Officials at the Further Education Funding Council were given full details about the gaping hole in Bilston's budget and were heavily involved in the drafting of the college's recovery plan.
The revelations will re-open the debate over whether the college in Wolverhampton was closed for educational, financial or political reasons and whether the council should have acted earlier. Bilston has now merged with nearby Wulfrun College.
Ministers have been keen to show that they are as tough on failing colleges as they are on failing schools. Bilston had debts of more than pound;10 million and received the worst-ever inspection report for an FE college. A police investigation is continuing into allegations that public funds were misused.
Taxpayers have been left to foot the bill - covering the debts and the expected pound;1m auditors' fees - to untangle the complex financial web of franchised courses and subsidiary companies. This year the merged college will receive almost twice the average level of funding per student that Wulfrun College would have done.
FEFC finance director Geoff Hall said the council had acted as quickly as it could.
"We couldn't have taken more determined action, in the face of a strong principal and a weak governing body, than we took. It was very difficult to break through the barriers at that college," he said.
Former managers at the college believe that Bilston was not allowed sufficient time to turn itself around after the departure of former principal Keith Wymer. They complain that the inspection, undertaken in February this year, came at a time when Bilston was shedding senior staff under a recovery plan agreed with the council.
"If we had been allowed to develop the recovery plan we could have turned that college round at a fraction of the cost it is taking now," said Alan Millington, former chair of governors.
"We worked extremely hard, seemingly with the approval of the funding council but it kept moving the goalposts. It was like they needed a high-profile scapegoat to scare the rest of the sector."
The college was in conflict with the council over the withdrawal of demand-led funding. The loss of the money, which paid for the college expansion, resulted in a 20 per cent cut in Bilston's budget for 1997-98. However, Bilston continued to "go for growth" and attempted to make up the shortfall through commercial ventures while it challenged its level of funding.
Much of the debt comes from this and a dispute over so-called "amber" units - courses which had been delivered but which were then disputed by the council.
"The FEFC has been very quick to apportion blame for the multiplicity of college failures we are seeing to governors, managers and auditors. Perhaps with 70 colleges in serious financial difficulty they should be looking closer to home," said Paul Goddard-Patel, former finance officer at Bilston.
At the beginning of March officials from the council met with Mr Goddard-Patel at his request to discuss the college's finances.
After the meeting, Lisa Dean, then regional finance director of the FEFC, wrote to Mr Wymer. "I remain concerned about the financial viability of the college.
She said: "The college's viability is dependent on a significant increase in income-generating activities over the next six months which I believe is ambitious".
However, the council agreed to pay pound;640,000 as long as an audit of the college's forecasting procedures was put in place. A recovery plan was drawn up in the summer and Alan Birks, principal of South Birmingham College, was drafted in to turn Bilston around.
But the results of the inspection heralded a change in approach by the council. An inquiry team, led by former chief inspector Terry Melia, recommended that the college should be merged with Wulfrun. Bilston's governors offered to resign, although they were asked to stay on by the council before they were later "sacked".