The High Court has ruled emergency laws underpinning a government back-to-work scheme are “incompatible” with the European Convention on Human Rights.
The ruling stems from a case brought by Cait Reilly in 2012, who said being forced to work for free at a Poundland store breached her human rights.
The government brought in new rules in 2013 allowing unpaid work schemes to continue pending further legal appeals.
Ministers said they were “disappointed” by the ruling and would appeal.
But lawyers for Miss Reilly claimed the government owed about Â£130m to people who had fallen foul of the retrospective legislation and ministers should admit they made a mistake.
The 24-year old graduate challenged the legality of an unpaid work placement she undertook in 2011, part of the government’s “mandatory work activity” programme.
She said that she was told that if she did not agree to take part in the scheme, which she said involved stacking shelves, she would lose her Jobseeker’s Allowance.
‘Minority of cases’
The government was forced to pass emergency legislation amending the scheme last year after Court of Appeal ruled that the regulations underpinning it did not comply with existing laws giving the Department for Work and Pensions the power to introduce the programme.
The legislation was designed to reinforce the rules to make it clear that claimants must do all they can to find work in order to claim benefits and to ensure the government did not have to repay money to claimants who had not complied with the conditions of their benefit claim.
But Mrs Justice Lang, sitting at the High Court in London, ruled on Friday that the retrospective legislation interfered with the “right to a fair trial” under Article Six of the Convention on Human Rights.
The Department for Work and Pensions said it was “disappointed” by the ruling – which it said applied to a minority of claimants – and would launch an appeal.
“We disagree with the judgment on the legislation and are disappointed,” a spokeswoman said.
“It was discussed, voted on and passed by Parliament. While this applies to only a minority of past cases and does not affect the day to day business of our Jobcentres, we think this is an important point and will appeal.”
She said the legislation remained “in force” and the government would not be compensating anyone who had been docked benefits pending the outcome of its appeal.
But Paul Heron, a solicitor for Public Interest Lawyers, said it was a “massively significant” ruling and the DWP’s decision to appeal against it would be a further blow to the “upwards of 3,000 cases sitting in the tribunal system waiting for this judgement”.
He claimed people were owed anything from four weeks benefit, about Â£250, to several thousand pounds and were having to mostly represent themselves at tribunals.
He told BBC News it was “about time the DWP just held their hands up, admit they made an error, and pay people the money they were entitled to at the time. That is what a responsible government would do.”
The back-to-work schemes have been condemned by critics as “slave labour” because they involve work without pay but are seen by supporters as a good way of getting the unemployed back into the world of work.
The Supreme Court upheld the Court of Appeal’s ruling on the regulations last year although the judges also rejected claims that the schemes were “exploitative” and amounted to “forced labour”.
Ministers said that the most recent legal judgement had upheld this view.
“We’re pleased the Court recognised that if claimants do not play by the rules and meet their conditions to do all they can to look for work and get a job, we can stop their benefits,” the spokeswoman added.
Poundland, one of several employers which took part in the scheme, withdrew from it in 2012.
Nearest tube: Elephant & Castle underground station (Northern and Bakerloo lines).
Nearest Railway Station: Elephant & Castle
Buses from Elephant and Castle: ask bus driver for Burgess Park. Bus numbers: 12, 171, 148, 176, 68, 484, 42, 40, 45