diff --git a/api/utils/sshutils/conn.go b/api/utils/sshutils/conn.go
index e01ebb0585ba5..8d1210191c8f3 100644
--- a/api/utils/sshutils/conn.go
+++ b/api/utils/sshutils/conn.go
@@ -43,10 +43,12 @@ func ConnectProxyTransport(sconn ssh.Conn, req *DialReq, exclusive bool) (*ChCon
 
 	channel, discard, err := sconn.OpenChannel(constants.ChanTransport, nil)
 	if err != nil {
-		ssh.DiscardRequests(discard)
 		return nil, false, trace.Wrap(err)
 	}
 
+	// DiscardRequests will return when the channel or underlying connection is closed.
+	go ssh.DiscardRequests(discard)
+
 	// Send a special SSH out-of-band request called "teleport-transport"
 	// the agent on the other side will create a new TCP/IP connection to
 	// 'addr' on its network and will start proxying that connection over
diff --git a/api/utils/sshutils/conn_test.go b/api/utils/sshutils/conn_test.go
new file mode 100644
index 0000000000000..a644d34c53d1c
--- /dev/null
+++ b/api/utils/sshutils/conn_test.go
@@ -0,0 +1,170 @@
+/*
+Copyright 2022 Gravitational, Inc.
+
+Licensed under the Apache License, Version 2.0 (the "License");
+you may not use this file except in compliance with the License.
+You may obtain a copy of the License at
+
+    http://www.apache.org/licenses/LICENSE-2.0
+
+Unless required by applicable law or agreed to in writing, software
+distributed under the License is distributed on an "AS IS" BASIS,
+WITHOUT WARRANTIES OR CONDITIONS OF ANY KIND, either express or implied.
+See the License for the specific language governing permissions and
+limitations under the License.
+*/
+
+package sshutils
+
+import (
+	"crypto/rand"
+	"crypto/rsa"
+	"crypto/x509"
+	"encoding/pem"
+	"net"
+	"testing"
+	"time"
+
+	"github.com/gravitational/teleport/api/constants"
+	"github.com/stretchr/testify/require"
+	"golang.org/x/crypto/ssh"
+)
+
+type server struct {
+	listener net.Listener
+	config   *ssh.ServerConfig
+	handler  func(*ssh.ServerConn)
+
+	cSigner ssh.Signer
+	hSigner ssh.Signer
+}
+
+func (s *server) Run(errC chan error) {
+	for {
+		conn, err := s.listener.Accept()
+		if err != nil {
+			errC <- err
+			return
+		}
+
+		go func() {
+			sconn, _, _, err := ssh.NewServerConn(conn, s.config)
+			if err != nil {
+				errC <- err
+				return
+			}
+			s.handler(sconn)
+		}()
+	}
+}
+
+func (s *server) Stop() error {
+	return s.listener.Close()
+}
+
+func generateSigner(t *testing.T) ssh.Signer {
+	private, err := rsa.GenerateKey(rand.Reader, 2048)
+	require.NoError(t, err)
+
+	block := &pem.Block{
+		Type:  "RSA PRIVATE KEY",
+		Bytes: x509.MarshalPKCS1PrivateKey(private),
+	}
+
+	privatePEM := pem.EncodeToMemory(block)
+	signer, err := ssh.ParsePrivateKey(privatePEM)
+	require.NoError(t, err)
+
+	return signer
+}
+
+func (s *server) GetClient(t *testing.T) (ssh.Conn, <-chan ssh.NewChannel, <-chan *ssh.Request) {
+	conn, err := net.Dial("tcp", s.listener.Addr().String())
+	require.NoError(t, err)
+
+	sconn, nc, r, err := ssh.NewClientConn(conn, "", &ssh.ClientConfig{
+		Auth:            []ssh.AuthMethod{ssh.PublicKeys(s.cSigner)},
+		HostKeyCallback: ssh.FixedHostKey(s.hSigner.PublicKey()),
+	})
+	require.NoError(t, err)
+
+	return sconn, nc, r
+}
+
+func newServer(t *testing.T, handler func(*ssh.ServerConn)) *server {
+	listener, err := net.Listen("tcp", "localhost:0")
+	require.NoError(t, err)
+
+	cSigner := generateSigner(t)
+	hSigner := generateSigner(t)
+
+	config := &ssh.ServerConfig{
+		NoClientAuth: true,
+	}
+	config.AddHostKey(hSigner)
+
+	return &server{
+		listener: listener,
+		config:   config,
+		handler:  handler,
+		cSigner:  cSigner,
+		hSigner:  hSigner,
+	}
+}
+
+// TestTransportError ensures ConnectProxyTransport does not block forever
+// when an error occurs while opening the transport channel.
+func TestTransportError(t *testing.T) {
+	handlerErrC := make(chan error, 1)
+	serverErrC := make(chan error, 1)
+
+	server := newServer(t, func(sconn *ssh.ServerConn) {
+		_, _, err := ConnectProxyTransport(sconn, &DialReq{
+			Address: "test", ServerID: "test",
+		}, false)
+		handlerErrC <- err
+	})
+
+	go server.Run(serverErrC)
+	t.Cleanup(func() { require.NoError(t, server.Stop()) })
+
+	sconn1, nc, _ := server.GetClient(t)
+	t.Cleanup(func() { require.Error(t, sconn1.Close()) })
+
+	channel := <-nc
+	require.Equal(t, channel.ChannelType(), constants.ChanTransport)
+
+	sconn1.Close()
+	err := timeoutErrC(t, handlerErrC, time.Second*5)
+	require.Error(t, err)
+
+	sconn2, nc, _ := server.GetClient(t)
+	t.Cleanup(func() { require.NoError(t, sconn2.Close()) })
+
+	channel = <-nc
+	require.Equal(t, channel.ChannelType(), constants.ChanTransport)
+
+	err = channel.Reject(ssh.ConnectionFailed, "test reject")
+	require.NoError(t, err)
+
+	err = timeoutErrC(t, handlerErrC, time.Second*5)
+	require.Error(t, err)
+
+	select {
+	case err = <-serverErrC:
+		require.FailNow(t, err.Error())
+	default:
+	}
+}
+
+func timeoutErrC(t *testing.T, errC <-chan error, d time.Duration) error {
+	timeout := time.NewTimer(d)
+	select {
+	case err := <-errC:
+		return err
+	case <-timeout.C:
+		require.FailNow(t, "failed to receive on err channel in time")
+	}
+
+	return nil
+}