City were eliminated from the third round of the competition as goals from Donnell McNeilly, Michael Golding, and Shim Mheuka sent the London club on their way to the next stage, despite a Leicester goal from Jayden Joseph in the second half.
The young Foxes found themselves behind within the first minute in Seagrave - McNeilly sent a left-footed effort into the back of the net from 20 yards out, but the game remained within reach at the interval.
Seventeen-year-old Joseph broke through the Chelsea defence shortly after the restart to draw Leicester back level, but a goal from Golding, and a late strike from Mheuka, condemned City to their fate in the competition.
Leicester return to U18 Premier League South action in the new year when they welcome Chelsea once again to Seagrave, looking to kickstart the second period of their season.
The details
City: French, Aluko, Ali, Beale, Amartey, McAlinney, Dyke, Joseph, R.Evans, Briggs, J.Evans.
Subs: Khela, Bausor, Rhomas, Donnelly, Onanaye, Toure, King.
Goal: Joseph 51'.