The National Council for Voluntary Organisations is to ask the National Audit Office to investigate "outrageously bad funding practice" that could prevent charities bidding for the £70m Communitybuilders programme.
The two-year programme, which offers loans and grants for community cohesion projects, has £28m left to distribute.
But the Social Investment Business, which manages the programme on behalf of the Communities and Local Government department, told potential applicants last month that it would no longer consider bids unless they could spend any funds they received by 31 March 2011.
The announcement, which it blamed on the Treasury's demand that money be pledged and spent within the same financial year, means that applicants could have as little as seven weeks to spend the money because decisions on bids are due by 11 February.
Ben Kernighan, deputy chief executive of the NCVO, said he would ask the NAO, which scrutinises public spending, to consider the matter: "Ministers should step in to allow this money to be spent over a proper period so that the aims of the fund can be properly achieved. I will ask it to look into what appears to be an example of outrageously bad funding practice."
He said: "Funders should be designing their funds to achieve outcomes over proper timescales. Why is the Social Investment Business making decisions about this year's funding seven weeks before the end of the financial year? This is public money."
Melanie Carter, public law partner at the specialist charity law firm Bates Wells & Braithwaite, released a statement saying the new timescale was "wholly impractical for bidders" and appeared to be unlawful.
"The government will be opening itself up to claims by successful bidders that they had a legitimate expectation of a period longer than just seven weeks in which to spend these funds," said Carter.
"If the government has led voluntary organisations to believe that they could spend into the next financial year and those voluntary organisations will now lose money as a result of this change, I would expect a challenge to succeed."
Louise Whitfield, a solicitor for Pierce Glynn, told Third Sector that a judicial review could be an option, although she urged affected parties to find out how CLG and the SIB made the decision first.
An SIB spokeswoman said it was still working with CLG to find a solution. "We told organisations whose applications would be affected by this change in government rules as soon as possible," she said.
"Our investment team is working extremely hard to help people review their applications so they are still able to access Communitybuilders funding, and we are doing everything we can to ensure that as many projects as possible are unaffected."