A university graduate has won a Court of Appeal ruling that a flagship Government back-to-work scheme requiring her to work for free at a Poundland discount store was unlawful.
Three judges in London declared that the regulations under which most of the schemes were created are unlawful and quashed them.
The Government expressed "disappointment and surprise" at the decision and said it now intends to introduce new regulations to ensure future schemes are lawfully based. Moves to appeal to the Supreme Court against the ruling are also under consideration.
Cait Reilly, 24, from Birmingham, and 40-year-old unemployed HGV driver Jamieson Wilson, from Nottingham, both succeeded in their claims that the unpaid schemes they were required to participate in were legally flawed.
Their solicitors said later the ruling means "all those people who have been sanctioned by having their jobseeker's allowance withdrawn for non-compliance with the back-to-work schemes affected will be entitled to reclaim their benefits".
Public Interest Lawyers said: "The result is that over the past two years the Government has unlawfully required tens of thousands of unemployed people to work without pay and unlawfully stripped thousands more of their subsistence benefits."
Employment minister Mark Hoban said he was disappointed and surprised at the court's decision on the regulations. But he said the judges' ruling had upheld the Government's right to run back-to-work schemes. Mr Hoban said: "The court has backed our right to require people to take part in programmes which will help get them into work. It's ridiculous to say this is forced labour. This ruling ensures we can continue with these important schemes."
A DWP spokesman said: "We have no intention of giving back money to anyone who has had their benefits removed because they refused to take getting into work seriously. We are currently considering a range of options to ensure this does not happen."
Mark Serwotka, general secretary of the Public and Commercial Services union, said: "The Government cannot continue to help private companies and charities to exploit people who are out of work, and these schemes must surely now be scrapped and the work brought back in-house."
But Matthew Sinclair, chief executive of the TaxPayers' Alliance, said welfare "can't be an alternative to work", and added: "The Government needs to stand by the simple principle that benefits are there to provide a safety net that will catch people when they fall, not a comfy hammock they can rest in indefinitely at the expense of struggling taxpayers."