Plymouth Ocean Projects, which ran courses under franchise agreements with Mid-Kent and South Devon colleges, says it has lost more than Pounds 500, 000 because the council would not fund the courses.
The council held that the scuba diving courses were for leisure purposes only and therefore not eligible for funding under Schedule 2 of the Further and Higher Education Act.
Under the Act, the Secretary of State can intervene if he thinks the council has acted unreasonably. But Mr Blunkett has told the company that "he does not consider that he should exercise any of his statutory powers in relation to the council".
Dave Welsh, who runs Plymouth Ocean Projects, was still defiant. As The TES went to press, he was meeting barristers to discuss possible action in the civil courts, against either the colleges, the council or ministers.
He said: "I will definitely be seeking a judicial review of the funding council's decision-making process, which I regard as flawed."
The dispute has centred on what constitutes a leisure course under the Act.
The council can fund courses which "give progression" to academic or vocational courses. It argued that this did not apply to the open-water and advanced open-water diving courses provided by Mr Welsh's company.
The council has been concerned that if its ruling was held to be wrong, this would open the floodgates for claims for funding for other courses, currently defined as recreational.
The ruling by the Secretary of State says the courses are not eligible for funding as they do not prepare a student for direct entry to a course. "The fact that college principals or auditors consider that they are eligible is not relevant to eligibility if their view should turn out to be wrong," the letter says.
In addition, "on any footing it had been made clear that eligibility was in doubt. Proceeding with contracts therefore had a risk attached to it." The council had acted reasonably throughout and was not in breach of any duty.
As for Mid-Kent, the company's relations with the college were governed by contract. "It would not be appropriate for the Secretary of State to become involved in a contractual dispute: the appropriate forum is a court."
A spokeswoman for the FEFC said: "Ministers have found that the council has acted correctly throughout. If Mr Welsh wishes to take the matter through the courts, that is up to him."