The advice agencies, which include law centres, citizens advice bureaux and independent advice centres, are obliged to pay local government pay scales.
Because of last year's local government pay settlement, they are faced with pay bills of around 8 per cent over two years. Many are warning that without funding from the Government to cover extra employment costs, they will be forced to make redundancies, withdraw from the contracts or close altogether.
Advice UK, which represents around 1,000 independent advice centres, has written to the Lord Chancellor's Department, which funds the Legal Services Commission, warning that the severe financial difficulties that advice centres are currently facing could within a year "turn into a complete breakdown of our ability to deliver the services and a profound undermining of the Government's social inclusion strategy".
Chief executive Steve Johnson told Third Sector that the new funding regime could tip many advice centres, already reeling from cuts in local authority funding, over the edge.
"It takes just the flap of a butterfly's wing to turn a sustainable operation into a complete failure. Every last one is under threat of closure, depending on what happens with other funders," he said.
A spokeswoman for the Legal Service Commission said: "The reality of the present budget position is that we do not have the funding to guarantee these increases at the present time."
The Community Legal Service is a prime example of the Government's attempts to involve the sector in public services. It replaced legal aid, which was confined to private solicitors, with a new system in 2000, involving solicitors and not-for-profit advice centres. In many cases, contracts comprise up to 90 per cent of their income.