The former chief of staff had applied for an urgent court injunction to stop the federal independent MP from ending her employment, after alleging she was pushed into resigning.
Ms Rugg wanted to keep working for the member for Kooyong as an advisor, doing policy and media work, while she pursued legal action against Dr Ryan and the Commonwealth.
The parties spent a month in mediation, which failed to resolve the dispute and the case will now go to trial.
Ms Rugg alleges she was unfairly dismissed after refusing to work more than 70 hours a week for the MP, on a salary of $166,000.
However, she will no longer be paid by the Commonwealth after the Federal Court dismissed Ms Rugg's application on Tuesday.
Justice Debra Mortimer found there was no "prospect whatsoever of a co-operative relationship being restored" between the pair.
She said Ms Rugg had failed to prove she wanted to continue working for and supporting Dr Ryan, because her evidence was more focused on her own career.
"(Ms Rugg) has given a lot of evidence about her own ambitions, her own desires to be in Canberra," Justice Mortimer wrote.
"There is little if anything in this kind of evidence that refers to supporting and assisting Dr Ryan. It is all about Ms Rugg."
She was critical of Ms Rugg's post about the case on Instagram while the parties were in private negotiations.
"I do not see how this is the conduct of a person who wishes to return to work closely and professionally with Dr Ryan," Justice Mortimer said.
Even if Ms Rugg had persuaded her she was dedicated to working for the MP, it was "wholly unreasonable to impose such an obligation on Dr Ryan", she said.
"Especially since the working relationship would be resumed while the parties continue to prepare for trial - a trial which, on any view, will be hotly contested and subject to considerable scrutiny," she said.
Ms Rugg claimed in court documents that Dr Ryan said "this is bigger than Kooyong" and she needed to know her staff were prepared to work hard for her if "I want to be prime minister one day".
Justice Mortimer said Ms Rugg's allegations against Dr Ryan were serious and could affect the MP's reputation personally and professionally.
The parties were ordered to decide a timeline for trial and meet before March 20 for a case management hearing.
Ms Rugg is seeking compensation and pecuniary penalties from both parties, and has added serious contraventions of the Fair Work Act against the Commonwealth to her dispute.
Dr Ryan disputes all of Ms Rugg's claims, including that she pushed or jostled her to resign, effective January 31.
Outside court, Ms Rugg's lawyer Josh Bornstein said his client was disappointed with the court's decision.
"The case is at an early stage," he said.
"The focus will now turn to preparing the case for trial."
He said the trial could have far-reaching ramifications for all Australians who are expected to work long hours.
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