The freezing of care home fees by Sefton Council has been ruled unlawful by the High Court.
The council, which froze fees paid to private care homes for elderly residents for the second year in a row due to budget constraints, has been told to reconsider its decision.
Judge Raynor QC said the council had failed to properly assess "the actual costs of care".
The legal action was brought by Sefton Care Association.Contrary to guidance
The association represents the interests of 40 home operators providing about 1,600 beds and four individual proprietors.
David Collins, managing director of David Collins Solicitors, who brought the case for the association, said: "There is every reason to believe other councils are doing exactly the same as Sefton."
Judge Raynor ruled that Sefton Council "failed adequately to investigate or address the actual costs of care with the claimants and other providers", which was contrary to relevant guidance.
The judge said setting fee levels significantly below actual cost would inevitably lead to a reduction in the quality of service provision which "may put individuals at risk".
A spokesman for labour-controlled Sefton Council said: "The judgment does not say that we have made the wrong decision.'Massive impact'
"It is merely critical of some elements of the process we went through. The proposal not to increase fees for care homes has not been criticised.
"A large part of our budget spend is on this type of care and we have to get the best possible value."
Dr Ros Altmann, director general of Saga which specialises in services for the over-50s, said: "I expect many local authorities have been taken aback by this ruling, and quite a few legal and financial teams scrambled to assess what could be a massive impact upon the way councils fund care for older people, and how this ruling could reach far and wide."
Sefton council's decision to freeze fees paid for 2011-2012 was made in December 2010.
The council has the 13th highest proportion of people aged 65 and over in England, with 1,595 people placed at residential and nursing care homes.