Prime suspect: First, Lord Levy. Now police are heading for the PM

Panic in Downing Street provokes extraordinary charm offensive to placate angry party lenders. By Marie Woolf and Francis Elliott

June 20 was not a day for politics. The sun was shining and England's footballers were preparing to take on Sweden in the World Cup.

Tony Blair's official spokesman briefing journalists on the Prime Minister's day did little to stir the midsummer torpor as he ran through a routine list of engagements. Mr Blair hoped to catch something of the match if his work commitments allowed, the spokesman said, exciting little interest among political reporters.

But a full list of the Prime Minister's meetings for 20 June would have had them scrambling to their phones and computers since it would have included news of an extraordinary and highly controversial encounter.

For that was the date on which Mr Blair secretly met Sir Gulam Noon, a possible key witness should the cash-for-honours investigation ever reach the courts. The arrest this week of Lord Levy makes such an outcome markedly more likely. None doubt now that the Metropolitan police investigation is serious.

Ever since it was revealed that Mr Blair planned to ennoble party donors the secretive worlds of political fundraising and the award of honours have been dragged bit by bit into the light.

The reputations of rich and powerful men have suffered in the process and it seems possible that some will wreak revenge on those they hold responsible.

Today we reveal how Mr Blair has sought to placate at least three millionaires who secretly lent large sums to Labour and were later nominated by him for peerages. But in meeting Sir Gulam he has opened himself to Opposition accusations that he is seeking to influence the outcome of the investigation.

The private audience Mr Blair gave to the curry magnate in Downing Street was an entirely cordial affair. It needed to be. Sir Gulam made little secret of his fury when it emerged that his peerage had been blocked because he had failed to declare his £250,000 loan to Labour.

"I am absolutely devastated," he told this newspaper in March. "I have done nothing wrong. I have done exactly what they asked me to do."

It emerged last week that that included removing references to the loan from his peerage nomination papers - at Michael Levy's suggestion. The Prime Minister's fundraiser "reminded" Sir Gulam, in a telephone conversation on 5 October, 2005, that the rules meant he did not need to mention the loan.

In previous conversations with the millionaire, the Prime Minister's envoy had also told him that loans did not need to be declared, under the rules.

This advice came only a day after Sir Gulam had, after consulting his accountant, submitted the forms to Richard Roscoe, the civil servant responsible for dealing with honours at Downing Street, including the £250,000 figure along with around £220,000 of direct donations he had made since 2000. New forms were swiftly filled out, this time making no mention of the loan. It was these forms that were submitted to the Appointments Commission, which was vetting the honours nominations, and these that led ultimately to Sir Gulam forfeiting the peerage Tony Blair believed he deserved.

The key question is how Lord Levy knew that Sir Gulam's nomination forms had initially included a reference to the loan? If the honours system and the funding of the Labour party were entirely separate, why was the Prime Minister's fundraiser involved in the filling out of nomination forms?

And who at Downing Street had told him that the loan had been included on the form?

It seems likely that Sir Gulam knows the answers to these questions. So perhaps it is not surprising that, according to a well-placed source, Downing Street has conveyed to the businessman that it remains "very keen" that he take his place on the Labour benches in the House of Lords. There has even been talk in Whitehall that his name could appear on Mr Blair's resignation honours list, which, because of ambiguity in the rules, may not have to be vetted by the Appointments Commission which blocked the names Mr Blair wanted.

Sir Gulam was not the only Labour donor angry at being dragged into the media firestorm - nor the only backer targeted in the No 10 charm operation.

Barry Townsley and Sir David Garrard also received a friendly handwritten note from the Prime Minister expressing his regret that they had not been given peerages. The millionaires, like Sir Gulam and the founder of the Priory clinic Chai Patel, had given substantial sums to Labour at the last general election.

All four have in recent weeks found themselves being interviewed, under caution, by senior Metropolitan police officers. Both Mr Townsley and Sir David provided full statements to the police, who did not take away or request any documents. But the interviews, in their lawyers' offices, are understood to have been formal affairs. With top lawyers present, both witnesses, frequently answered "no comment" to questions on their lawyers' advice because the interviews were conducted under caution.

The media attention had been so intense that both men have taken on Lord Bell - Baroness Thatcher's famous PR guru to represent them.

And although many would have understood if they had called in their loans to the Labour party, both Mr Townsley and Sir David have decided to extend the loans until next spring.

But last week, when asked if they would like to take part in an advertisement in The Times from donors supporting the Labour party, both declined.

Chai Patel, the founder of the Priory clinic, is also understood to have refused. Like the other donors he is thought to be bruised and somewhat baffled by his involvement in the cash for honours affair, not least because his motivation was not to gain a peerage but to help the party.

Like Sir Gulam, he was advised directly by Lord Levy not to mention the loan he had made to the Labour Party on his House of Lords nomination form. He too has remained loyal to the Labour Party and he has not called in the loan, which was due for repayment next month.

Grave though the party's financial position is (£27m in the red at the last count) few in Downing Street are worrying about Labour finances this weekend.

Mr Blair must have known that Lord Levy was due for questioning at Colindale police station, as he faced David Cameron at Prime Minister's Questions.

It would not have been until after he returned to his office, however, that he found that his old friend, confidant and fund-raiser extraordinaire had been arrested.

When news began to filter through to Downing Street of the arrest, all hell broke loose. "People have been running around - it's been pretty extraordinary," one No 10 official later told journalists at a drinks reception.

Some of those "running around" are themselves the subject of police inquiries, including some of the Prime Minister's inner circle.

Names in the frame include Jonathan Powell, Mr Blair's chief of staff, Ruth Turner, director of government relations, who is said to have had a role in arranging peerage applications. John McTernan, Mr Blair's director of political operations, is also reported to have obtained party signatures for the peerage applications.

But how much did Mr Blair know of what was being arranged in his name? When the story of the secret loans first broke in March a figure described as a "senior member of the Prime Minister's inner circle" gave an extraordinary insight into the scramble for cash ahead of the last election.

"Why did the party do it? Because the party was skint. We were going to get beaten up if the others were doing it.

"Blair knew exactly what was going on. As far as he was concerned, it was absolutely legal. It wasn't a matter of convincing him, because it was absolutely legal. It was a matter of everyone convincing each other."

The Independent on Sunday has established that the "senior Labour figure" was Lord Levy himself. There are a number of Mr Blair's circle that would privately rejoice if Michael Levy were to come to a sticky end as long as no blame were to attach to the Prime Minister. But his words suggest that should the bagman tell all he knows of his master's complicity, their fates will be linked.

It is a message Lord Levy is said to have made forcefully in a conversation with Labour's chairman, Hazel Blears, on Friday night, adding to the sense of panic among the party's high command.

A political reckoning may yet intervene before the nation is treated to the sight of a serving PM led away by police. MPs are this weekend assessing whether to launch a last-ditch effort to force Mr Blair out before the summer parliamentary recess.

"We know this coming week is basically our last opportunity to get rid of Blair for another six months or so. If he gets through this week, he'll get through party conference in the autumn," said one MP, loyal until now.

Some, desperate for Gordon Brown to seize his moment, are even talking about forcing his hand by collecting signatures to support the Chancellor's nomination for leader without his permission.

Labour backbenchers will meet tomorrow for a routine meeting in the Commons after a weekend spent assessing just how angry ordinary members and voters have become.

The cooler view is that Mr Blair remains safe until the party conference at least - unless anyone is charged. "A charge changes everything," said a senior backbencher. "That really would trigger an immediate defenestration."

Assistant Deputy Commissioner John Yates, the man in charge of the investigation, told MPs last week that his team had interviewed 48 people. With an eye to the politics of his task, the policeman let it be known that the total included more Conservative than Labour figures.

But he also made clear that at least three figures were so far declining to co-operate. It has been reported that among those refusing may be some of Labour's secret lenders.

But what of Mr Blair himself? When will he receive the knock at the door? It is hinted that the investigation will conclude in September, leading to speculation that Mr Blair - surely the police's last port of call - could be interviewed after he returns from his summer holiday.

The betting among MPs from both main parties is still against charges being laid. But as - Mr Blair's secret meeting with Sir Gulam suggests - Downing Street is preparing for the worst.

The Investigation: Law that could bring down PM

The Met investigation is looking at possible breaches of at least two laws.

The first, Honours (Prevention of Abuses) Act 1925, was last used to convict the honours broker John Maundy-Gregory, who sold peerages on behalf of David Lloyd George. Section 1 (1) states that:

"If any person accepts, obtains or agrees to accept or obtain from any person, for himself or for any other person, or for any purpose, any gift, money or valuable consideration as an inducement or reward for procuring or assisting or endeavouring to procure the grant of a dignity or title of honour to any person or otherwise in connection with such a grant, he shall be guilty of a misdemeanour."

The other key law is much more modern. It was Tony Blair who passed the Political Parties, Elections and Referendums Act 2000, which outlaws secret donations including "any money lent to the party otherwise than on commercial terms". Just what "commercial terms" means, however, is open to interpretation, leading many to conclude it will be difficult to secure convictions under this law.