The UK government has asked train firm GNER to surrender its £1.3bn-franchise on the main London to Edinburgh route.
GNER has faced financial woes since the London bombings, as passenger numbers dipped, power prices rose and Network Rail's compensation payments declined.
As a result it would not have been able to meet the terms of the franchise, which involved paying hundreds of millions of pounds to the government.
The government has invited new bidders for the route franchise.
It is not yet clear whether GNER and its parent company, Sea Containers, will bid for the contract, though a spokesman for GNER suggested it was likely.
Sea Containers recently sought protection from its creditors under US bankruptcy law.
"The government made it clear that rail operators that fall into financial difficulty should expect to surrender the franchise and not receive financial support," said Transport Secretary Douglas Alexander.
"To do otherwise could set the precedent that we are willing to bail out operators at extra cost to the taxpayer."
Analysts said that GNER's rivals First Group and Sir Richard Branson's Virgin Trains will probably table a bid.
Earlier this week, the UK government gave Virgin a £1.4bn subsidy to run the London-to-Glasgow, west-coast service and help offset high track charges.
Some rail operators have complained that the government is expecting too much revenue from their operations, making it difficult to run services profitably.
GNER is not the only train operator with funding problems
The BBC's transport correspondent, Tom Symonds, says a new competition to run the London-to-Edinburgh service will now begin, with a new contract to be signed within 18 months.
Ministers have announced a deal to allow GNER to continue to run its trains until a new franchise can be signed.
According to Robert Mackenzie, chief of executive of Sea Containers and chairman of GNER, the rail company did not breach its franchise agreement but would not be able to meet payments that were due to start in May.
"We would have preferred a renegotiation of the current contract, but that was not available," said Mr Mackenzie.
GNER has been unable to meet the terms of the franchise, which required revenue growth of 10% last year.
As well as running to Edinburgh, the East Coast Main Line also goes to Aberdeen, Inverness and Glasgow.
Unions criticised the development, which comes at a time when GNER is embroiled in a dispute over working hours.
"Priority number one must be for the government to tell GNER today that its plans to cut jobs across the franchise will not be allowed to proceed," said Bob Crow, general secretary of the Rail Maritime and Transport Union.
"The franchising process is now in complete disarray and there should be an immediate moratorium on the whole process."
Gerry Doherty, general secretary of the Transport Salaried Staffs Association, said the situation provided further evidence that the franchise system was not working in the public interest.
"GNER is losing the contract because it cannot afford to pay £1.3bn to run the service, while at the same time the government is giving Sir Richard Branson £1.3bn to run the West Coast line," he said.
"At least Sir Richard will now be able to afford to bid for the East Coast line at the taxpayers' expense. What a farce.
"The sooner it is taken back into the public sector and run for the benefit of passengers, the better."