Richard Branson’s U.K. rail business faces a fresh threat as the government considers taking over the West Coast route a week after halting its transfer to FirstGroup Plc following the discovery of flaws in the bidding process.

Allowing Branson to keep the route pending a new contest once the current contract expires on Dec. 9 could be legally problematic, Transport Minister Norman Baker said. The other option would be to assign the line to Directly Operated Railways Ltd., set up by the government in 2009 to run failed franchises.

“Both are still being evaluated,” Baker said in an interview in London. “The issue is that the franchise will have expired. Can Virgin continue under the present arrangement, or should the state come in with the existing operation that runs the East Coast mainline and deal with the West Coast as well?”

Transport Secretary Patrick McLoughlin will make his plans known to Parliament on Oct. 15. Plumping for the nationalization option would “kill Virgin Rail off” because the company has no other franchises and could not keep the current management team in place for the two years it might take to rerun the West Coast selection process, spokesman Arthur Leathley said.

“Directly Operated Railways would in some ways be the worst option of all,” he said. “A move to FirstGroup wasn’t popular with staff, but they’re a strong company and the contract would have run for 13 years. DOR is a dead-end solution, with nothing happening and no investment, as with the East Coast.”

Primary Route

Aberdeen, Scotland-based FirstGroup, which was awarded the West Coast franchise on Aug. 15 after a 5.5 billion-pound ($8.8 billion) bid, before being stripped of the contract on Oct. 3, declined to say if it would sue the Department for Transport in the event of Virgin being allowed to keep the operation.

The West Coast is Britain’s busiest inter-city route, carrying 31 million people a year between London and Glasgow in Scotland via a network that includes Birmingham, Liverpool and Manchester. Virgin, which has run the line since privatization, reckons the 150 or so contracts required to operate the business couldn’t in any case be properly negotiated in the period left.

“The reason they give you four months to hand over the franchise is because it takes four months to get these things done,” Leathley said. “DOR would come in absolutely cold and even if they could arrange the contracts they’d pay top dollar.”

Not-for-Profit

Baker, a Liberal Democrat who was the only transport minister to survive a government reshuffle last month, said DOR has demonstrated its competence on the London-Edinburgh East Coast line, where performance has shown a marked improvement.

“We are pretty confident, if we decide to take that route, that there would be no problem with them operating it,” he said on the sidelines of the Travel 2020 transport conference.

Branson would be willing to run the West Coast network on a not-for-profit basis, with proceeds going to good causes until the re-tendering took place, Leathley said. Other options might include payment via a flat fee or as a percentage of revenue.

Stagecoach Group Plc, Branson’s minority partner in Virgin Trains with a 49 percent stake, has “not yet specified” what terms it would find acceptable, though the Perth, Scotland-based company invests a proportion of its earnings in community projects “as matter of course,” spokesman Steven Stewart said.

Preparing for Handover

DOR is going ahead with preparations to take over the West Coast in the event that the Department for Transport asks it to do so, spokesman Paul Emberley said. The East Coast route, while “consistently at the bottom” of on-time performance tables in 2011-2012, has shown signs of improvement, the company said in its annual report last month.

FirstGroup Chief Executive Officer Tim O’Toole is reserving judgment on whether to seek redress for losses incurred after being stripped of the West Coast until an official inquiry discloses findings at the end of the month, according to the company, which has seen 265 million pounds wiped from its market value since the contract decision.

“We are exploring all of our rights and options at this point,” FirstGroup said in an e-mailed response to questions. “We have not yet had the full and detailed briefing from the DfT for us to understand exactly what happened.”

The DfT has said only that it will refund costs to the four West Coast contenders, which included French state railway SNCF and NV Nederlandse Spoorwegen of the Netherlands, as well as FirstGroup and Virgin, which spent 14 million pounds on its bid.

Three civil servants have been suspended pending the investigation into the West Coast award and another into the wider franchising process that’s due to report in mid-December.

A new West Coast franchise is unlikely to start until March 2014, Peter Hyde, an analyst at Liberum Capital in London, said this week in a note to investors. Bidding for the Great Western, Essex Thameside and Thameslink franchises, which were slated for renewal in 2013 and have also been suspended, will most probably be delayed for six months, he said.

With assistance from Thomas Penny in London. Editors: Chad Thomas, Heather Harris. To contact the reporters on this story: Tom Metcalf in London at tmetcalf7@bloomberg.net; Chris Jasper in London at cjasper@bloomberg.net. To contact the editor responsible for this story: Chad Thomas at cthomas16@bloomberg.net.