Col Gaddafi has paid damages to families of American IRA victims
Gordon Brown declined to put formal pressure on Libya to get compensation for IRA victims, No 10 has confirmed.
The victims say Libya should pay compensation because it supplied the IRA with explosives used in atrocities.
Mr Brown told a victims' lawyer it was not "appropriate" to discuss the claims, but aides have denied he was trying to protect oil deals with Libya.
Democratic Unionist MP Jeffrey Donaldson said the PM had done far less for victims than US leaders had.
Mr Brown's office released a letter written by the prime minister to IRA victims' lawyer Jason McCue last October in which Mr Brown wrote that the government did not "consider it appropriate to enter into a bilateral discussion with Libya on this matter".
He added that Libya would be "strongly opposed to reopening the issue."
In an earlier letter dating from last September, the prime minister told Mr McCue that Libya was now an "essential partner" in the fight against terrorism and it was in the UK's interests for that co-operation to continue.
Mr McCue has been lobbying the government to raise the matter of compensation at the highest levels of the Libyan government.
It does make Britain look very, very weak and insignificant
His campaign follows out-of-court deals agreed by Libya with three American victims of IRA atrocities.
More than 100 UK IRA victims, who had been pursuing similar claims through the American courts, had been excluded from those deals.
Mr Donaldson told the BBC that the US government had "held the Libyans' feet to the fire" in order to win a multi-million pound settlement for its nationals.
"I want to know - and the victims are entitled to know - why Gordon Brown does not have the same desire to stand up for the victims of IRA terrorism as George Bush showed standing up for American victims," he said.
"He got a multi-million dollar deal in terms of compensation from the Libyans."
Mr Donaldson is part of a cross-party group of MPs preparing to travel to Tripoli for talks about compensation.
The victims' campaign has been boosted by the Scottish government's decision to free Lockerbie bomber Abdelbaset Ali al-Megrahi on compassionate grounds.
The victims argue Libya should show similar compassion regarding their demands.
'Not about money'
Mr Parry said the government's main consideration should be the safety of its citizens
Colin Parry's 13-year-old son Tim was killed in Warrington in 1993 by an IRA bomb thought to be made from Libyan Semtex.
"It does make Britain look very, very weak and insignificant if, for reasons of worrying about oil deals or other economic considerations, this government of ours is prepared to disregard all the pain of the thousands of victims of IRA terrorist campaigns," he said.
"It isn't about the money. It's about Libya saying, 'We now want to be a normal state.'
"If that's the case then they've got to address the sins they committed in the past. The only way they can do that... is financially - to compensate those people their actions hurt so badly."
Libya are an essential partner in the fight against terrorism and it is in the UK's interests for this co-operation to continue
A Downing Street spokesman said the government had raised the issue of compensation with Libya informally but it was felt that formal negotiations stood little chance of success.
The Conservatives said the public needed to know "on what basis" the government had reached its decision not to press for compensation.
Shadow foreign secretary William Hague told Sky News: "These latest revelations are part of an ever-expanding farce, with more revelations really every day about how the government have conducted themselves.
"These latest revelations greatly strengthen the case we have made for an independent inquiry."
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