A refusal by Nauru to agree to a contract extension until the 11th hour has caused chaos and confusion on the island, after refugees and asylum seekers were told to clear out of the processing centre and warned healthcare may stop.

Australia and Nauru have been working towards Nauru taking over contracts to provide welfare and garrison service to the 400 or so asylum seekers and refugees on the island, but Nauru has struggled to be ready.

As a result Australia has repeatedly extended its $432m contract with Canstruct, which contracts Wilson to provide security, with the most recent six-month extension due to expire at midnight on Tuesday.

However as late as Tuesday afternoon there was no decision made on either extending with Canstruct or Nauru signing a new contract, which resulted in fear and confusion among the refugee and asylum seeker group.

The standoff, which saw Canstruct and Wilson inform other stakeholders they were “demobilising” only ended late on Tuesday afternoon when Nauru agreed to a three-month extension.

The chaos appears to have come from Nauru exercising its right of approval for regional processing centre-related contracts.

The Australian government is currently in caretaker mode ahead of next month’s federal election, and bipartisan support is required to extend significant contracts.

It is understood the home affairs department provided a briefing to government and the opposition, gaining the authorisation to extend the contract – because it believed Nauru is not adequately prepared to take over.

However the government of Nauru appeared to refuse. It is understood the government wanted to replace Canstruct with Eigigu Solutions Holdings, a company linked to the Nauruan government.

As a result caseworkers for the refugees and asylum seekers on Nauru were told on Tuesday to inform their clients to clear out of the processing centre because Canstruct and Wilsons were “demobilising”.

The contracted health provider, IHMS, also relies on Canstruct-provided infrastructure and Wilson security to do its work, and there were concerns it would also cease its work.

A letter sent to employees of Host (contracted by the Nauruan government to provide casework and employment services to refugees and asylum seekers) and seen by Guardian Australia, revealed all people currently in regional processing centre 1 (supported accomodation including for the most ill among the cohort) “will be discharged… due to Canstruct and Wilson demobilising”.

“I’m sure this will be anxiety provoking for some clients and we may see some form of escalation in negative behaviour [from] some,” it said.

Canstruct had been contacting refugees and asylum seekers over the previous two days to tell them to pick up their support payments by 6pm Tuesday before staff close the “beach house” office and leave Nauru, the letter said.

It also asked people to not try and seek appointments with IHMS – the contracted health provider “until we get more information about what is occurring there”.

Host’s its contract is due to end next week, when Eigigu Solutions Holdings is expected to take over.

The Department of Home Affairs and Canstruct did not respond to requests for comment.

The incident is the latest in growing concerns over Nauru’s desire for further control over the regional processing centre and the refugees and asylum seekers.

The Australian federal court last year heard of several instances of Nauruan government bureaucrats seeking to block the emergency medical transfers of people to Australia.

The Nauruan government receives visa fees from Australia for each person on Nauru who was sent there under the regional processing arrangement.

The Nauruan government is itself gearing up for an election. Last week a video from the government’s information office said the country had “a bright future” with improved health, education and public services from a stronger economy – largely driven by the offshore processing arrangement.

The Baron Waqa-led government has come under increased scrutiny over its crackdown on opposition figures, including the operation of a blacklist against a group of people known as the Nauru 19. The group includes a former president and high-profile Nauruans involved in a protest against a government crackdown on MPs in 2015.

The government sought to convict and jail the protesters, but in September the Australian judge Geoffrey Muecke ruled there was no prospect of a fair trial for the group and the government had acted in “a shameful affront to the rule of law”.