The discovery comes as negotiations regarding the purchase of the site reach a crucial stage.

Kiama Council plans to buy the 3.3-hectare hospital site from the Illawarra Shoalhaven Local Health District and build a new nursing home and hostel for the council's Blue Haven Aged Care Facility, replacing the current Havilah Place nursing home and hostel.

The proposed development would see all hospital buildings demolished except for the heritage-listed Barroul House, with the health district retaining approximately 2000sqm of the site for a new building catering for outpatient services.

The $58 million project has attracted an $8 million commitment ($4.8 million for the council and $3.2 million for the health district) from the NSW government through the $100 million Illawarra infrastructure fund, established following the lease of Port Kembla.

Kiama Council's director of community services Clare Rogers said the health service and the council jointly commissioned a contamination assessment which indicated the presence of fibro asbestos in areas of fill on the site, the extent of which could not be determined by an initial assessment.

Further testing will be undertaken to obtain a remediation quote, however Ms Rogers said neither the council nor the health district included a contingency for site remediation in their economic modelling.

"If council were to meet the cost of the remediation, the impact on the viability of the project would be significant," Ms Rogers said.

"It is proposed the NSW government be approached to provide funding to meet the cost."

On Tuesday night, Kiama councillors were presented with a report giving an overview of the project in open council, however discussions surrounding the sale were taken behind closed doors with councillors voting 5-4 to keep the matter confidential.

Kiama mayor Brian Petschler said if negotiations were a 24-hour clock "then it would be five to midnight".

Kiama councillor Dennis Seage said he did not believe the council should have to bear any costs of the remediation, rather the costs should be borne by the current owners.

He said discussions should be taking place in open council.

"Personally, I think the whole thing should be in the public forum," Cr Seage said. "This is all public money, including a government grant of $8 million."

Kiama council endorsed plans for the hospital site in July.

Concerns were raised by the Kiama Hospital Auxiliary that it had not been properly publicised that the plans would result in the closure of in-patient beds, which will be initially relocated to Port Kembla, then to a redeveloped Shellharbour Hospital.

At the same time, the proposal to sell eight residential lots at the southern end of the hospital site was labelled "inappropriate" by a group of residents from nearby streets.

The council estimates the sale of the eight residential lots will generate a net return of $1.2 million, which will assist with cash flow during the project.