Ofgem has publicly threatened Utilita with a ban on new customers.
The energy regulator said the challenger supplier will face the sanction if it does not stop installing cheaper first-generation smart meters (SMETS1), which are known to stop working properly when customers switch suppliers, "at volume".
Ofgem said Utilita's actions are undermining the smart meter rollout, which will help enable the UK to "transition to a more flexible energy market and the move to a low carbon economy".
New rules were introduced nearly 18 months ago obligating suppliers to offer the newer second-generation SMETS2 smart meters - which enable "smart meters to operate reliably for all consumers regardless of their energy supplier" - where possible.
Ofgem said in a statement that the supplier "will have to install 15,000 second generation meters by July 31 2021 or be banned from taking on new customers".
The regulator is now considering whether a final order compelling the supplier will be required and fines issued for the failures.
Charles Hargreaves, Ofgem's Deputy Director of Conduct and Enforcement, said: "Smart meters are vital for upgrading Great Britain's energy infrastructure, enabling customers to be better informed and engaged in managing their energy consumption by providing them with real time information on their energy use.
"Ensuring all energy suppliers take all reasonable steps to install SMETS2 meters for new and replacement meters is critical to the success of the smart meter rollout."
Utilita boss, Bill Bullen, said the company was “shocked and disappointed at the tone of Ofgem’s announcement”.
He said: “To say we have been ‘failing to act on smart meters’ is grossly unfair – in fact, we have led the way in prepay smart energy, installing the first smart meter in Britain in 2005, many years before the national rollout began and before any government obligation was introduced. Since 2005, we have installed effective smart meters in 90% of our customers’ homes, giving many vulnerable and low-income households the best energy service they have ever experienced.”
He defended the use of SMETS1 metres, saying they are “proven, secure, robust and reliable" for pay-as-you-go customers.
He said: "Serving PAYG energy households effectively is our main objective, and SMETS2 meters do not enable us to do this in the same way that SMETS 1 meters do.”
The move comes less than a month after Utilita agreed to pay £500,000 in compensation for mistakenly overcharging 40,000 pre-payment customers. The supplier reported itself to the regulator. The company apologised for the error, which related to overcharging between May and September 2019.