The High Court has unanimously declared the government's offshore processing scheme is invalid, after two Tamil men challenged the legality of the policy.
The court found that two Tamil men were denied legal fairness when seeking a review of their refugee claims.
The judgment in favour of the Sri Lankans will have major implications for Australia's offshore detention system, which processes asylum seekers on Christmas Island.
In a unanimous decision, the High Court declared it was an error of law for the "offshore processing regime" to deny asylum seekers their rights to apply for a protection visa.
The two asylum seekers, identified only as plaintiffs M61 and M69, arrived by boat in 2009, reaching Christmas Island on October 2.
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Both claimed refugee status out of fear they faced persecution from the Sri Lankan army, agencies of the government and paramilitary groups because of their alleged support for the Liberation Tamil Tigers of Eelam.
Faced with deportation, the pair appealed to the High Court on grounds of lack of procedural fairness because former immigration minister Chris Evans had failed to personally consider their cases.
The minister has the power under the migration act to grant a visa if it is in the public interest.
The High Court upheld their argument that they had been denied procedural fairness when having their claims for refugee status assessed.
"Because these inquiries prolonged the detention of the plaintiffs, there was a direct impact on the rights and interests of the plaintiffs to freedom from detention at the behest of the executive," the judgment said.
The court found the government had erred in not regarding the asylum seekers as being bound by the Migration Act and decisions of Australian courts.
The Australian government and the immigration minister have been ordered to pay the pair's legal costs.
