Australia's High Court dealt a heavy blow to the government on Wednesday by blocking its plans to send asylum-seekers to Malaysia, ruling they could not go to a nation lacking legal safeguards.
Australia had hoped to send up to 800 asylum-seekers to the Asian nation in exchange for resettling 4,000 of its refugees, and the decision leaves hundreds of boat people in legal limbo.
The nation's top court found that under Australian law the government could not send asylum-seekers to be processed in another nation unless that country was compelled to adequately protect them.
"The country must be legally bound by international law or its own domestic law to... provide protection for asylum-seekers pending determination of their refugee status," it said in a summary of the judgment.
"In addition to these criteria, the Migration Act requires that the country meet certain human rights standards in providing that protection."
Refugee activists rejoiced at the decision which they said vindicated their view that Malaysia was a dangerous destination for asylum-seekers and that sending vulnerable people there would breach Australia's legal obligations.
The government was despondent at the ruling on the politically divisive issue, which comes as the minority coalition government's popularity sinks to record lows in opinion polls.
"Let's make no bones about it, today's decision by the High Court is a profoundly disappointing one," Immigration Minister Chris Bowen said.
The so-called Malaysia Solution was part of Australia's regional response to halting the flow of thousands of boat people who arrive on its shores each year, which is also set to involve a centre in Papua New Guinea.
Bowen said the court ruling could have ramifications for the regional policy, but he would not indicate how his centre-left Labor government of Prime Minister Julia Gillard would react.
Human rights groups had slammed the Malaysia deal, accusing Australia of abandoning its international obligations to asylum-seekers by dumping them in a country without proper protections for its more than 90,000 refugees.
Lawyers for the two Afghan men at the centre of the High Court case had argued that the deal breached Australia's duties towards asylum-seekers because Malaysia is not a signatory to the UN convention on refugees.
The High Court sided with them in a majority ruling which cannot be appealed. Experts said the government could, however, attempt to amend the Migration Act to get around the ruling.
The court said that in deciding the matter, it expressed no view about whether Malaysia met relevant human rights standards or whether refugees in that country were treated fairly.
Canberra unveiled its new strategy in May, promising that all maritime arrivals would be processed offshore with the first 800 to go to Malaysia and that they would be treated humanely.
The first group were set to leave for Kuala Lumpur two weeks ago, but refugee lawyer David Manne applied for an injunction pending a High Court hearing saying the men feared for their safety in Malaysia.
Amnesty International said Canberra should never have contemplated "outsourcing Australia's refugee protection obligations to a country which regularly canes, detains and abuses asylum seekers".
Conservative opposition MP Scott Morrison agreed, describing the government's asylum and border policy as "a complete and utter mess."
"I've been to Malaysia. I've seen the conditions under which asylum-seekers would be living, and it was clear to me that the protections the minister (Bowen) boldly claimed existed simply didn't exist," he said.
Australian governments have long grappled with how to handle boat people, over the years detaining them in desert centres, on the tiny Pacific island nation of Nauru and on the remote Indian Ocean territory of Christmas Island.
In 2010, arrivals peaked at close to 7,000, but far fewer than half that number have arrived in Australian waters so far this year.