercial issue for the firms involved. HM Treasury is not, and has never been, involved in this matter.”

The Sunday Herald contacted Lloyds Banking Group for comment, but the only statement that was given came from a spokesman for Scottish Widows, which is owned by Lloyds. He said: "We have taken a decision that it is in the best interest of our policyholders if we pursue this action through another group, represented by Mishcon De Reya. At all times, our sole aim has been to ensure the best possible outcome for our policyholders."