The Olympic Stadium deal with West Ham United and Newham Council has collapsed, sports minister Hugh Robertson confirmed today.
Legal challenges by Tottenham Hotspur and Leyton Orient, plus an anonymous complaint to the European Commission, have led to fears that court action could drag on for years while the stadium remains empty.
The stadium will now remain in public ownership and be leased out to an anchor tenant following a new tender process by the Olympic Park Legacy Company (OPLC).
West Ham vice-chairman Karren Brady confirmed the club will bid again to become a tenant at the stadium.
Mr Robertson said: "The key point is the action we have taken today is about removing the uncertainty. The process had become bogged down in legal paralysis.
"Particularly relevant has been the anonymous complaint to the EC over 'state aid' and the OPLC received a letter from Newham Council yesterday saying because of the uncertainty they no longer wanted to proceed. That was the straw that broke the camel's back and we thought it better to stop it dead in its tracks now.
"We know there is huge interest in the stadium out there from private operators and football clubs and, crucially, we remove any uncertainty."
Some £35 million already earmarked under the Olympic Budget will be used to transform the stadium after the Games. Prospective tenants will then be asked to bid for the stadium, with the running track remaining in place.
Mr Robertson added: "This is not a white elephant stadium where no one wants it. We have had two big clubs fighting tooth and nail to get it.
"The new process will be more like how Manchester City took over the Commonwealth Games stadium, which is regarded as a leading example of how to do it."
The tenants would pay an annual rent to the OPLC, which should prove to be less costly for the likes of West Ham.
The move will also remove uncertainty over the stadium ahead of London's bid for the 2017 world athletics championships, although that was not a major consideration in the decision to abandon the current deal.
The Government, the London mayor's office and the OPLC have moved to scrap the current deal as there were fears that the legal challenges could take years to come to a conclusion.
It is understood that no contract has been signed with West Ham, allowing the move to a fresh tender process, but the club will be encouraged to bid again.
A joint statement by Ms Brady and Newham chief executive Kim Bromley-Derry said they welcomed the move.
The statement said: "Uncertainty caused by the anonymous complaint to the European Commission and ongoing legal challenges have put the Olympic legacy at risk and certainly a stadium, as we envisioned it, may not be in place by 2014 due as a direct result of the legal delay.
"Therefore we would welcome a move by OPLC and Government to end that uncertainty and allow a football and athletics stadium to be in place by 2014 under a new process. If the speculation is true, West Ham will look to become a tenant of the stadium while Newham will aim to help deliver the legacy."
Andrew Boff, Olympic spokesman for the Conservative Group on the London Assembly, said: "This catastrophe is entirely down to Sebastian Coe's insistence that the stadium should retain an athletics track after the Olympics.
"That criterion reduced the number of bidders for the site and prevented any serious sustainable regeneration plans, with the exception of that by Spurs, coming forward.
"Conservatives on the London Assembly warned the OPLC that sticking to this demand would threaten the long-term sustainable use of the site.
"Coe's masterplan has turned the Olympic legacy into the Millennium Dome mark two but with a financial climate that gives it a less positive future.
"If the Government had insisted that an athletics track had been at the Dome, would it have been rescued by AEG?
"The OPLC, the mayor and the coalition have inherited some deeply-flawed legacy plans from the previous government. They must now put those plans right.
"The Government and OPLC must now drop their demand for an athletics track to be part of any future regeneration."