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The government has been told that it is not legally obliged to pay compensation to workers who lost their pensions due to company insolvency.

But the European court of justice commented that the pension protection schemes currently in place in the UK are both "inadequate" and "incompatible with community law".

The case was brought to the EU court by trade union Amicus, which was representing workers affected by the collapse of Allied Steel and Wire and United Engineering Forgings in 2002.

While the court's decision will not directly result in these employees receiving compensation, the case will now be taken back to the high court.

The court of justice revealed that 35,000 people in Britain lost half of their pension benefits in 2004, while more than 65,000 lost 20 per cent.

Its ruling was based on whether Westminster should have done more to protect workers' pensions under the EU insolvency directive; created 24 years ago.

Although the court said that the Department for Work and Pensions (DWP) "did not provide them with the level of protection called for by the directive", it ultimately ruled that the directive "cannot be interpreted as demanding a full guarantee of the rights in question".

In response to today's ruling, the DWP said that while it had "every sympathy" for those who have lost their pensions", it thought the decision was a "common sense judgement which recognises that [the EU insolvency directive] does not require member states to ensure pensions are guaranteed in full".

"We note that the court appears to have given a steer that damages may not be payable, but this is now a matter for the high court to decide. It would be inappropriate for us to comment further at stage," a spokesperson added.