Many angry victims of the News of the World's journalism used to try their hand at suing, and the paper's battle-hardened lawyers were good at seeing them off. Still they regularly paid out £1.2m a year on a variety of libel claims.

But in May 2008, Tom Crone, the paper's veteran head of legal, got a nasty shock. His opponents in one lawsuit against the paper suddenly appeared to have got hold of a smoking gun.

It was a piece of evidence that seemed to guarantee that the complainant in question, Gordon Taylor of the Professional Footballers' Association, could virtually write his own cheque in privacy damages and blow a major hole in the tabloid's budget.

Worse, much worse, was the fact that this single document, later christened the "For Neville" email, was capable of wrecking all the previous NoW efforts to cover up its hacking scandal. In the end, this piece of evidence would not only cost Crone his own job, but also help destroy the entire newspaper for which he worked, the flagship of Rupert Murdoch's British fleet.

News of the "For Neville" email originally arrived on Crone's desk at Wapping, in the form of an "amended particulars of claim" from Taylor's lawyers, dated 12 May 2008. It used dry legal language, but Crone immediately saw its force.

It detailed the contents of one of the documents seized in the raid on Glenn Mulcaire, the News of the World's private detective who had recently been jailed for phone hacking along with "rogue reporter" Clive Goodman. What it revealed was the way senior staff at the NoW had been involved in systematic hacking – the very thing the paper had been strenuously denying all along, not only to Taylor's lawyers, but to its readers, parliament and public. The legal pleadings said: "Prior to 29th June 2005, Mr Ross Hindley acquired a transcript of 15 messages from the claimant's mobile phone voicemail and a transcript of 17 messages left by the claimant on Ms Armstrong's [a business associate of Taylor] mobile phone voicemail. At all material times, Mr Hindley was a journalist employed by NGN working for the News of the World."

"By email dated 29th June 2005, Mr Ross Hindley emailed Mr Mulcaire a transcript of the aforesaid 15 messages from the claimant's mobile phone voicemail and 17 messages left by the claimant on Ms Armstrong's mobile phone voicemail. The transcript is titled 'Transcript for Neville' and the document attached to the email was called 'Transcript for Neville'. It is inferred from the references to Neville that the transcript was provided to, or was intended to be provided to, Neville Thurlbeck. Mr Thurlbeck was at all material times employed by NGN as the News of the World's chief reporter."

Taylor's lawyers had obtained a copy of the "For Neville" email, with its lists of carefully transcribed hacked private messages, from the police under a court order. It was one of the 11,000 files seized from Mulcaire that were mouldering in bin bags since Scotland Yard had been persuaded to drop their pursuit of a case so potentially embarrassing to their tabloid journalist friends. Crone must have been shocked to realise the incriminating nature of the information the Metropolitan police possessed which could be used in future against his own employers.

Faced with such a crisis, Crone decided he had to consult his new boss, who was to authorise a huge, secret payout which buried the "Neville" dossier. He went to see the abrasive and self-confident younger son of the proprietor, 36-year-old James Murdoch.

Rupert's offspring had arrived in December 2007 as chief executive of News International, the company that controls all four Murdoch UK papers, the NoW, the Sun, the Times and Sunday Times. He had not been around when the original hacking affair erupted the previous year with the jailing of two employees, and presumably knew little of its history. At this week's parliamentary hearing, his octogenarian father hastened to protect James when the subject came up, saying his son had only been in charge of the papers for "a very few weeks".

But the truth about who said what in the subsequent conversation with James now threatens to derail not just one paper, but the whole of Rupert Murdoch's dynastic ambitions.

Neither side disputes that James, without telling his father, agreed to hand over almost £1m of the company's money for a settlement that was to be kept totally confidential: £300,000 charged by their own outside lawyers, another £220,000 for the fees of Gordon Taylor's lawyers, and a monster payoff of £425,000 in personal damages to Taylor. This was a sum almost twice the £250,000 that, according to James, outside counsel had advised was the likely damages Taylor could get if he won at trial. On the face of it, the deal made little commercial sense.

James, previously regarded as the heir apparent, now stands accused of complicity in an attempted coverup of crimes within his company. If that turns out to be true, it will be fatal for James' ambition, and also open him to a raft of legal dangers, as lawsuits proliferate against the Murdoch empire.

For the contents of the "For Neville" email are so obviously toxic that James, a reluctant witness, last week emphatically testified to MPs on the culture, media and sport committee and that he was never told about its existence.

Crone, with all his authority as the tabloid group's most long-serving and senior consigliere, at once publicly contradicted him. Crucially, Crone has the support of the third man at the crucial meeting. This was Colin Myler, the then editor of the NoW, who issued a formal statement jointly with Crone on Thursday, backing the lawyer's version of events.

John Whittingdale, the committee chairman, is demanding to know whether his committee has, yet again, been misled, and Tom Watson, the Labour MP who extracted James Murdoch's disputed testimony, has notified the police.

The gauntlet has been thrown down to Rupert Murdoch and his son this weekend, in the most melodramatic fashion yet.