The former chief executive of the NHS trust at the centre of a superbug scandal in which 90 patients died will not receive any severance pay.
Rose Gibb resigned ahead of the Healthcare Commission's report
Health Secretary Alan Johnson said Maidstone and Tunbridge Wells NHS Trust may have acted unlawfully in agreeing the cash package for Rose Gibb.
Ms Gibb resigned days before the Healthcare Commission criticised the trust over Clostridium difficile.
Health campaigners welcomed the news, saying it was "justice".
Geoff Martin, from campaign group Health Emergency, said: "It was always well out-of-order the health trust was even considering making a pay-off.
"The idea taxpayers' money would have been paid to her after the chaos that reigned across the Maidstone and Tunbridge Wells trust, and the dire consequences, would have been absolutely appalling."
He said campaigners wanted to see the same approach taken to chiefs of other health trusts which fail.
And he added: "It's still not going to bring back the 90 people who died - it's not the end of the story.
"There is still a police investigation into the notion of corporate manslaughter."
Mr Johnson made the announcement on a visit to Maidstone Hospital on Thursday, where he met staff and patients.
He said legal advice showed the correct process had not been followed.
"The trust, under the leadership of the new chairman, has decided it will not, at this time, be paying any of the severance package originally agreed," he added.
He said leadership of the trust had "failed completely".
The trust has never confirmed the amount of the package.
Maidstone was one of three hospitals where patients died following two outbreaks of C-diff.
Relatives of C.diff victims marched to Downing Street
Mr Johnson said the hospitals - Maidstone, Pembury and the Kent and Sussex at Tunbridge Wells - would be among the first in England to be deep cleaned and would get an extra £350,000 to pay for the work.
He also named the preferred bidder appointed to build a new £228m Pembury Hospital, starting in the New Year.
The hospital, expected to be completed by 2010, will replace Pembury and the Kent and Sussex.
"The new hospital at Pembury is a hugely significant development," said Mr Johnson.
"With a new leadership team in place the trust can now look to the future."
Director leaves post
Mr Johnson's visit coincided with a march through London to Downing Street by about 50 friends and relatives of people who died.
They carried a banner with the names and faces of 80 of the C-diff victims.
The trust also revealed on Thursday that the former director of nursing, Bernard Place, had left his post.
A statement said that following discussions between Mr Place and the trust about the recommendations of the Healthcare Commission report, he had "accepted that his employment be terminated by mutual agreement".
Trust chairman George Jenkins said he was reviewing the leadership of the health trust and reviewing Ms Gibb's severance arrangements.
He said: "Due process is being followed and until these processes are complete, including referral to HM Treasury, the trust will not be making any severance payment to Ms Gibb. This is being examined as a matter of urgency."
He said the trust was now "making great strides" in reducing C-diff rates.