Peter Carroll, from the Gurkha Justice Campaign, said the fight to allow them to stay in this country would continue with renewed vigour.
He added: "The one group of people that has never let this country down has been let down today in a manner which is truly appalling."
David Enwright, a solicitor representing the Gurkhas, said: "This government, Mr Woolas, should hang their head in shame so low that their forehead should touch their boots.
"This is a disgrace and a betrayal of our armed forces and our veterans."
Dhan Gurung, the first ex-Gurkha to be elected as a councillor in the UK, said the announcement was "insulting to loyal Gurkhas".
He added: "If they want Gurkha soldiers, they should treat them equally."
Three years continuous residence in the UK during or after service
Close family in the UK
A bravery award of level one to three
Service of 20 years or more in the Gurkha brigade
Chronic or long-term medical condition caused or aggravated by service
Gurkhas who retired before 1997 must meet at least one of these conditions
But Prime Minister Gordon Brown insisted the new rules were fair and took into account "the responsibilities we have accepted" towards the Gurkhas.
"To go back 20 years from 1997 is something that's a major change in policy and will help a large number of Gurkhas if they wish to make the decision to come to Britain," he said.
"And remember that there are costs involved in that decision that we have got to meet."
Gurkhas have been part of the Army for almost 200 years and are hand-picked from a fiercely-contested recruitment contest in Nepal to win the right to join.
They have seen combat all over the world, with 200,000 having fought in the two world wars and 45,000 believed to have lost their lives fighting for Britain.
The regiment moved its main base from Hong Kong to the UK in 1997 and the government had argued that Gurkhas discharged before that date were unlikely to have strong residential ties with the UK.
That meant those who wanted to settle in the UK had to apply for British residency and could be refused and deported.
Gurkhas are known for their bravery and fighting spirit
Mr Woolas outlined the eligibility criteria in a written ministerial statement. Gurkhas and their families will be allowed to stay in the UK if they meet at least one of five requirements.
These are three years of continuous residence in the UK, close family in the country, 20 or more years of service, a level one to three bravery award, and a serious medical condition caused or aggravated by service.
Alternatively, veterans can gain residency if they meet at least two of an additional set of three criteria.
These are having been awarded an MoD disability pension but no longer having a chronic condition, having been mentioned in dispatches, and 10 years' service or a campaign medal.
But Ms Lumley, whose father served with the Gurkhas, said most Gurkhas would not have been allowed to stay in the UK for three years or have gained a bravery award.
She added that only officers would have achieved 20 years of service, and that it would be near-impossible for troops who served in the 1950s and 1960s to prove that their medical conditions were caused by their time in the forces.
"They've given five bullet points that virtually cannot be met by the ordinary Gurkha soldier," she said.
"It is so obvious that the treatment of the Gurkhas has been a huge injustice," she said.
"To treat them like this is despicable."
Awarded a UK MoD disability pension but no longer have a chronic medical condition
Mentioned in dispatches
Service of 10 years, or a campaign medal for active service
Gurkhas who retired before 1997 must meet at least two of these conditions
The Home Office said that as a result of the decision, a total of 4,300 Gurkhas who served prior to 1997 would be eligible for residency.
A spokesman added there were currently 1,300 applications outstanding, 300 of which would now be granted.
In September, Mr Justice Blake ruled that instructions given by the Home Office to immigration officials were unlawful and needed urgent revision.
He said the Gurkhas' long service, conspicuous acts of bravery and loyalty to the Crown all pointed to a "moral debt of honour" and gratitude felt by British people.
The government promised to revise its guidance, but in March 2009, the Gurkhas returned to the High Court to try and enforce the ruling.
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