A group of Chinese political activists filed a lawsuit in federal court against Yahoo on Tuesday, saying the company failed to properly oversee a $17m (£13.6m) fund it created a decade ago to help Chinese writers, democracy advocates and human rights lawyers persecuted for standing up to the country’s government.

The lawsuit, filed in US District Court in Washington, accuses Yahoo senior executives of turning a blind eye as the fund’s manager, Harry Wu, illegally spent millions of dollars on high-end real estate, inflated staff salaries and a museum documenting the history of forced labour camps in China.

According to the lawsuit, Mr Wu, a veteran Chinese dissident who died in April 2016, spent less than 4 per cent of the money on humanitarian aid.

The lawsuit demands that Yahoo replenish the trust, which has been significantly depleted.

Suzanne Philion, a spokeswoman for Yahoo, declined to comment, saying the company does not discuss litigation.

The legal action arrives at an awkward time for Yahoo, which is in the final stages of merger negotiations with Verizon Communications. The discussions have been buffeted by revelations that Yahoo delayed disclosures of huge hacking intrusions that compromised its computer network.

The lawsuit is also a reminder of one of the more ignominious episodes in Yahoo’s history. In 2007, the company, based in Silicon Valley, belatedly acknowledged that it had provided Chinese authorities with the identities of subscribers in China whose emails had angered the government. The disclosures led to the jailing of two activists who were given 10-year prison sentences.

In a public rebuke, a congressional panel criticised Yahoo’s chief executive at the time, Jerry Yang, and accused him of lying about the company’s cooperation with Chinese security officials.

“While technologically and financially you are giants, morally you are pygmies,” Democratic member of the House of Representatives, Tom Lantos, said during a televised hearing in 2007.

To settle litigation against the company, Mr Yang subsequently gave $3.2m to relatives of each of the two jailed dissidents. And in an unusual move, the company provided more than $17m for the creation of a humanitarian fund dedicated to helping Chinese activists and their families.

To administer the money, Yahoo turned to Mr Wu, a politically connected rights advocate who had spent 19 years in Chinese labour camps before gaining US asylum.

An irascible, strong-willed figure, Mr Wu ended up spending much of that money on his organisation, the Laogai Research Foundation, which had worked to expose China’s exploitative use of prison labour, especially involving people jailed for political crimes.

The expenditures included a $2.5m town house in the Dupont Circle neighbourhood of Washington, a $60,000 raise for Mr Wu and what the lawsuit contends was a no-show job for his wife. Mr Wu, the documents show, also spent $800,000 from the fund to defend himself against a number of lawsuits accusing him of sexual harassment or the misuse of federal grants.

According to the foundation’s filings, only $700,000 was distributed to Chinese dissidents or their families, many of whom were forced into poverty by the government in its effort to dissuade others from publicly criticising the ruling Communist Party.

Of the original $17.3m, less than $3m is thought to remain.

Mr Wu died last year at 79 while on vacation in Honduras. In an interview with The New York Times shortly before his death, he defended his decision to pull back from the fund’s original mission, saying that the intended recipients were too demanding and could not be trusted.

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The museum he created in Dupont Circle was closed shortly after his death, and several people involved with his organisation, the Laogai Research Foundation, said it had been crippled by internecine fighting and litigation.

In a statement issued Tuesday, the board said it hoped to reopen the museum and resume operations in the near future.

“The LRF is currently going through a process of house-cleaning, including a thorough independent audit, making a complete inventory, resolving all the past problems, including the problems left behind as a result of former employees’ non-cooperation,” the statement said.

The lawsuit was filed on behalf of eight dissidents in China who said that the Yahoo executives who sat on the board of the humanitarian fund did not do enough to rein in Mr Wu’s inappropriate and profligate spending. The suit was filed by Cohen Milstein Sellers & Toll, a Washington firm that specialises in litigating allegations of human rights abuse.