In 1937, Orson Welles was producing (and directing and acting in) plays for the Federal Theater Project, which was part of the government's Works Progress Administration. His first three productions (an all-Black production of Macbeth, a surreal farce called Horse Eats Hat, and Christopher Marlowe's Doctor Faustus) had been very successful, and then he announced that the fourth production from Project 891 (his Federal Theater production company) would be The Cradle Will Rock, a "labor opera" by a young playwright named Marc Blitzstein.
Welles had originally agreed to direct this show for the Actors Repertory Company, but when they couldn't come up with the funding, he decided to do it for Project 891. This caused quite a furor in Washington. They had already had to force Welles to change some lines in Horse Eats Hat which were considered too risque (they are very bland by today's standards, of course). But The Cradle Will Rock was considerably more troubling, since it was about the unionization of the steel industry, which was being violently disputed at that time. Then, as now, conservative factions in the government didn't want tax dollars to go towards promoting any radical art.
The government didn't want to appear to be censors, though, so they announced that because of budget cuts they weren't opening any new shows until the beginning of the next fiscal year. Welles was originally inclined to go along with this. Project 891 was a wonderful vehicle for his ideas, and also it employed a lot of people who needed the work, so he didn't want to rock the boat. And, much as he admired Blitzstein, Welles was nowhere near as radical as the playwright or the play.
Hoping to change the government's mind, however, Welles announced a special invitation-only preview of the show. This went well, but the next day the government padlocked the theater.
As Welles said, "I was very ambiguous in my feeling, and I wasn't sure that we weren't wrecking the Federal Theater by what we were doing. But I thought if you padlock a theater, then the argument is closed. If they hadn't padlocked the theater, I would never have taken that strong a stand. The padlock was an insult. That's what unified everybody, you know. The padlock was the thing that made us move."
Legally, they could put on the play somewhere else, not produced by the Federal Theater, but Actors' Equity told its members they were not to appear on stage in the show since it was the government's right to postpone or cancel a show if they wanted to, just like any other theatrical producer. Plus, by padlocking the theater the government had effectively impounded all the sets and costumes.
Both Welles and Blitzstein had mixed feelings, but they decided to go ahead and perform the show at another theater. They didn't managed to get a theater until the night before the premiere, so Welles went to the original theater and led the audience through the streets to the new location, where they were seated and the show was put on.
Since the actors were prohibited from appearing "onstage," the stage was bare except for Blitzstein himself, at the piano, and the actors were spread out through the audience, standing up as it came time to perform their parts.
(Some accounts say that the actors' participation was not planned. Blitzstein was on the stage, performing all the parts, and then Olive Stanton, the homeless actress who was the star of the play, stood up in the audience and started to sing her part. The other actors followed suit. This is the version that is shown in Cradle Will Rock, Tim Robbins' excellent film about these events.)
The news of the company's defiance of the government was big news, of course, and the show was packed. The next day, Welles attempted to get the government to back down and let them use the original theater, with the sets and costumes, but they didn't budge.
Actors' Equity dropped their ban after the first night, though. However, the show continued to be performed from the audience for the rest of its run. It has often been performed this way since, too.
This was the end of Welles' work for the Federal Theater (as you can probably imagine) and so he was forced to start his own company, The Mercury Theatre. He had just turned twenty-two, by the way.
(For a more complete account, please refer to Barbara Leaming's excellent Orson Welles: A Biography, from which this account was drawn.)