A Christian school in Durham is set to close after a damning Ofsted inspection found that it was "inadequate", the worst level possible, across all areas of its work.

The Durham Free School was set up in 2012 on Christian principles. However, it has struggled to attract pupils and found itself facing a cash crisis last year. Its head teacher, Peter Cantley, was terminated on "performance grounds" but was fighting his case through an employment tribunal, arguing that he had been unfairly dismissed because of his "whistleblowing".

The Ofsted report, carried out in November, rated the school as inadequate in all four categories: leadership and management, behaviour and safety of pupils, quality of teaching and achievement of pupils. It was put in 'special measures', with inspectors saying that the standard of students' work was low and progress was inadequate, that leaders did not have high enough expectations and that students' "low aspirations" were not challenged.

Inspectors also said that governors placed "too much emphasis on religious credentials when they are recruiting key staff and not enough on seeking candidates with excellent leadership and teaching skills".

The report criticised standards of teaching and also noted that "Some students hold discriminatory views of other people who have different faiths, values or beliefs from themselves."

It said that progress was being made under acting head Julian Eisner, who had taken over after Cantley's departure.

However, Education Secretary Nicky Morgan – herself a Christian – said that she had taken the "difficult decision" to close the school as she did not believe it could be sufficiently improved in a reasonable time. In a statement for the Northern Echo explaining her decision to withdraw funding she said: "My moral mission as Education Secretary is to ensure that every time a pupil enters the school gate they step into an environment where they can flourish. One day spent in a failing school is one day too many, and I am deeply concerned when I hear of pupils being let down."

She continued: "What Ofsted found is enough to shock any parent, including me. Its report, published on Monday, paints a picture of a school in disarray. Bad behaviour, including cases of bullying, appears to be rampant. Standards are low, while progress is inadequate. And school leaders are failing to prepare pupils for life in modern Britain.

"I have considered if it is possible for this to be turned around quickly and investigated the possibility of injecting new leadership. But it is clear to me that this has been a troubled school for some time and there is no imminent prospect of improvement.

"That is why I have taken the difficult decision to close the school."

She said that the closure of the school was "an extremely rare case" and that officials were working with the local council to ensure that all the children would have places at other local schools. The decision, Morgan said, was made "with the best interests of the children in mind".

The school did not reply to a request for comment. However, on its website it says that it was set up in response to parents' concerns that secondary school provision was concentrated in the north of the city, with many children disadvantaged. It also says: "We also want to support the ethos of Church of England primary schools, by offering continuity of ethos, but without imposing church attendance related admissions criteria."

It also includes testimonials from parents saying that they are happy with their childrens' progress at the school and paying tribute to the teaching there. One said: "I back the school 100 per cent! My son is getting on so well and it's all thanks to the love and care in the school," while another added: "We're very proud of what the school has achieved... Mine and my husband's views are great school great friendly staff and it will go far."

The Archbishop of York was quoted in today's Daily Telegraph as attacking the principle of free schools. He said: "What I haven't bought is the idea that we should have free schools. Because the ones that have gone for free schools in the majority are people with means and ability ... I think that is just a confusion of policy.

"What should have happened is that the Government should have invested all that money in raising the level of achievement in schools that are less achieving, not by putting in these so-called competing places."