The NHL club made the announcement late Friday afternoon, issuing a brief statement from current owner Mario Lemieux.
"Jim Balsillie delivered a notice of termination today, and it is our understanding that he has stopped negotiating with the National Hockey League to get the necessary consent to buy the Pittsburgh Penguins," Lemieux said in the release. "While these developments create significant uncertainty, the Penguins organization will re-evaluate our situation after the Pennsylvania Gaming Control Board makes the decision on the awarding of the Pittsburgh gaming licence."
Balsillie is co-chief executive officer of BlackBerry maker Research In Motion Ltd (TSX:RIM).
Isle of Capri Casinos Inc. has promised to build a US$290-million arena to replace the 45-year-old Mellon Arena - at no cost to taxpayers or the team - if it's awarded the licence.
A decision is expected next week.
"What is clear is the best way to assure that the team remains viable and in Pittsburgh is to award the gaming licence to the Isle of Capri," Lemieux said.
NHL commissioner Gary Bettman also conceded that the Penguins' future in Pittsburgh is dependent on the licence being granted.
"Today's development was unfortunate," he said in a statement. "If the Isle of Capri is not granted the licence on Wednesday, then an already difficult and volatile situation will be aggravated.
"It is imperative that the Penguins have a new arena on economic terms that make sense for the franchise for the team to remain in Pittsburgh."
Balsillie signed an agreement to buy the team in October for a reported $175 million, pending approval from the league.
According to sources, part of the reason the deal fell through was that Balsillie wasn't happy with the NHL's insistence that keeping the team in Pittsburgh be part of the deal.
Speculation has swirled that Balsillie could move the team to Hamilton, which is close to his home and RIM's head office in Waterloo, Ont., a move that Lemieux has said he was opposed to.
"It was very important for us to keep it here it Pittsburgh," Lemieux said when Balsillie signed the purchase agreement. "I think Jim is committed as long as we build a new arena and we have a fair deal."
But Balsillie had indicated his plans were to keep the team in Pittsburgh.
Balsillie, 45, became the front-runner in the bidding for the team in the fall after a deal involving former Torontonian Sam Fingold fell apart this summer.
Research In Motion is one of Canada's most prominent technology companies but it faces regulatory investigations and is subject to a cease-trade order forbidding insiders, including Balsillie, from buying or selling RIM shares.
The Penguins, two-time Stanley Cup champions in the 1990s, were purchased in federal bankruptcy court in 1999 by a group led by Lemieux, who retired as a player last season and later put the team up for sale.