People selling violent or pornographic films to children are not breaking the law because of a mistake made in 1984.
It has emerged that a 25-year-old Act regulating the video industry was never reported to the European Commission and so is not valid.
Lavinia Carey, Director-General of the British Video Association, said: “What a ludicrous situation to find ourselves in after all this time.”
The Lib Dems said the error had “thrown film censorship into chaos”.
The Department for Culture, Media and Sport said that it had received legal advice that people who had previously been prosecuted and convicted would be unable to overturn their convictions or seek compensation.
The Government will bring in emergency legislation to make the law effective.
Nearly 2000 convictions were made under the Act between 1995 and 2007.
Barbara Follett, Minister for Culture and Tourism, said: “Unfortunately, the discovery of this omission means that, a quarter of a century later, the Video Recordings Act is no longer enforceable against individuals in United Kingdom courts.”
In a letter to representatives of the video industry, Barbara Follett said: “As the then British Government did not notify the European Commission of the VRA’s classification and labelling requirements, they cannot now be enforced against individuals in UK courts.”
A spokeswoman for the Home Office said: “The important thing is that we close this loophole as quickly as possible.”
“No one should see this as a green light to act unlawfully. We will continue to prosecute breaches vigorously once this technical loophole is closed,” she added.
Lawyers discovered the error while going through the Act before ministers amended it to create a new video games classification system.
Earlier this month, research emerged that showed almost all 14 to 17-year-olds had viewed online pornography.
Research carried out in 2005 found that 93 per cent of boys and 62 per cent of girls had viewed pornography by 18.
Another study, by children’s charity Beatbullying, found more than a third of teenagers have received indecent sexual images by text message or email.