Newham College will go to court unless officials lift the guillotine on new training contracts with industry. At least six other colleges are also considering legal action.

The threat, which will be hugely embarrassing for ministers, came as the Further Education Funding Council launched a crash review into the principles of college funding in the wake of the crisis.

Officials must draw up a complete list of priorities for colleges, develop a financial monitoring system and undertake a root-and-branch review of franchising before the funding round in March.

Newham outlined its threat in a letter to the FEFC this week, giving the council a week to back down before it launches judicial review proceedings.

The college, which stands to lose up to o500,000 in the row over so-called demand-led funding, is challenging the council’s decision to warn colleges that expansion cash would not be available for contracts signed after January 28.

The threat of action comes just days after ministers confirmed that a claim for o84 million to fund college expansion during this academic year would be met. They had threatened to cancel the budget, which pays for work that exceeds college targets, from last month.

Principals and governors are furious at the handling of the crisis, which led to a letter from David Melville, the FEFC chief executive, warning colleges to halt new commitments from January 28.

Ministers and funding officials should have consulted principals about the decision to revoke expansion cash, Newham says, and taken account of contract negotiations with outside bodies.

John Hall, of the national law firm Eversheds, who is conducting the action, said the FEFC had been given a week to respond before an application was made for leave for judicial review. If the case goes ahead, it is expected to be heard within weeks.

Mr Hall said: “The colleges have got the bit between their teeth and they are determined to ensure that fair play is preserved.”

“We’re not trying to make a political point,” said Martin Tolhurst, Newham’s principal. “Our business is under threat. A large flexible FE college does not enrol its student or sign all its contracts at the same time.”

The crisis had prejudiced contract negotiations, he added, and could have serious implications for capital grants from the Government and Europe.

As The TES went to press, the FEFC was believed to be preparing a concession to colleges. New guidance is thought to indicate that colleges will get expansion cash for students who enrol during the rest of academic year (even if they exceed targets), but only as long as the colleges do not exceed the forecasts produced in the autumn.

It seemed clear, however, that no funding would be available for contracts with outside bodies signed after January 28.

Meanwhile, the FEFC is embarking on a review of funding to cope with the loss of demand-led funding estimated at o75m-o100m in the next academic year. Detailed options for spreading the burden will be published next week, although officials have indicated that colleges will not be allowed to collapse because of the funding crisis.

Officials from the Department of Education and Employment and the Treasury will be brought into a new forecasting and control group that will be charged with keeping a cap on expenditure.

Roger Ward, chief executive of the Association of Colleges, said: “o100m will come out of the sector in 1997-98, and the effects will make next year an extremely difficult year to manage.”