Shortly after the local government watchdog issued a damning public interest report and warned that unless relationships on the council improved the town's people faced "a bleak future", Mayor Martin Winter issued a statement calling on national party officials to tackle what he called "the most appalling behaviour of several senior Doncaster Labour Party members".

The mayor said the findings of the district auditor's report, which focused on how the authority had controversially removed its former managing director, Susan Law, had vindicated his attack on party colleagues whom he said were attempting to rule the Labour group of councillors "through intimidation, fear and victimisation".

His comments were made against a backdrop of threatened expulsion from the party after he and two other Labour Cabinet members – Stuart Exelby and Eva Hughes – formed their own independent group on the council in the wake of the local elections.

Party officials have given the "gang of three" until the end of next week to return to the official Labour group or be kicked out of the party.

The huge schism in Labour's ranks could have significant implications both for next year's mayoral elections – when Mayor Winter may stand against Labour to try to win a third term – and the next General Election, with several members of the government threatened by the fallout.

Transport Minister and Doncaster Central MP Rosie Winterton has close links with Coun Exelby, who was her agent at the last General Election. The town's four Labour MP's, who also include Housing Minister and Don Valley MP Caroline Flint, Cabinet Office Minister and Doncaster North MP Ed Miliband, and Barnsley East and Mexborough MP Jeff Ennis, issued a joint statement in which they said the issue was a matter for the national Labour Party.

The further disintegration of party relationships in Doncaster came on the day departing district auditor Sue Sunderland said that unless councillors of all parties and the mayor "don't work together, the future is bleak for the people who live in Doncaster."

Her stark assessment was delivered to a meeting of the council's Cabinet which then discussed the findings of the public interest report, written by John Prentice, the town's new district auditor.

It found several councillors and officers had poorly handled an investigation process, which ultimately led, nearly 18 months ago, to Ms Law receiving a £120,000 pay-off and overall costs to the council of over £300,000. Strict confidentiality rules were breached and there were also failures to remain impartial.

Referring to the "Donnygate" scandal which led to criminal convictions for a series of councillors, the report said: "Overall, these actions are very disappointing and… unacceptable particularly given the council's well-publicised governance problems highlighted in the 1990s."

It also revealed the district auditor considered a corporate governance inspection of the council – the first step towards the Government directly intervening in the running of an authority. Instead the council has one year to prove it can run itself satisfactorily.

The breakdown in relationships between the mayor and managing director came after Ms Law, in December 2005, called the police in to investigate the Glass Park community project, run by Martin Winter before he became mayor. The police announced there would be no charges in June 2006 and shortly afterwards an investigation began into Ms Law's conduct.

Earlier the same year, the entire Labour Cabinet had threatened to resign over the mayor's leadership style – all but two changed their mind.

The report found the fallout between Mayor Winter and Ms Law was partly caused by tensions between the mayor and Labour councillors.

Last night a party spokesman said national officials called on all individuals concerned to work together.