The utility company had already faced strong criticism from business leaders who said it was a burden on industry.
But the move, which will put thousands of LFC's 44,000-strong workforce out of work, has provoked angry protests.
Franc Contreras, Al Jazeera's correspondent in Mexico City, said the government "is taking things very carefully".
"[The government] knows that this union is very powerful and there are many angry workers right now. [People are losing their jobs] in the middle of an economic crisis," he said.
"It's a difficult decision, but [it is] indispensable for the sustainability of Mexico in the future"
Mexico's finance minister
"It is a very complicated situation. During the summer, the electricity workers' union elected its own official, and in Mexico you are not allowed to do that - it is the federal government that decides.
"So, when [this election] happened, the federal government last week said that it would not recognise his leadership. Then came the decision to seize control of the power company."
Federal police have guarded the LFC offices in Mexico City in the wake of protests against the decree by thousands of LFC workers.
"It's a difficult decision [to close LFC] but [it is] indispensable for the sustainability of Mexico in the future," Agustin Carstens, finance minister, said of the shutdown on national television on Monday.
Luz y Fuerza had been losing about 30 per cent of electrical supplies due to defects in the system, at a cost of about $1.9bn per year, Carstens said.
"In the short term there'll be a complicated transition period, but there's no doubt that in the medium term this will generate large benefits," Carstens said, adding that about 10,000 LFC workers could be re-hired.
The Electrical Workers Union, which represents LFC, has urged workers to reject a redundancy package, which Carstens has said may cost $1.5bn.
Union leaders have called for a large demonstration to be held in the Mexican capital on Thursday, but have denied claims that they will try to disrupt power services to more than 20 million people in central Mexico.
Meanwhile, Mexican authorities said a lawyer for another state power company involved in the closure of LFC was shot dead on Monday in Cuernavaca in central Mexico.
The woman, identified in news reports as Amelia Avila Vasquez, was the head of the legal department of the Federal Electricity Commission (CFE), which is taking over Luz y Fuerza's operations.
The Morelos state attorney general's office said that her family had reported that she had received death threats.