United lost 3-2 at home to a fearless and skilful Athletic Bilbao, their second successive European defeat at Old Trafford, in the first leg of their round-of-16 tie.
Central defender Xandao scored with a cheeky backheel to give Sporting a 1-0 win over City in Lisbon, ending the Premier League leaders' run of six straight wins.
Valencia, 4-2 winners over PSV Eindhoven at home, and Atletico Madrid, who beat Besiktas 3-1, completed an excellent night for Spanish clubs.
A Luuk de Jong penalty gave Twente Enschede a 1-0 win at home to Schalke 04 and Olympiakos Piraeus won by the same score away to Ukraine's Metalist Kharkiv thanks to David Fuster's second-half strike, the Greek champions' ninth successive win in all competitions.
AZ Alkmaar beat Udinese 2-0 and Standard Liege were held 2-2 at home by Hannover 96 in the other ties.
United, beaten 2-1 at home by Ajax Amsterdam in the previous round, have won only once in five European outings at Old Trafford this season.
"We were well beaten, they were the better team," manager Sir Alex Ferguson said in a television interview.
"Our defending wasn't very good tonight, our attacking play was very open at times."
Athletic took the game to United, pressuring them in their own half in a style which has become the trademark of their eccentric Argentine coach Marcelo Bielsa who led Chile to the last 16 of the 2010 World Cup.
Although Wayne Rooney gave United a 21st minute lead, it was completely against the run of play and Athletic continued to push forward, creating numerous chances while Bielsa paced up and down his technical area, immersed in thought in his characteristic style.
The equaliser came in the 41st minute when a well-worked move ended with Fernando Llorente ghosting in to meet Markel Susaeta's chipped cross with a powerful low header.
Athletic's fans outsung the home supporters and were given more to celebrate in the 71st minute with a superbly worked move which ended with Ander Herrera flicking the ball over the United rearguard for Oscar De Marcos to hook the ball in with a first time shot.
That goal had also been on the cards and it got worse for the hosts with a bizarre third which stemmed from a free-kick awarded to Bilbao because United defender Patrick Evra kicked the ball after his left boot had fallen off, infringing the rules.
Athletic swiftly attacked and De Marcos' shot was parried by David de Gea. Although there seemed to be no Athletic player in sight, Rafael was caught napping and the always dangerous Iker Muniain stole in to fire the ball into the roof to net.
"I don't know how you describe the third goal," said Ferguson.
Rooney pulled one back with a injury-time penalty to keep U
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