The government quango, which funds education and training for people aged 16 and over, claims the charity failed to meet its contractual objectives.
The man in charge of the charity does not wish to be named, fearing court action could jeopardise his home as well as his charity's future. In contrast to his organisation's small budget for fighting the case, the LSC received £10.4bn from the Government in 2006/07.
His case has been taken up by the NCVO, which said the terms of the LSC contract broke at least six provisions of the Compact code on funding and procurement.
"We are concerned by this extreme action," said Stuart Etherington, chief executive of the NCVO. "It is disconcerting that the LSC allowed this situation to get so severe."
Etherington has written to Alan Johnson, Secretary of State for Education and Skills, urging him to consider abandoning legal proceedings in light of the Compact breaches.
His letter also expresses concerns about the LSC's frequent infringements of the Compact, the agreement between voluntary and public bodies outlining how each should behave towards the other.
"We have identified several breaches in the Compact by the LSC that may well have contributed to the organisation not being able to demonstrate meeting its objectives," wrote Etherington. "We have tried to liaise directly with Mark Haysom, chief executive of the LSC, but he has not responded."
Cathy Robinson, the LSC's solicitor, said: "The LSC does not consider it has breached the compact in this case and will treat voluntary sector organisations in the same way as any others that receive public funding."