The flamboyant businessman was arrested on a European warrant. Sources close to Mr Brown said it arose after a financial dispute over an investment made by the former Manchester United chairman Martin Edwards.

Police went to the political benefactor’s Majorcan villa hours before he was due to throw a spectacular 40th birthday party. After he is extradited Mr Brown will be questioned over alleged dishonesty, forgery, perjury, perverting the course of justice, false accounting and obtaining a passport by deception.

The Lib Dems, already risking bankruptcy if the donation is ruled ineligible by the Electoral Commission, sought to distance themselves yesterday from the latest events. Sir Menzies Campbell, the party leader, had publicly defended Mr Brown last autumn.

In a villa sheltered by the Sierra de Tramuntana mountains in Majorca, Mr Brown spent last Wednesday lunchtime putting the finishing touches to his birthday celebrations and preparing for an afternoon in the office. A joint team of Spanish National Police and Civil Guards crept past his convertible Jaguar, Porsche Cayenne and swimming pool at 12.30pm. Mr Brown was flown to Madrid where, at a closed hearing yesterday before an investigating magistrate in the Audiencia Nacional, the highest criminal court, he agreed to be extradited. He was led to the cells and should be returned to Britain within ten days.

Criminal proceedings were launched against Mr Brown in London by his bank. HSBC had previously brought a civil action against 5th Avenue Partners, which is a London investment vehicle owned by Mr Brown.

The criminal matters involve allegations that large amounts of falsified paperwork were submitted in the civil case.

Friends of Mr Brown say that the dispute with HSBC began last year when a consortium of investors, including Mr Edwards, asked one of Mr Brown’s companies to invest money in stock market bonds. The Times was unable to contact Mr Edwards yesterday.

HSBC took action against Mr Brown after concerns over their investment, friends claim. Mr Brown was voluntarily interviewed by police over the matter last October.

A spokesman for Mr Brown said: “Michael Brown has banked with HSBC for a number of years. In his financial affairs it is quite usual and proper to be subject to scrutiny and internal review from time to time. All matters are expected to be satisfactorily resolved. Settlement discussions are expected to be successful. He is eager to return to the UK as soon as possible.”

Mr Brown was ineligible to make an individual donation to the Liberal Democrats because his name did not appear on the electoral roll in Britain. The record gifts were paid last year through 5th Avenue Partners. The Electoral Commission is investigating whether this entity was genuinely “carrying on business” in Britain. If not, the gift will have to be surrendered, risking financial ruin for the Lib Dems.

Sir Menzies said last year that he would take more money from Mr Brown and that there were no plans to give back the previous donation. The money had already been spent on newspaper and poster advertising and helped the Lib Dems to win their biggest tally of seats in the Commons.

The Lib Dems issued a statement yesterday saying: “We are not aware that this has any connection with the Liberal Democrats. Any further action is a matter for the police and for the relevant authorities.”

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