Thames Water has moved closer to temporary public ownership after Environment Secretary Emma Reynolds objected to its proposed £10billion rescue plan.
She warned the deal would overburden customers and fail to fix the company’s operational and environmental problems.
Ms Reynolds is understood to regard the creditors' plans as "weak", particularly in light of what she described as "15 years of mismanagement and failure" at Thames Water.
The Environment Secretary is expected to update Parliament on the situation on Tuesday.
The rescue package has been proposed by London & Valley Water, a consortium backed by major hedge funds including Elliott Management and Silver Point Capital.
Under the plans, creditors would inject £3.35billion of fresh equity into Thames Water and establish a new £6.55billion debt facility designed to stabilise the company's finances.
In return, the consortium wants Ofwat to accept a series of undertakings on future investment rather than imposing financial penalties linked to pollution incidents and leakage failures until 2030.
The creditors have also proposed writing off £9.4billion of Thames Water's existing debt and have pledged to invest £20billion into the business during the five years to 2030.
Emma Reynolds objects to the proposed £10billion rescue package
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However, the restructuring package would cost Thames Water almost £750million in associated fees and expenses, including payments to bankers, lawyers and advisers involved in the process.
Thames Water supplies water and wastewater services to around 16 million customers across London and the south-east of England, making it the largest water company in the UK.
The utility has spent years battling a growing debt burden that has now reached almost £20billion and is expected to exhaust its available cash resources by October unless fresh funding is secured.
Concerns over the company's financial stability first emerged three years ago, prompting the Government to prepare contingency plans in the event of a collapse.
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Ms Reynolds slammed "15 years of mismanagement and failure" at Thames Water
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The company has also faced sustained criticism over its environmental record, including sewage discharges into rivers and persistent leakage issues across its network.
In May last year, Ofwat imposed a record £122.7million fine on Thames Water after finding breaches of rules relating to sewage spills and shareholder payouts.
The utility has additionally faced scrutiny over executive remuneration during a period in which it has come under increasing pressure over its operational performance.
The Government has consistently maintained that its preferred outcome would be a market-led rescue of the company, although ministers have repeatedly stated they would intervene if required.
Should the proposed rescue package fail to secure approval or if creditors decide to withdraw their support, Thames Water would be expected to enter a special administration regime.
Under such an arrangement, Government-appointed managers would take control of the company to ensure services continue operating while a longer-term solution is pursued.
Supporters of special administration argue it would allow Thames Water to be restructured, force existing investors to absorb losses and potentially enable the business to be sold without its substantial debt burden.
However, ministers are understood to be concerned that placing Thames Water into public control could have a "chilling effect" on future infrastructure investment across the UK at a time when the Government is seeking greater levels of private sector funding for major projects.
Ofwat would still need to conduct a three-month public consultation and secure High Court approval before any rescue package could be implemented, leaving limited time to reach a resolution before Thames Water's expected cash deadline in October.