Niki was Air Berlin's most valuable asset, and finding a new owner for it was key to administrators' plans to keep it flying, alongside regional airline LGW, even after the parent company's collapse.
German flag carrier Lufthansa said Wednesday it was abandoning its efforts to acquire Niki, citing persistent objections by European Union antitrust regulators against a possible tie-up between the two airlines.
The move comes after the European Commission said last week it had "deep competition concerns" about Lufthansa's plan to buy out 81 aircraft from Air Berlin's 140-strong fleet plus Niki for €210 million ($250 million).
In contrast to its debt-saddled mother corporation, Niki was a profitable budget airline until Air Berlin was declared bankrupt in August.
The German government said it regrets the EU's stance and will do everything it can to limit the damage to taxpayers. "This will hit employees especially hard".
The Austrian government said it will make sure that Niki passengers stranded overseas will be brought home, for instance by chartering planes from other airlines, a spokesman for acting transport minister Joerg Leichtfried said by telephone.
Vestager previously said that, given its dominant position in domestic air travel, Lufthansa might have to give up certain routes in exchange for approval.
Niki Lauda said he was interested in buying the airline back.
Lufthansa said on Wednesday it still meant to pursue growth plans for its Eurowings budget subsidiary and would apply for any Niki slots that become free in the event of an insolvency.
The decision by Lufthansa could pitch Niki into financial turbulence as it loses bridge financing from the German airline giant.
Lufthansa said it had offered to give up slots but the Commission "considers this to be insufficient" and clearly indicated that it wouldn't now approve the acquisition of Niki.
Air Berlin said in a statement Tuesday that prospective buyers IAG had withdrawn their interest in Niki, while there was also no workable offer from Thomas Cook, leaving Lufthansa as the group's only option for sale. It has a deadline of December 21 to approve the deal or open a longer investigation.