The Financial Services Authority is to be sued over allegations that it ignored warnings about the solvency of Independent Insurance.
The case will be brought by creditors of the collapsed insurer after they lost substantial sums when it went into provisional liquidation in June.
The FSA enjoys statutory immunity from being sued, but the creditors believe they can get around this problem by taking their case through the European courts.
Stephen Alexander, a partner at Class Law, which is representing the creditors, said: "We are focusing on Independent's insurance policies, which give people personal rights that are protected under European law." Class Law plans to launch the action against the FSA next month.
This will be the second challenge to the Government's role as regulator of the City under European law. Last week the European Union said it might bring a case against the UK authorities for failing to regulate Lloyd's of London, raising the prospect of compensation for Names.
The Independent Insurance case is directed at the FSA, which comes under the umbrella of the Treasury. The creditors argue that the FSA failed to act on a series of warnings about Independent's solvency from its French counterpart. The FSA said it would "vigorously defend" its record.Reuse content