The UK and Dutch governments are preparing court action against Iceland to recover 4bn euros (£3.5bn) lost when the country's bank system collapsed.
It follows a referendum in Iceland which rejected a repayment plan.
The UK said it was "disappointed" by the "no" vote, while the Dutch finance minister said the time for negotiations was "over".
Iceland's Finance Minister Steingrimur Sigfusson said that resolving the row in court would take at least a year.
The UK and the Netherlands say they are owed the money following the collapse of Icelandic savings bank Icesave. British and Dutch depositors were bailed out by their governments, which are now demanding their money back.
Iceland held a referendum at the weekend on a repayment plan, but with about 90% of the vote counted, 59.1% were against and 40.9% in favour.
Johanna Sigurdardottir, Iceland's Prime Minister, said the rejection meant "the worst option was chosen" and had split the country in two.
UK Treasury minister Danny Alexander said the decision was "disappointing" and the matter would go to an international court.
Dutch Finance Minister Jan Kees de Jager said he would be consulting Britain about taking further steps against Iceland, but added that the matter would likely end up in court.
"I am very disappointed that the Icesave agreement did not get through. This is not good for Iceland, nor for the Netherlands.
"The time for negotiations is over. Iceland remains obliged to repay. The issue is now for the courts to decide," Mr de Jager said in a statement.
The Icelandic people were damned if they did and damned if they didn't. It looks as if they still couldn't stomach the idea of paying off the debts of privately owned banks - even if the revised deal was considerably more generous.
The consequences of this referendum vote is that Iceland's years in the financial wilderness could be extended much further.
Moody's and other ratings agencies look set to downgrade the country even further, making it prohibitively more expensive to borrow on the open markets.
Iceland's bid to join the EU will be paused or even vetoed by Britain and the Netherlands. And the tiny Atlantic economy is facing legal action in the EFTA court which might force it to pay up sooner than planned and at a punitive interest rate.
Democracy doesn't pay if you're an Icelander.
Iceland's Finance Minister Steingrimur Sigfusson told a news conference that the dispute with Britain and the Netherlands would take at least a year to resolve in court.
"My estimate is that the process will take a year, a year and a half at least," he said. However, some analysts believe the legal process would take considerably longer.
Iceland's Landsbanki bank ran savings accounts in the UK and Netherlands under the name Icesave and investors there lost 4bn euros (£3.5bn; $5.8bn).
When it collapsed in 2008, the British and Dutch governments had to reimburse 400,000 citizens - and Iceland had to decide how to repay that money.
Mr Alexander, Chief Secretary to the Treasury, said on the Andrew Marr programme: "It's obviously disappointing... We tried to get a negotiated settlement.
"We have an obligation to get that money back, and we will continue to pursue that until we do... We have a difficult financial position as a country and this money would help," he said.
He added: "We have a very clear outcome of the vote. The bill was rejected by a clear majority so we proceed in accordance to that. I think it's very hard to interpret this in any other way than the fact that the Icelandic people are not prepared to accept payments or shoulder the burden unless there is a clear legal obligation to do so."
Mums gone to Iceland....
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