The Kenyan parliament has voted against a bill to establish a special tribunal to try those implicated in the 2008 post-election violence.
This could pave the way for a list of suspects to be handed over to the International Criminal Court (ICC).
A judge asked to investigate the violence gave a 1 March deadline for the tribunal to be set up.
A cabinet minister said the president and prime minister have let down the country and should resign.
Some 1,500 people were killed after political and ethnic rivalries caused clashes around the country.
President Mwai Kibaki and Prime Minister Raila Odinga attended the session of parliament to lead the vote in favour of the bill.
A growing number of MPs had opposed the bill, saying they did not have faith in Kenya's justice system and that those involved in the violence should be tried at The Hague.
The tribunal was recommended by a commission of inquiry into the violence, chaired by Justice Philip Waki, which was established during mediation talks chaired by former UN chief Kofi Annan.
Justice Waki handed a sealed list of suspects to Mr Annan, which would be forwarded to the ICC if the Kenyan government did not implement the probe team's recommendations.
Minister for Nairobi Metropolitan Development Mutula Kilonzo, who was part of the mediation team that crafted the power-sharing agreement, said the two leaders no longer had the mandate to lead the country.
"The president and prime minister have let down the country - They ought to resign and take the country to an election," he said.
He said the coalition government had failed to implement one of the key pillars of the agreement.
"The mediation process has also collapsed because it was about this -impunity," he said
But Justice Minister Martha Karua said the rejection of the bill was a "collective failure".
"We have abdicated responsibility as a National Assembly. When we say The Hague, we are saying only those who bear greatest responsibility are going to be tried. We are saying the rest should go scot-free," she said.
Mr Annan had previously expressed satisfaction with the government's efforts but correspondents say his position may change if the government fails to meet the March deadline.
"The envelope - it is up to His Excellency Kofi Annan who is holding it to decide what to do," Ms Karua said, referring to the sealed list of suspects.
'Blackmail and threats'
The BBC's Anne Mawathe in Nairobi says the government could possibly ask for more time to establish the local tribunal.
The bill required the support of 145 MPs to be passed, but only 101 MPs voted for the bill.
The bill cannot be re-introduced to parliament until six months have elapsed.
The vote was initially set to be held on Tuesday, but the government delayed it to marshal support.
One MP who was opposed to the bill accused the government of using threats, blackmail and bribes to coerce MPs into voting for the bill.
Gitobu Imanyara, the Chama Cha Umma (CCU) party leader, said that the creation of a special local tribunal would entrench the culture of impunity.
He added that the government could not be trusted to try the ringleaders.
"This is the first time we stand a real chance, a real opportunity of arresting the culture of impunity. Let it be one person or two who go to The Hague," he said.
Widespread clashes broke out after Mr Odinga said the results of the December 2007 election had been rigged in favour of the president.
After weeks of talks led by Mr Annan, in February 2008 the rivals agreed to share power to bring an end to the violence.
In December 2008, the Electoral Commission of Kenya, which presided over the controversial poll, was disbanded by parliament following recommendations by another inquiry into the voting process.