The woman had complained that the council failed to tell her funding of £90 per week, which she was receiving from the council for looking after her step-granddaughter, would be withdrawn after she obtained a residence order from the courts.
She said that the council's policy on funding was too rigid and failed to take account of her particular circumstances.
The Ombudsman said she was let down by the council and found fault by the council because it failed to tell the woman what the payments it made to her were for, or whether they were time limited and did not carry out the means test before she went to court for the residence order, contrary to its own policy.
A report into the issue said: "While councils have responsibilities to children in need, they also have responsibilities to provide proper support to those people who agree to take on the primary care and upbringing of such children."
The council has agreed to a raft of changes to remedy the situation, including reviewing its policy in relation to residence order allowances and including a review of its means test.
It has also agreed to pay £7,500 compensation to the woman, plus £90 a week until she is reassessed under a new means test, when it is finalised.
