The council had earlier rejected a $220,000 offer from the receivers, electing instead to try to recover the full amount, but the decision backfired.
It now plans to look at the personal liability of the company's directors.
Other local authorities have also been caught up in the company's woes - North Shore City has lost $1.4 million.
Chequer Packaging Ltd (CPL), the Auckland company which manufactured Dunedin's rubbish bags in Christchurch, was placed in receivership in January last year, owing the council $395,718.
Council water and waste services manager John Mackie said the company had a manufacturing and distribution contract with the council.
CPL distributed the bags to supermarkets and other outlets, collected the money after deducting manufacturing costs, and held it in a trust account for the council.
The account had been in place until CPL was sold to a private equity group in 2004, in which the ANZ National Bank had an 80% shareholding.
When the sale occurred, the trust account was discontinued, so while the council thought it had security through the trust, that was not the case, Mr Mackie said.
The High Court in Auckland found in a decision made public on June 4 that there was "no clear ascertainable subject matter of the trust", concluding that the council did not have a proprietary interest under the trust arrangement.
While it found the ANZ National Bank-private equity group had made a contractual breach by dissolving the trust, the council was nevertheless an unsecured creditor.
"We're pretty upset about the decision," Mr Mackie said.
The council had been in dispute with the receivers over the $360,000 left for distribution.
Asked why the level of money the council was owed got so high, Mr Mackie said the company had fallen behind in its payments.
"They had a history of that."
The council had been "managing" payments from the company to get them up to date, had carried out credit checks on CPL, and staff were in weekly contact with the company.
City Environment general manager Tony Avery said the $395,718 was for months, rather than years, of sales, and while the council had attempted to get payments up to date, it had been caught out when the company went into receivership.
The council received about $2 million a year from sales of the bags, meaning the money lost represented about three months of bag sales, he said.
The company took about 10c per bag for manufacture and management, and the council took the rest.
The council made no profit on the user-pays system - money raised by bag sales funded rubbish disposal.
Mr Mackie said the council would not get caught out again - it was now billing supermarkets directly.
The rubbish bags were being made by a new company which had bought CPL's assets.
A sum of $180,000 had been written off in the 2006-07 financial year, and this year's cost would be $215,718.
Mr Avery said the costs had not come to light until now because the matter had been before the court.
Although there was a 28-day appeal provision, the council's lawyers had advised an appeal was unlikely to be successful.
"Under the circumstances, there is little alternative to writing off the entire debt owed by Chequer Packaging Ltd."
The matter was discussed by the council's infrastructure services committee yesterday.
Council chief executive Jim Harland said the council had to accept the case had been lost.
The council could not guarantee the outcome of a court case.
He rejected a suggestion from Cr Teresa Stevenson that the council make a public apology to ratepayers.
Cr John Bezett said the council had to accept the decision but had to make sure a similar thing did not happen again.
He hoped the council would be changing the way it operated.
The council increased the cost of the bags last month, with the 40-litre receptacle rising from $1.20 to $1.50 and the 65-litre bag up 25c to $1.75.
