Struggling Virgin Trains East Coast (Vtec) will be stripped of its contract on 24 June, UK Transport Secretary Chris Grayling announced today.
The Stagecoach-dominated firm will be replaced by a public sector "operator of last resort" (OLR) which will revive the historic name London North Eastern Railway (LNER).
Vtec, which is the third private operator to hit financial difficulties running Scotland-London trains for bidding too much, was denied a new contract.
The franchise, which operates trains between Edinburgh, Aberdeen, Inverness, Glasgow and King's Cross, was operated by the UK Government from 2009 to 2015 after the last collapse.
Perth-based Stagecoach, which has a 90 per cent stake in the franchise, angered MPs by announcing the decision minutes before Mr Grayling made a statement to the House of Commons.
Mr Grayling said: "Stagecoach and Virgin Trains got their bid wrong and they are now paying a price."
However, he also said: "The route has its challenges but it is not a failing railway."
Services continue as normal, pre-booked tickets will remain valid, and staff will be transferred to LNER.
Vtec had struggled to repay the £3.3 billion it bid to run the franchise - twice as much as its two private sector predecessors, GNER and National Express, which defaulted on their contracts.
LNER, one of the classic "Big Four" railway companies, ran trains including the Flying Scotsman on the Edinburgh-London line from 1923 until nationalisation in 1948.
Mr Grayling said the decision had been "very finely balanced" between an operator of last resort and a new, non-profit contract for Vtec.
However, he said he wanted the "smoothest possible transition" to the planned new East Coast Partnership, which is due to run both trains and tracks on the route from 2020.
Scottish Government transport minister Humza Yousaf had told MSPs today he had no preference between the two options, and the key issue was ensuring no reduction in services.
However, hours later tweeted: "While supportive of UK Govt running East Coast Mainline as Operator of Last, they have failed this franchise 3 times in last decade.
"I'll be speaking to UK Govt later today & demanding Scot Govt is involved new board SoS is setting up - we cannot be ignored."
In a later statement, he said: “In the circumstances of the third successive failure of the UK Government’s east coast franchise, an operator of last resort solution is the better of the available options.
“Given the importance of east coast services to Scotland, we will press the UK Government for involvement in the new LNER Board.
“We will also require assurance that there will be no reduction in service levels for Scottish passengers, and that promised improvements to Scottish east coast services will still be delivered without further delay."
Scottish Labour transport spokesman Colin Smyth said: “Just hours before the UK Government confirmed its failed privatisation experiment had come undone, SNP transport minister Humza Yousaf brazenly shrugged his shoulders and said he doesn’t even care whether the east coast rail franchise is in public hands or not.
“That is an insult to passengers and hard-work rail staff, not to mention potentially damaging to Scotland’s economy."
Stagecoach Group chief executive Martin Griffiths said: "We are surprised and disappointed the Department for Transport (DfT) has chosen not to proceed with our proposals.
"We believe our plans offered a positive, value-for-money way forward for passengers, taxpayers and local communities, ensuring the continuation of the exciting transformation already underway on East Coast and a smooth transition to the Government's new East Coast Partnership.
"However, we respect the Government's decision.
"We will work constructively with the DfT and the OLR in the weeks ahead to ensure a professional transfer to the new arrangements, supporting our employees and maintaining the same clear focus on our customers as we have over the past three years."
Anthony Smith, chief executive of the independent watchdog Transport Focus, said: "Whichever organisation runs East Coast services, under whatever new arrangements, passengers will be looking for the quality of current services to be maintained and built on.
"East Coast is currently the top-rated franchised train service in Great Britain – with 92 per cent overall satisfaction with the last journey in the latest National Rail Passenger Survey.
"While reliability must continue to improve, and promised and new investments made, passengers will continue to judge services by the performance on the day of the train company and Network Rail, value for money, cleanliness of the train and crowding levels.
"Having more stability in the underlying contract between Government and the train company will help achieve these things that matter most to passengers."
The RMT, the largest rail union, called for the switch back to the public sector to be permanent.
General Secretary Mick Cash said: "This is the second time the Government have called upon the public sector to launch a rescue operation on the east coast main line, and instead of being a temporary arrangement Chris Grayling should listen to his staff and the public and make it permanent.
"After three shambolic private sector failures on the east coast, the message should now sink in that these cowboys cannot be trusted and should be locked out of the system on a permanent basis.
"Anything else risks playing out the same expensive farce over and over again."
Mick Whelan, general secretary of ASLEF, the main train drivers’ union, said it hoped Mr Grayling would now bring the rest of our railways into public ownership too.
He said: ‘It’s important staff and passengers are properly protected while, once again, the transport secretary tries to patch up a failing franchise system that everyone knows doesn’t work.
"Britain’s railways should be run, successfully, as a public service, not for private profit.
"Because they cannot do it."