Sega and Bartle Bogle Hegarty are set to split after only ten months, allowing the agency to pitch for Microsoft's rival X-box account.
The contract between BBH and the computer games giant expires at the end of the month, but industry sources say both parties have agreed not to renew it.
The divorce will leave BBH free to contest the assignment to launch Microsoft's first venture into the games market, which is expected to be backed by a pan-European budget of about dollars 50 million.
Sega has confirmed that it will be reviewing its agency arrangements to reflect the broadening of its business to include mobile phones and other handheld devices.
It is understood that Microsoft approached BBH about two months ago with an invitation to join X-box's longlist, but it was told that nothing could be done while the contract with Sega was still in place.
The Sega pan-European account was claimed to be worth pounds 60 million when BBH took it over from WCRS in February. But the company is thought to be spending only about pounds 2 million next year with more ad hoc advertising promoting specific products rather than the brand.
As a result, BBH is believed to have had talks with Jean-Francois Cecillon, the chief executive of Sega Europe, about the future of the contract and to have agreed last week to pitch for X-box.
Gwyn Jones, the managing director of BBH, said: 'We are under contract to Sega until the end of the year when it will be up for review.'
Sega has been encountering tough trading conditions in the market, which had stalled while awaiting last month's arrival of the Sony PlayStation 2 console.
A Sega spokesman claimed that the company's sales had been 'phenomenal' during the past few months and that its Dreamcast consoles had been outselling PlayStation 2.
However, he added: 'There is only a finite number of consoles that can be sold and there will be a review of our agency arrangements.'