Less than a month after Premier Barry O'Farrell resigned for misleading the Independent Commission Against Corruption in a separate investigation, the commission has heard Mr Gallacher was intimately involved in a cash-for-favours scheme in which Mr Tinkler's Buildev paid tens of thousands of dollars in illegal donations to a Liberal Party slush fund.

The stunning development embroiling Mr Gallacher in the current corruption inquiry arrived at the commission only 24 hours earlier. A series of secret hearings occurred on Thursday night when this matter, along with other new information, was explored.

The new evidence is so serious that the current inquiry may have to stop while the material is investigated.

In other dramatic evidence on Friday, federal Liberal MP Karen McNamara was accused of participating in electoral fraud over her involvement in raising funds for Central Coast MP Darren Webber, the state member for Wyong, while the NSW Liberal Party's former chief fundraiser, Paul Nicolaou, was alleged to have taken a secret cut of all the donations he collected.

Mr Gallacher’s shock departure from the ministry follows the suspension of upper house Liberal MP Marie Ficarra from the parliamentary Liberal Party on Monday over allegations she solicited an illegal $5000 donation from a property developer.

Premier Mike Baird said he had accepted Mr Gallacher's resignation from the ministry and Attorney-General Brad Hazzard would act as police minister until a replacement was appointed.

"I make no judgement regarding those allegations. However, it could take considerable time for them to be resolved, and this would constitute an unacceptable distraction for my government," Mr Baird said.

"We need to be completely focussed on delivering results for the community."

Mr Gallacher said: ‘‘I have spent my entire professional life fighting corruption and crime. I am disappointed that this allegation has been made and the manner in which it came to be made but it will be dealt with through the processes of ICAC."

The ICAC is investigating allegations former energy minister Chris Hartcher and fellow central coast MPs Chris Spence and Mr Webber corruptly solicited hundreds of thousands of dollars in illegal donations from property developers and other sources in exchange for political favours.

The three Liberal MPs have already joined the independents on the crossbench in Macquarie Street.

The commission was shown June 2010 emails in which Buildev executives Darren Williams and David Sharpe discussed which company should be used to funnel the illegal donations into the slush fund, a "sham business" called Eightbyfive set up by a staffer to Mr Hartcher.

"Which entity will I give Mike Gallacher?" Mr Williams asked Mr Sharpe.

Mr Sharpe replied: "Ask Nathan as I think it's best to come through Patnack [Patinack Farm, Mr Tinkler's horse racing business] get right away from property minning [sic] infrastructure."

Property developers have been banned from making political donations since December 2009.

The inquiry heard that Mr Tinkler's Buildev had plans for a coal loader at the old BHP site at Mayfield in Newcastle.

Mr Williams admitted that he had a close relationship with Mr Gallacher and that Mr Hartcher would be useful to Buildev's plans because "he was in government".

Counsel assisting the inquiry, Geoffrey Watson, SC, accused Buildev's Mr Williams of lying during a tense morning in the ICAC witness box.

"You know that you can go to jail for giving false evidence," threatened Mr Watson. "This is your big chance, Mr Williams, to give this an innocent complexion."

When Mr Williams said he "honestly" could not recall the contents of an email about the Eightbyfive scheme, Mr Watson suggested that the ICAC had information which might help him.

He then sensationally put to Mr Williams: "The truth is you had a close, long-standing personal connection with the [then] shadow minister, Mike Gallacher. It was through him that the two of you hatched a corrupt scheme to make donations to the Liberal Party using the Eightbyfive business, correct?"

"No," Mr Williams said.

"By the end of this you are going to regret giving that answer," Mr Watson said. "We don't go off half-cocked. We don't put something as serious to you as this without knowing plenty of stuff.''

Operation Spicer, the inquiry into Liberal Party slush funds, started public hearings on Monday and had been slated to run for up to four weeks.

The inquiry has previously heard Mr Hartcher did favours "repeatedly" for Buildev, which paid $66,000 into the Eightbyfive slush fund.