The DoH confirmed it had terminated the south London ISTC scheme procurement process, which had reached preferred bidder stage with Clinicenta, earlier this month.
Under new EU procurement rules, the DoH is likely to have to pay the company millions of pounds in compensation.
The£35m contract would have provided a new surgical centre at Queen Mary's Hospital in Sidcup, with existing facilities receiving varying degrees of refurbishment. Clinicenta would have provided clinical services including ear, nose and throat, general surgery, ophthalmology, urology, trauma and orthopaedics from April 2008.
A statement from Queen Mary's Sidcup trust said: 'This a sensible decision considering that health services are currently under review locally and across the country.'
The cancellation marks another contraction of the wave-two procurement, which has been running since March 2005. It was originally expected to deliver 250,000 procedures a year and create an extended choice network that would deliver an additional 150,000 procedures and cost£3bn over five years.
The wave-two procurement has been less attractive to independent bidders because, unlike the first wave, it does not guarantee payment irrespective of the number of procedures carried out.
Only two contracts have been signed, both with BUPA, and volumes are down to 130,000 procedures a year. Of the 24 contracts initially up for grabs, a combination of DoH cancellation and providers walking away leaves just 13. This is expected to fall further.
A DoH spokesperson said the south London cancellation was 'strategic and operational'.
'The DoH is in discussion with NHS London to consider how best to move forward, with the aim of ensuring healthcare services are effective, accessible, and best meet the needs of the local community.'
NHS London remained on course to meet the 18-week referral to treatment target, he added.
However, cancellation is likely to be linked to the precarious financial situation of four heavily indebted acute trusts in south London, each of which is seeking to treat more patients.
David Loasby, spokesman for NHS Partners Network, which represents ISTC providers, said: 'We are disappointed that wave two programmes have been scaled back. Inevitably it shakes investor confidence and our willingness to bid for future schemes.'
- London turnaround director Anthony Sumara has taken over as acting chief executive of Bromley Hospitals trust. The trust faces historic debts of£87m and needs to save£12.5m a year.
New player in ISTC market
A company part-owned by GPs and consultants is entering the independent sector treatment centre market.
Centres of Clinical Excellence - which describes itself as a partnership of healthcare professionals and also has funding from City institutions - has taken over Nations Healthcare.
Nations already operates ISTCs in Burton and Bradford and is due to run the country's largest single ISTC in Nottingham.
The two existing ISTCs are expected to provide a total of 90,000 procedures over their contract period. The Burton centre, in particular, needs to increase throughput. MP Charlotte Atkins told Parliament earlier this year that one primary care trust with a£2m annual contract had sent just 59 patients there in six months.
Centres of Clinical Excellence managing partner Dr Ali Parsa said GPs are more likely to refer to centres where they know the doctors and understand what work the unit does, he said.
The company has also got planning permission for a£20m private hospital near Bath and plans to build around 20 more around the country.