The fate of the Government's controversial Bill to introduce foundation hospitals in the NHS was thrown into doubt last night when peers rejected the proposals for the second time.

They voted by 169 to 101 - majority 68 - to insist on the deletion of a key clause introducing the plan in the Health and Social Care (Community Health and Standards) Bill.

Hours earlier, the Government's Commons majority slumped to just 17, when Health Secretary John Reid only just succeeded in persuading MPs to overturn the Lords' earlier decision rejecting the Bill. MPs voted by 302 to 285.

But the present session of Parliament ends today and peers and MPs must agree every clause of the Bill for it to become law.

Following the Lords' rejection, the Bill will return to the Commons in an 11th hour game of Parliamentary ping pong unless a compromise can be worked out.

Yesterday, the nervousness of business managers was underlined when Sports Minister Richard Caborn was brought back from Australia to bolster the Government vote in the Commons.

Although a narrow victory for the Prime Minister, the vote, on a flagship Government policy and coming in the middle of a state visit by President Bush, will be seen as an embarrassment for Mr Blair.

The plans for foundation hospitals were mauled by former health secretary Frank Dobson, former Cabinet minister Clare Short and health select committee chairman David Hinchliffe.

Ms Short said: "Most of us agree that there should be more decentralisation in the health service, as we said in our manifesto.

"But many of us object to this proposal because it takes the most privileged hospitals in the country and decentralises them and gives them more authority and more privileges - leading to greater inequality."

Health Secretary John Reid rejected her charge, insisting it was the Government's intention within four years to raise every hospital to the level of foundation status.

Dr Reid, while acknowledging the plans could have been better handled, accused peers of trying to wreck plans to modernise the NHS.

But Mr Dobson said few backed the plans, except for think tanks and NHS managers, and warned their adoption could damage Labour.

Liam Fox, Conservative Party Co-Chairman and former shadow health secretary, said later: "This is the lowest majority yet achieved under Tony Blair's premiership.

"He is presiding over a divided Government and party that is losing its way and he is a prime minister who is losing his grip over events."

Dr Reid warned Labour backbenchers: "If people vote against the Government they will be harming not only the National Health Service but harming our own Government."

North unions will fight on

Liz Twist, North-East head of health for the Unison public sector union, said: "The fight against foundation hospitals will go on. What it does show is how strong the feelings are."

Ms Twist urged people living near hospitals preparing to apply for foundation status to voice their concerns.

"There is still room for local communities to express their opposition to these proposals. There are clear concerns about the effect foundation hospitals would have on local services," she said.