The Office of the Third Sector might have withdrawn grants worth £750,000 to voluntary organisations because of political fears about the unpopularity of the causes involved, according to some of the organisations affected.
Thirty-two voluntary organisations were offered grants in October as part of the campaign research programme, which was set up to stimulate campaigning among groups working with vulnerable people.
Those selected included organisations working with ex-offenders, refugees, transgendered people and Gypsies.
But third sector minister Angela Smith suddenly announced on Friday that funding had been withdrawn and reallocated to the £16.7m hardship fund, which helps charities that provide front-line services to disadvantaged people.
A spokesman for the OTS admitted the decision, which was taken without consultation, breached the Compact, but said the Government's priority was supporting charities during the recession.
The decision provoked legal threats from umbrella body the NCVO, whose chief executive Stuart Etherington said the move was "completely unjustified".
His organisation is studying the contracts signed by the OTS to see whether charities could launch legal claims against the Government.
Richard Corden, chief executive of the Commission for the Compact, said the OTS decision was "deplorable". Kevin Curley, chief executive of local infrastructure group Navca said it undermined confidence in the OTS.
Some of the organisations selected to receive awards said believed political considerations might have played a part in the U-turn.
"We thought at first that someone had looked at the list and freaked out," said Jerome Phelps, director of the London Detainee Support Group, which works to improve the welfare of immigration detainees.
Phelps said he was surprised when Capacitybuilders, which was delivering the scheme on behalf of the OTS, selected his organisation because it planned to expose government abuses.
"This is a shoddy way for the Government to be treating the sector," he said, "I hope somebody will be called to account."
Successful applicants were promised an initial sum of £4,000 this month and up to £15,000 to follow.
"It's devastating; we put a lot of work into it," said Ann Owen, secretary of volunteer-run Houghton Racecourse Community Access Point, which helps young people.
Rikki Arundel, founder of social enterprise GenderShift, which planned to run a campaign highlighting the health inequalities facing transgendered people, said: "It is extremely disappointing. This campaign is really important for the transgendered community."
Arundel added: "I can't see how the transfer of such a small sum as this is going to make much difference to the hardship fund, unless it's also getting a much larger sum from somewhere else.
"I suspect the Government is terrified that the Daily Mail and the Sun would spread it across the front cover and make it look like it's supporting all the loony left causes."
Capacitybuilders selected a four-person panel, consisting of Angela Sarkis, Titus Alexander, Rachael Stokes and Jessica Ellis to select beneficiaries. A spokeswoman said it was not consulted by the OTS about the decision to scrap the scheme.
An OTS spokesman said "This decision was taken because of the pressing need to support the sector through the recession. It was a difficult decision, but in the current circumstances the minister believes it is right that we channel money into supporting organisations providing vital recession services to the most vulnerable and disadvantaged people in society."