Billionaire Ashley, who has compiled a string of stakes in retailers after building up Sports Direct, had offered to underwrite a 150 million pound rights issue in exchange for the Debenhams CEO role and a pledge by lenders to write off a similar amount of debt.
Debenhams, once the country's biggest chain of department stores, rejected the offer on Monday afternoon.
Sports Direct has also offered to buy Debenhams outright, but the strained relations between the two sides make it more likely that Debenhams will enter a form of administration on Tuesday that would wipe out all shareholders.
"In the continued absence of any such engagement from the board of Debenhams and Debenhams' lenders, there is a likely significant and negative impact on Debenhams' current shareholders and other stakeholders, including suppliers and employees," Sports Direct said.
Debenhams declined to comment. Its shares were down 10 percent at 1.8 pence.
Despite its long history, Debenhams has been battling for survival after a consumer shift online and to cheaper outlets destroyed 90 percent of its share value in the past year.
The company, which had 19 million customers and 2.9 billion pounds in sales last year, has said it needs to refinance its balance sheet and restructure the business to make it more sustainable. It plans to close about 50 underperforming stores, putting about 4,000 jobs at risk.
With a deadline looming that would give the lenders full control of Debenhams, Ashley has stepped up efforts to beat them to it. Owning 30 percent of the group, he has already forced the chairman out of the company and the CEO off the board.
As well as the underwritten rights issue, Sports Direct said it is still considering its options regarding the 61 million pound takeover offer it made at the end of March. It has until April 22 to make a firm offer or walk away.
LACK OF TRUST
However, a source familiar with the situation said that there is a lack of trust between the two sides, with Debenhams fearing that Ashley could renege on his investment offer after he takes control.
If no solution can be found, Debenhams will fall into the hands of its lenders at the close of business of Monday. It is then likely to be put in a so-called pre-pack administration that enables stores to keep operating while its lenders restructure the operations and seek to cut rents.
"Ashley becoming CEO is a major sticking point for the lenders; there is a major trust deficit here," the source said, declining to be named because the talks are private.
For its part, Sports Direct said Debenhams and its advisers had undertaken a "sustained programme of falsehoods and denials" and called on board members Terry Duddy and David Adams to take a lie detector test.
The company added that Ashley had taken his own lie detector test, after the companies clashed in a meeting, and said: "Mike Ashley's score, for example, was so significantly high as to be considered rare in comparison to others".
Laith Khalaf, a senior analyst at Hargreaves Lansdown, said the strings attached to Ashley's offer looked too much for the lenders to swallow.
"In theory, a deal could be struck, but relations seem far from cordial and the Debenhams management look set on giving the lenders control," he said.
Ashley, who also owns Premier League soccer club Newcastle United, made his fortune from building retailer Sports Direct into a dominant presence on Britain's shopping streets and online.
The 54-year-old businessman said in March that he was willing to step down as CEO of Sports Direct if he could take an executive position at Debenhams.
In recent years he has pounced on other weak retailers, including department store chain House of Fraser, and analysts have speculated that he could put the two together and could also use Debenhams' excess store space to sell brands he already owns.
(Reporting by Kate Holton; Editing by Keith Weir and David Goodman)
By Kate Holton