It aims to stamp out the practice of low-spending colleges franchising to higher spenders. The practice can bring cash benefits to both but drives up costs to the taxpayer.

A college gets an average of Pounds 18.50 for every “unit” of costs under the FEFC funding formula. But this applies only within set recruitment targets. If a college goes beyond target, it gets Pounds 6.50 per unit.

The two-year-old system has been effective in encouraging colleges to grow while driving down costs. But colleges were quick to see benefits from doing deals. Successful colleges could sell to the unsuccessful and split the difference.

“This could result in provision being funded at a higher rate than necessary and possibly lead to a ‘trading’ of units to colleges that had not achieved their targets,” said the council. Such arrangements would not normally be eligible for funding, according to an FEFC circular giving new guidance on franchising.

Colleges are unruffled by the clampdown on a practice that they say is largely defunct, but they are afraid that the growth mechanism, called the “demand-led element”, will be scrapped. The FEFC is under pressure from the Treasury to do so and could use the potential abuse of the system as an excuse.

Martin Jenkins, principal of Halton College said: “This has been a lever that has led to some of the best innovations in FE. If cut it would have a dramatic influence on franchising.”

It is now widely accepted that training revolutions in companies such as Tesco have resulted from such collaborative schemes. The giant food chain negotiated a national contract with Halton, one of the colleges growing fastest from franchises with industry. The FEFC says the last thing it would want to do is kill them off.

David Eade, principal of Barnsley College, says politicians have missed the importance of this development. “There’s a lot of evidence to show this has been a major expansion of vocational work which will have a significant impact on national targets for education and training.”

When it came to collaboration with industry, it was also far more cost-effective than the day release that flourished in the 1960s and died in the 1970s. “It is also negligible investment - just Pounds 200 million out of the FE budget of Pounds 3bn,” he said.

Fears that the FE funding system was being abused arose because inadequate guidance was given to support the complex formula devised after college incorporation in 1993, said several principals.

David Bunch, principal of North Derbyshire (another successful franchiser), said: “This (FEFC) report on collaborative programmes is extremely helpful to us overall. The problem is that it should have been issued a couple of years ago.”

Another successful principal was more blunt. “What the FEFC saw as scams and loopholes, we spotted as a natural route for growth. To grow is second nature to most of us.”

The council has also considered the issue of higher education institutions looking to enter the FE market. It says “unit trading” between colleges, universities and external institutions is forbidden unless there are exceptional circumstances.

There might, for example, be specialised further education provision at a university that is not available elsewhere. The university might wish to collaborate with another institution and deliver part of the programme on college premises.

A spokeswoman for the FEFC said: “They should not franchise in this way but we will consider it on an exceptional basis. Specialised art and design courses not available in another college are examples.”

The council has also closed a loophole in funding regulations that allowed colleges to claim cash for pupils by registering them under special franchise arrangements.

The key element is the premises where the education takes part. Premises are important for determining whether a 16- to 18-year-old belongs to the school or to college. If the provision takes place on school premises, it cannot be claimed unless delivered in a part of the premises that belong to the college and that are identified as such.

In addition, the resources must be the property of the college, the participants must be students of the college, and provision must not be confined to former pupils.

The circular warns that collaborative arrangements “carry significant risks for colleges, both to their flow of funds and potentially to their reputations as providers of education”.

They need to be fully aware of what is going on. They should give “particular consideration” to the effect of collaboration on the college’s character and risks to its solvency. Governors must be kept informed of new contracts and significant changes to existing ones.

They may delegate to the principal the job of ensuring adequate scrutiny of individual contracts. Governors should approve a generic contract for franchising but they do not need to examine every one.

Colleges should ensure their partners do not subcontract to third parties. They must enter into a direct contract with the organisation delivering the provision.