The Court of Appeal's unanimous decision against discount store Poundland is a "huge setback for the Department for Work and Pensions (DWP), whose flagship reforms have been beset with problems since their inception", according to Public Interest Lawyers.
The lawyers, who represented Cait Reilly and 40-year-old unemployed HGV driver Jamieson Wilson, said that "until new regulations are enacted with proper parliamentary approval, nobody can be compelled to participate on the schemes".
Today's judgment sends Iain Duncan Smith back to the drawing board to make fresh regulations which are fair and comply with the court's ruling.
Until that time nobody can be lawfully forced to participate in schemes affected such as the Work Programme and the Community Action Programme.
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.
University graduate Cait Reilly's successful appeal was made by Lord Justice Pill, Lady Justice Black and Sir Stanley Burnton.
In November 2011, Miss Reilly had to leave her voluntary work at a local museum and work unpaid at the Poundland store in Kings Heath, Birmingham, under a scheme known as the "sector-based work academy".
She was told that if she did not carry out the work placement she would lose her jobseeker's allowance.
For two weeks she stacked shelves and cleaned floors.
The Court of Appeal has ruled university graduate Cait Reilly's claim that requiring her to work for free at a Poundland discount store was unlawful.
Three judges in London ruled that the regulations under which most of the Government's back-to-work schemes were created are unlawful and quashed them.
Miss Reilly, 24, from Birmingham, and 40-year-old unemployed HGV driver Jamieson Wilson, from Nottingham, both succeeded in their claims that the unpaid schemes were legally flawed.
Their solicitors said later the ruling means "all those people who have been sanctioned by having their jobseekers' allowance withdrawn for non-compliance with the back-to-work schemes affected will be entitled to reclaim their benefits".
A judge at the High Court has upheld the legality of the Government's back-to-work scheme, but raised concerns about the letters it sends to jobseekers.
These letters are used to warn claimants that they may lose their benefits if they fail to participate in the schemes without good reason.
A spokeswoman for the Department for Work and Pensions said: "We do not believe there is anything wrong with the original letters and we will appeal this aspect of the judgment, but in the meantime we have revised our standard letters."
A spokeswoman for the Department for Work and Pensions said: "We are delighted, although not surprised, that the judge agrees our schemes are not forced labour.
"Comparing our initiatives to slave labour is not only ridiculous but insulting to people around the world facing real oppression.
"Thousands of young people across the country are taking part in our schemes and gaining the vital skills and experience needed to help them enter the world of work - it is making a real difference to people's lives.
"Those who oppose this process are actually opposed to hard work and they are harming the life chances of unemployed young people who are trying to get on."
Today’s decision should mean that many of those subjected to benefit sanctions will be entitled to reimbursement by the Department of Work and Pensions. It is truly extraordinary that the Government has found itself in this position by failing to provide basic information to those affected. We welcome the Court’s ruling on this issue but we continue to maintain that the Regulations themselves are unlawful and ought to be quashed. We are seeking permission to appeal the Court’s findings in this regard.
Mr Justice Foskett, sitting at the High Court in London today, said that "characterising such a scheme as involving or being analogous to 'slavery' or 'forced labour' seems to me to be a long way from contemporary thinking".
He said that both of the claimants were entitled to a declaration that there had been breaches of the 2011 jobseeker's allowance regulations in their cases.
But he ruled that the mistakes did not invalidate the 2011 jobseeker's allowance regulations, nor did they breach human rights laws banning slavery.