A £3.4 million project was intended to convert the former United Reformed church in Spencer Street into a new home for the Loft Theatre, leading to £6 million of private sector investment including redeveloping the theatre's current site and that of the neighbouring dole office as premises for start-up businesses.

But regional development agency Advantage West Midlands told Warwick District Council there was "no likelihood" it could continue the funding because of £40 million savings demanded by the Government.

The council has already bought the church and its leader Cllr Michael Doody said he had contacted AWM chairman Sir Roy McNulty to demand it honoured the agreement.

He said: "Advantage West Midlands is saying the finances are being cut and we will not get it but we have a signed agreement with them to pay the money.

"My understanding is, when you sign an agreement like that, you keep it. A knight of the realm's signature should stand for something."

Cllr Doody said Advantage West Midlands had offered to pay enough for the authority to honour its agreements, but insisted the benefits would be far greater if the work went ahead.

He ruled out doing nothing and said he had been in "very positive" discussions with Loft Theatre chairman Michael Rayns and had support from Warwick and Leamington MP Chris White.

Mr White has written to business and enterprise minister Mark Prisk to ask if the agency could "unilaterally" breach its contract. He told the minister the project was of "vital" importance to the town's economic development.

He said: "Anything that's going to help create jobs in the constituency has to be a good thing.

"It's a question of making a strong case. I don't think this is over by any means."

The MP denied the project would be a victim of government cuts, adding "The government hasn't asked for anybody to stop funding the Spencer Yard project. This is an AWM issue."

The coalition government has announced it will be abolishing regional development agencies by March 2012.

An Advantage West Midlands spokesman said the agency was reviewing all 600 of its funded projects and was in discussions with district council officials and others involved to resolve the situation.