A government scheme which forced a woman to work for Poundland without pay was unlawful, the court of appeal found today.
The ruling threatens to derail the government's work experience programme, which forces benefit recipients to do unpaid work for profitable companies or risk losing their entitlements.
"Today's judgment sends [welfare secretary] Iain Duncan Smith back to the drawing board to make fresh regulations which are fair and comply with the court's ruling," solicitor Tessa Gregory said.
"All of those who have been stripped of their benefits have a right to claim the money back that has been unlawfully taken away from them."
Cait Reilly, a geology graduate from Birmingham University, had to leave her voluntary work at a local museum and stack shelves and clean floors for no pay for Poundland, which has a turnover of £500 million.
She was told that if she refused she would lose her jobseekers' allowance.
Jamieson Wilson had his jobseekers' allowance stripped for six months after he refused to clean furniture for 30-hours a week.
As a qualified mechanic, he felt the work was not connected to his career and would not help him re-enter the job market.
"It beggars belief that David Cameron's government is now so incompetent it can’t even organise work experience," Liam Byrne, shadow work and pensions secretary said.
"Two years in, David Cameron and Iain Duncan Smith’s so-called welfare revolution is in a state of advanced chaos."
TUC general secretary Frances O’Grady commented: "This blows a big hole through the government's workfare policies.
"It is pointless to force people to work for no pay in jobs that do nothing to help them while putting others at risk of unemployment.
"This policy is about blaming the jobless, not helping them."
The judges would not be drawn on whether the scheme broke anti-slavery human rights laws, but found the government had abused its power by not offering claimants enough information about the programme.
The three judges found Reilly had not been notified that she was free to refuse the offer, while Wilson should have been told that refusal to comply would result in half a year without benefits.
The ruling does not prevent the government running the welfare-to-work scheme and imposing sanctions, but will mean new rules have to be introduced.
The programme has been hugely controversial, with even the Department for Work and Pension's (DWP) own research finding it has zero effect helping people get jobs.
A DWP spokesperson said: "We are disappointed and surprised at the court's decision on our regulations and will appeal.
"The court has backed the right to require people to take part in programmes which help get them into work."