The City of London's big banks are considering suing the European Union over rules to cap bonuses after receiving legal advice that the pay regulation could be struck down in court.
The drastic options being weighed up by bankers underline industry anxiety over a fixed ratio pegging bonuses to salary, which will be debated by EU finance ministers in Brussels on Tuesday.
George Osborne, the U.K. chancellor, is planning to fight a rearguard action to revise the terms of the cap but diplomats are doubtful Britain will secure major changes at such a late stage.
The stark odds against Mr Osborne are prompting banks to consider other radical steps, including suing. Legal advice for one bank, seen by the Financial Times, argues that the proposed ban on bonuses that exceed salary "contravenes European law" because of an EU treaty provision that prohibits regulating pay in member states.
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The opinion is one of several commissioned by banks that raise doubts over the legality of the pay clampdown. But it remains unclear whether banks would brave a high-profile court challenge given the potential public backlash.
The confidential advice from law firm Shearman & Sterling concludes: "We believe, on balance, that a mandatory provision fixing the maximum salary-bonus ratio payable in the banking sector not only contravenes European law because the EU lacks the requisite competence to legislate on issues relating to pay, but may also violate the constitutions of certain member states, such as Austria, Germany and Poland."
No formal EU legal advice on the issue is public. But the European parliament and Brussels argue the objections of the banks are not relevant, as the bonus ratio does not regulate total pay and is justified as prudential financial measure, rather than as social policy.
"We are confident this proposal is absolutely legally sound," said the European Commission. "Excessive bonuses [at banks] led to excessive risk and taxpayers having to step in. That explains why prudential regulation is needed."
(Read More: Five Essential Questions on the Bonus Cap)
Mr Osborne has previously sanctioned UK legal action to prevent the EU from overreaching its powers in imposing EU-wide bans on the short-selling of financial products. While the chancellor believes the bonus curbs will backfire, there are no signs he has the appetite for a legal fight to protect banker pay.
British officials are also playing down the prospects of Mr Osborne invoking the rarely used "Luxembourg compromise" – a 1966 gentleman's agreement not to override states on vital national interests. One diplomat urged the British against putting too much faith in "General de Gaulle's jurisprudence".
Mr Osborne is instead seeking to stretch out negotiations and chip away at the details of the bonus cap, especially with regard to how the rules apply to non-EU banks and to bankers working for European banks outside the EU.
(Read More: Boris Johnson: Bank Bonus Caps 'Deluded Measure')
However, it is unclear whether there is sufficient support among finance ministers to reopen the topic with parliament, which strongly resisted such an exemption even in the knowledge that Paris supported it.
Ashley Fox, a British Conservative MEP, raised questions over the bonus cap's legal base and said he was given "woefully inadequate" answers. He added the "shoddy attempt to score political points with the City is likely to be rejected by the European Court of Justice, at great cost to the taxpayer".
Stephen Mavroghenis, the partner at Sherman who wrote the opinion, argues that Article 153(5) of the EU treaties "expressly precludes the EU from regulating pay in the member states", irrespective of the policy area.