A scheme under which jobseekers can lose benefits if they do not complete up to 30 hours a week of unpaid "work experience" is in disarray after companies and charities abandoned it in the wake of public anger.

The clothing retailer Matalan suspended its involvement in the Government project pending an internal inquiry after claims that the scheme was exploitative. Tesco delivered an ultimatum to the Department of Work and Pensions (DWP) demanding that ministers guarantee no one would lose their benefits, while both Oxfam and Shelter added their names to the list of organisations which have left it altogether.

The discount shop 99p Stores said it had also signed up to the scheme but was withdrawing because of the negative publicity, having not yet taken on a single worker through it. Waterstones, Sainsbury's and TK Maxx have also expressed their opposition.

The scheme attracted renewed criticism this week after a Tesco advert offered full-time hours for no pay. Instead, workers would receive only their Jobseeker's Allowance and some expenses, the advert said.

The figurehead for the backlash is Cait Reilly, a geology graduate from Birmingham, who was told she would lose her allowance if she refused to stack shelves at Poundland for no pay. Ms Reilly has since applied to bring a judicial review of the workfare scheme.

Other participants say they have been left in no doubt they would have their benefits cut if they refused a place on the scheme, in contradiction of DWP rules. One said he was placed in a company working alongside people on community service. "I spent eight hours a day, four days a week working for no money," said one participant, who asked not to be named. "I do not object on principle, it is not an issue doing a day's work but all the studies show it does not decrease unemployment. It makes a handful of Tory MPs happy and gives free labour to a lot of very rich firms."

Tesco, which has had 300 participants, said it had urged the DWP to soften the scheme's more punitive aspects. A spokesman said: "We understand the concern that those who stay in the scheme longer than a week risk losing their benefits if they drop out before the end of their placement. We have suggested to the DWP that, to avoid any misunderstanding about the voluntary nature, this threat of losing benefit should be removed."

The Commons work and pensions select committee is to examine the programme. Its chairman, the Labour MP Dame Anne Begg, said: "There is a huge risk that people on these schemes ... do not get into full-time work."

The Minister for Employment, Chris Grayling said: "Our Work Experience scheme is voluntary and thanks to companies like Tesco and many others has provided a route for literally thousands of young people to find their first job.The idea that providing Work Experience for unemployed young people is some kind of forced labour is utterly and completely absurd."

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Cait Reilly, 22, claims she was told by a Jobcentre Plus representative that participation on the work academy scheme was mandatory and her benefits depended on it.

She found that the project, which is actually voluntary, lasted four to six weeks and included a period of training as well as a stint of unpaid work experience, which involved working for 30 hours for as little as £50.45 in jobseeker's allowance. It is supposed to be followed by a guaranteed job interview. She claims the latter never materialised.