The Government’s plans for investing in Britain’s railways are in disarray after the company operating the most profitable route surrendered the contract yesterday.

GNER had signed the contract only 18 months ago, under which it had agreed to pay the Government £1.3 billion over ten years to run trains between London and Edinburgh.

Ministers were relying on the money to prop up loss-making services elsewhere, and to pay for improvements, such as longer trains and platforms, on overcrowded routes.

The failure of the contract also raises doubts about the viability of other franchises, such as South West Trains and First Great Western, where the operators have each promised to pay more than £1 billion over the next decade.

Passenger Focus, the rail passenger watchdog, said that the Government was partly to blame because it had accepted an unrealistic bid from GNER — said to be £300 million higher than any other company was willing to pay.

Anthony Smith, the watchdog’s chief executive, said: “This shows that driving a very hard bargain with train companies may not always be in the best interests of passengers. It will do nothing to calm concerns about the premiums which have been promised by some of the other companies.”

Tom Winsor, the former Rail Regulator, said: “The failure of GNER’s contract has cost the taxpayer hundreds of millions of pounds. Competition for franchises has ecome so vigorous that companies are sometimes tempted to put in optimistic bids — and it can go wrong.”

GNER will continue to run trains on the route for up to 18 months while the Department for Transport seeks another operator. The company will be allowed to keep an undisclosed proportion of any cost savings it makes, and any revenue it receives above a certain target.

The company attributed the failure of the contract to the downturn in tourism after last year’s bombings in London, a rise in electricity prices and the emergence of a small rival company on the same route.

The transport department refused to say how much it expected to lose from the contract’s failure and would not reveal the details of its temporary agreement with GNER.

A senior rail industry source said that bidders would offer several hundred million pounds less than GNER agreed to pay last year. First Group, the biggest train company, said that it planned to submit a bid.

Gerry Doherty, general secretary of the TSSA, the white collar rail union, said that the failure of the contract showed the current rail franchising system was fundamentally flawed. “Instead of this lottery, this franchise should be handed over to Network Rail to run it for the benefit of the passenger.”

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