ONE of Scotland's best known law firms is being sued for £28 million in connection with alleged fraud at a failed hedge fund, it has emerged.

Glasgow-based Levy & McRae is being pursued by the liquidator of Heather Capital, a £400m hedge fund set up by Scots entrepreneur Gregory King, which collapsed in 2010.

At a preliminary procedural hearing at the Court of Session before Lord Woolman, Richard Keen QC, acting for liquidator Paul Duffy, said the action proceeded on the basis of "breach of fiduciary duty and dishonest assistance" and alleged there had been "a fraud" on Heather.

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Mr Keen said the dishonest assistance element involved diversion of funds from Heather Capital "to the accounts of one Gregory King" allegedly with the assistance of Levy & McRae "and in particular its partner Peter Watson".

Mr Keen said two tranches of money - of £19m and then more than £9m - had been diverted from the hedge fund in early 2007.

He said there had also been a later diversion of £200,000 "to the personal account" of Mr Watson, then senior partner at Levy & McRae.

Mr Keen said the liquidator was told by Levy & McRae it held two files on Heather, but was refusing to release a third file on Mr King.

"We are anxious to recover the King file," Mr Keen said.

For the defenders, Alistair Clark QC said the allegations made by the liquidator against Levy & McRae and its partners were "extremely grave".

However the defenders' position was that they were "without foundation", he said.

He said he would be seeking evidence from the liquidator to justify the "very serious" claims.

He also said three individuals being sued joined Levy & McRae after the alleged incidents.

Mr Clark also said it was disputed that Heather was a Levy & McRae client before 2007, yet this claim underpinned the liquidator's whole case.

In response, Mr Keen said that Levy & McRae had previously accepted Heather was a client, but later said that was "a mistake" in a letter.

Mr Keen also said dishonest assistance did not rely on a client relationship, merely a breach of trust.

A further hearing is due in late April or May.

Mr King, who now lives in Spain, and three other men are the subject of a police report to the Procurator Fiscal for alleged embezzlement.

Mr Watson, 61, who left Levy & McRae last year to set up his own law firm, is not one of the four men in the police report.

Last month he was suspended from sitting as a sheriff in light of the Heather civil case.

Mr Watson said: "Proceedings are live which prevents fuller comment other than to say these proceedings are being robustly defended and any allegations of impropriety are denied."

Levy & McRae is one of several companies being sued by Heather's liquidator, Ernst & Young, as it seeks to recover money from the hedge fund.

Others include lawyers Burness Paull & Williamsons LLP and Knight Frank LLP.

Levy & McRae, which provides legal advice to the Herald & Times Group, publishers of The Herald, declined to comment.