University graduate Cait Reilly has won her Court of Appeal 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. The Department for Work and Pensions has not been given leave to appeal, but has said that, regardless, it will appeal to the Supreme Court.
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solicitors said later the ruling means "all those people who have been sanctioned by having their jobseekers' allowance withdrawn for non-compliance with the back-to-work schemes affected will be entitled to reclaim their benefits".
Lord Justice Pill, Lady Justice Black and Sir Stanley Burnton made the ruling.
Reilly described her two weeks at Poundland as "a complete waste of time".
She said: "The experience did not help me get a job. I wasn't given any training and I was left with no time to do my voluntary work or search for other jobs.
"The only beneficiary was Poundland, a multimillion-pound company. Later I found out that I should never have been told the placement was compulsory.
"I don't think I am above working in shops like Poundland. I now work part time in a supermarket. It is just that I expect to get paid for working.
"I hope the Government will now take this opportunity to rethink its strategy and do something which actually builds on young unemployed people's skills and tackles the causes of long-term unemployment.
"I agree we need to get people back to work but the best way of doing that is by helping them, not punishing them.
"The Government ought to understand that if they created schemes which actually helped people get back into work then they wouldn't need to force people to attend."
The Government must now table new regulations in accordance with the court's ruling.
Miss Reilly was first forced to participate in a scheme known as the "sector-based work academy" in November 2011.
She was told that if she did not carry out the work placement she would lose her jobseeker's allowance and for two weeks she stacked shelves and cleaned floors.
Wilson, a qualified mechanic, was told that he had to work unpaid, cleaning furniture for 30 hours a week for six months, under a scheme known as the Community Action Programme.
He objected to doing unpaid work that was unrelated to his qualifications and would not help him re-enter the jobs market.
He refused to participate and as a result was stripped of his jobseeker's allowance for six months.
Minister for employment Mark Hoban said in a statement: "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.
"We are however disappointed and surprised at the court's decision on our regulations. There needed to be flexibility so we could give people the right support to meet their needs and get them into a job.
"We do not agree with the court's judgment and are seeking permission to appeal, but new regulations will be tabled to avoid any uncertainty.
"Ultimately the judgment confirms that it is right that we expect people to take getting into work seriously if they want to claim benefits."
After the ruling Public Interest Lawyers, who represent Ms Reilly and Mr Wilson, said the Court of Appeal's unanimous decision was a "huge setback for the Department for Work and Pensions (DWP), whose flagship reforms have been beset with problems since their inception".
They said, "until new regulations are enacted with proper parliamentary approval, nobody can be compelled to participate on the schemes".
Solicitor Tessa Gregory, said: "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."
Gregory said: "The case has revealed that the Department for Work and Pensions was going behind Parliament's back and failing to obtain Parliamentary approval for the various mandatory work schemes that it was introducing.
"It also reveals a lack of transparency and fairness in the implementation of these schemes.
"The claimants had no information about what could be required of them under the back-to-work schemes.
"The Court of Appeal has affirmed the basic constitutional principle that everyone has a right to know and understand why sanctions are being threatened and imposed against them."
Louise Connacher, Director at Lupton Fawcett Lee and Priestly Solicitors in Leeds told HuffPost UK that the key issue was not one of human rights, but of fairness. "People did not understand what their options were, and what was compulsory or not.
"So these regulations no longer apply, void and have no effect. So if someone is in Poundland they can down tools immediately, and walk out.
The other effect is that the people have not gone on these schemes and not been paid their benefits, can claim the benefits they should have had. That's over two years worth of people who can demand their benefits back now. And Mr Duncan Smith has to rethink."
Tanya de Grunwald, founder of the graduate jobs blog Graduate Fog told HuffPostUK that Miss Reilly had "become the poster girl for interns everywhere, who feel they have no voice and no rights".
"Hundreds of thousands of young jobseekers empathise with her, whether they've worked for low or no pay as part of a government scheme or through a privately arranged unpaid internship.
"We congratulate her on her hard-won success - it is enormously significant in the fight for young people to be paid a fair wage for their labour."
TUC general-secretary Frances O'Grady said: "This blows a big hole through the Government's workfare policies.
"Of course voluntary work experience can help the jobless, and it is right to expect the unemployed to seek work.
"But 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. Ministers should now abandon this misguided approach, and instead guarantee real jobs for the long-term unemployed, especially the young."
The Court Of Appeal's judgment said that the challenge was to the lawfulness of the 2011 Government regulations made by Ian Duncan Smith, Secretary of State for Work and Pensions, under sections of the Jobseekers Act 1995.
Lord Justice Pill said he was "unable to conclude that the statutory requirement for the regulations to make provision" for back-to-work schemes "of a prescribed description" had been met.
He ruled: "The statutory requirement is that the prescribed description is in the regulation."
Declaring the regulations unlawful, the judge said they must be quashed since their central purpose was to impose "requirements" on jobseeker allowance claimants and sanctions for failing to comply.
Agreeing with Lord Justice Pill, Sir Stanley Burnton said: "I emphasise that this case is not about the social, economic, political or other merits of the Employment Skills and Enterprise Scheme.
"Parliament is entitled to authorise the creation and administration of schemes that ... are designed to assist the unemployed to obtain employment, and provided that the schemes are appropriate for that purpose, it is not easy to say what objection there could be to them.
"Parliament is equally entitled to encourage participation in such schemes by imposing sanctions, in terms of loss of jobseeker's allowance, on those who, without good cause refuse to participate in a suitable scheme.
"This appeal is solely about the lawfulness of the regulations made by the Secretary of State in purported pursuance of the powers granted by the 1995 Act as amended.
"Furthermore, like Lord Justice Pill, I recognise that there are considerable advantages in there being a large measure of flexibility in designing and administering a statutory scheme.
"However any scheme must be such as has been authorised by Parliament."