SCO Group - the company suing IBM for rights over Linux - has been dealt a huge blow to its credibility with its main investor, BayStar Capital, formally asking for its $20 million investment in the company to be redeemed, alleging a breach of agreement.

BayStar's investment in SCO became a matter of some controversy last month when it was revealed that Microsoft had acted as a middleman in the deal.

A SCO spokesman admitted that Baystar was now looking for a way out of that investment: "We received a letter from BayStar indicating that they believe that we had breached some sections of the exchange agreement that we had entered into in February," said SCO spokesman Blake Stowell. "They are asking us to redeem their shares based on the allegation that we've breached their agreement."

SCO declined to provide copies of the BayStar letter, but claimed that it did not provide specific information on the alleged breaches. "There isn't a single person at our company that knows today why (BayStar) believes we've breached some terms of the agreement," Stowell said.

BayStar was the lead investor in a $50 million deal that was first announced in October 2003 and amended in February. Last month, BayStar admitted that Linux rival Microsoft had made the introductions that led to the deal.

The investment has been seen as crucial in allowing SCO, which posted a $2.3 million loss in its most recent quarter, to continue with its multi-billion dollar lawsuit against IBM over IBM's contributions to the Linux operating system, and Linux advocates have criticized it as a proxy investment by Microsoft designed to undermine the credibility of Linux.

The news that BayStar now wants its money back was not well-received by the market. SCO's stock was down $1.30, or 13 percent on the day. "The short investors got a gift today, " said Dion Cornett, an analyst with Decatur Jones Equity. "The lead investor for SCO that had access to all the information that we wish we had access to, they're asking for their money back," said Cornett. "And not only are they asking for their money back, they are basically asserting material breach of representation and warrantees."

Cornett said that it was unlikely that BayStar would get its money back, because BayStar's agreement with SCO does not include contractual terms allowing BayStar to demand redemption. "This does not jeopardize SCO's ability to pursue their lawsuit against IBM," he said. "What it does jeopardize is their ability to get future investors."

The Royal Bank of Canada, which contributed the other $30 million to the February deal is "aware of what has transpired between BayStar and SCO", and is "looking at the situation", according to Paul Wilson, a spokesman for the Royal Bank's Capital Markets group.

Wilson declined to comment on whether or nor the Royal Bank would be asking for its money back as well. "Right now, the issue is between BayStar and SCO," he said.

BayStar declined to comment on this story.