Discussions over the sale of the Aurigny Group to rival airline Blue Islands have ended, Guernsey's Treasury and Resources Department has announced.
It concluded that it could not be certain the Gatwick slots would be safeguarded under the proposed plans.
It was also not sure the combined airline would become, and remain, profitable in the long-term.
The two sides had been undergoing due diligence checks, but no confidential information had been exchanged.
Cabernet Limited - which owns Aurigny Air Services and Anglo Normandy Aeroengineering - and Blue Islands were informed of the department's decision on Monday.
The department said it recognised the last two months, since negotiations were made public in July, had been "a trying time" for Aurigny staff and the department wished to place on record its gratitude for their patience and loyalty.
It said it now intended to focus its efforts on working collaboratively with the board and management of the Aurigny Group in developing a strategy for reducing the group's losses.
In November Aurigny announced a £1.5m loss in 2008 and its chairman said it was not expected to make a profit until 2011 at the earliest.
The States bought the group for about £5m in 2003.