Parents have been in tears over a termination notice served last week to Dunedin Hospital Early Childhood Centre by the Southern District Health Board, chairwoman Rachael Lee says.
Negotiations reached an impasse over what the DHB sees as a lack of progress towards the centre becoming wholly for DHB employees' children.
Both sides told the Otago Daily Times they were hopeful of reaching agreement over ways to "grandfather" existing centre children to prevent any having to leave.
At present, 68% of the roll of about 100 children are DHB employees' children.
Secretary Rachel Brooking said the DHB should revoke the "heavy-handed" six-month termination notice.
Both sought the same thing - a DHB-only facility - but differed on how to achieve it.
It would be "abhorrent" to the centre's child-centred philosophy for any child to have to leave.
The centre stopped accepting non-DHB children about three years ago, but the DHB had sought the right to ask these children to leave if they needed their spot, she said.
There was also issues over children of DHB employees who left for other jobs, eligibility of siblings of some existing pupils, and children of centre staff.
Ms Lee said the centre contacted the Ministry of Education after receiving the notice last Tuesday, to keep it informed, and were managing the issue sensitively with the centre's 25 staff members.
By the end of next year, the centre would be 78% DHB pupils, but this was not fast enough progress for the DHB, Ms Lee said.
Southern DHB chief executive Brian Rousseau said the centre made "zero progress" in the past two years in moving towards a DHB-only facility.
DHB operations manager (Otago) Megan Boivin said the termination notice had been necessary legally to signal the issue had reached an "impasse".
The DHB had acted transparently and fairly and sought to create as little disruption as possible for existing pupils.
DHB chief operating officer (Otago) Vivian Blake was confident arrangement could be made to grandfather existing pupils. The facility was crucial to the DHB being able to attract staff, she said.
