Citizens Advice Northern Ireland is arguing that the Department of Enterprise, Trade and Investment did not properly carry out due diligence when the contract was awarded last month.
In a preliminary hearing in the High Court in Belfast yesterday, the charity's barrister said many of Advice NI's members were specialist charities such as disability and mental health charities whose objects would permit them to give advice only to their own client groups.
Citizens Advice Northern Ireland is also questioning whether Advice NI's members have sufficient data-protection measures in place.
Derek Alcorn, chief executive of Citizens Advice in Northern Ireland, said the organisation had a very good working relationship with DETI and regretted having to take the court action, but that in the absence of an appeal mechanism there was no other course open to it.
His organisation had lost out earlier this year to private sector company A4e in bidding for a separate contract to run a telephone debt advisory service, he said.
In the case of the A4e win, Alcorn said the procurement panel had failed to exercise due diligence.
"We feel the same in this instance, and have queried a number of aspects of the process and raised a number of points of law," he said.
Bob Stronge, chief executive of Advice NI, criticised Citizens Advice Northern Ireland's legal action and warned that it risked antagonising the DETI and making it less likely that the department would award contracts to charities in the future.
He also warned that the legal action would see the money for the debt advice contract - worth £800,000 until 2011 with a possible extension until 2014 - disappear if it was not allocated by next March.
The case is expected to be resolved at a final High Court hearing on 29 October.