The decision comes as a blow to Drax, which plans to convert its coal plant in Yorkshire, England.

Two units were shortlisted for conversion in December to receive contracts under the government scheme.

The government is changing the way in which it supports renewable energy projects by replacing a mechanism for direct subsidy payments with a system where qualifying projects are guaranteed a minimum price at which they can sell electricity.

Drax said in a statement: “Nothing has changed, as far as our plans are concerned, between being deemed eligible in December and now. We have, therefore, commenced legal proceedings to challenge the decision.”

The legal challenge will set precedence in testing the legal framework of the subsidy scheme, due to start in April 2015.

The outcome could sway investors in future biomass conversion projects.

The government said the project for converting Drax's Unit 3 at the plant did not meet all its assessment criteria for the new Contracts For Difference scheme.

It recommended that Drax continue to use the current direct subsidy scheme, which analysts said was less lucrative.

Drax pledged regardless of the outcome of the legal challenge, it would continue with the biomass conversion project.