Fifa have banned Chelsea from registering any new players in the next two transfer windows.
The world's governing body have handed down the punishment after French clubs Lens made an official complaint over Chelsea's signing of their young player Gael Kakuta in 2007.
Fifa's Dispute Resolution Chamber (DRC) has now found in Lens' favour and ruled that the Blues are 'jointly and severally liable'.
As such, the Stamford Bridge club have been banned from signing players over the next two transfer windows, which means they will not be able to bring in any new faces until 2011.
18-year-old Kakuta, a regular in Chelsea's reserve side, has also been banned from playing for the next four months and fined £680,000.
Chelsea are also liable over Kakuta's fine, and they also will have to pay Lens £113,000 in compensation.
A Fifa spokesperson stated: "This decision confirms our aim to ensure contractual stability. It is an important ruling for football in general."
The full statement from Fifa reads: "On the occasion of its last meeting held on 27 August 2009, the Dispute Resolution Chamber (DRC) was called to pass a decision in a contractual dispute opposing the French club Lens to the French player Gael Kakuta and the English club Chelsea.
"The French club had lodged a claim with Fifa seeking compensation for breach of contract from the player and requesting also sporting sanctions to be imposed on the player and the English club for breach of contract and inducement to breach of contract respectively.
"The DRC found that the player had indeed breached a contract signed with the French club. Equally, the DRC deemed it to be established that the English club induced the player to such a breach.
"As a result the player was condemned to pay compensation in the amount of €780,000, for which the club, Chelsea, are jointly and severally liable, and sporting sanctions were imposed on both the player and Chelsea in accordance with art. 17 par. 3 and 4 of the Regulations on the Status and Transfer of Players.
"A restriction of four months on his eligibility to play in official matches has been imposed on Kakuta. Chelsea are banned from registering any new players, either nationally or internationally, for the two next entire and consecutive registration periods following the notification of the present decision. Furthermore, the club, Chelsea, have to pay Lens training compensation in the amount of €130,000."
Chelsea, who have yet to comment on the sanction from Fifa, do have the right to appeal the decision to the Court of Arbitration for Sport (CAS).
The Blues are not the first club to have been punished in such a way.
Roma were also given a ban for two transfer windows following defender Philippe Mexes' move from Auxerre in 2004.
Roma appealed to the CAS and had the ban cut to one transfer window. If the same situation was repeated it would mean Chelsea being unable to sign players until next summer.