The High Court in Ireland has ruled that laws cutting off internet users who have illegally downloaded content cannot be enforced in the country.
It is a victory for Irish internet service provider UPC which took the legal action against copyright owners, including EMI and Sony.
But it will be a blow to the music and film industry, which wants the strict rules as a deterrent against piracy.
It is likely to have a knock-on effect to similar policies in other countries.
Mr Justice Peter Charleton said in his judgement that illegal file-sharing was "destructive of an important native industry".
But he added that there were no laws in Ireland to allow the disconnection of pirates from the net and that any attempts to do so could be in breach of European legislation.
UPC said in a statement that it "does not condone piracy and has always taken a strong stance against illegal activity on its network".
"Our whole premise and defense focused on the mere conduit principal which provides that an internet service provider cannot be held liable for content transmitted across its network," the statement added.
The Irish Recorded Music Association (Irma) is considering its next move.
"The judge was very clear he wanted to rule in his favour but couldn't because the legislation wasn't in place," Lindsey Holmes, a spokeswoman for Irma told the BBC.
"The committee is meeting today. There is a couple of options - to appeal to the Supreme Court or to lobby government to change the legislation," she added.
In May, Ireland's biggest net firm Eircom began the process of implementing a 'three strikes and you're out' policy, sending warning letters to those identified as illegal file-sharers.
Although it has threatened to cut off internet access for persistent pirates it has not yet done so although it plans to continue its campaign.
France is pursuing a similar 'three strikes and you are out' policy, despite the fact that one ISP is refusing to send letters to its customers.
In the UK, the Digital Economy Act makes provision for similar policies although there are no current plans to cut people off.
Mark Mulligan, an analyst with research firm Forrester, thinks it is unlikely to happen in the UK.
"I don't think we will see three strikes imposed from the state," he said.
"Although the legislation is framed, there is still so much of it that is vague. The implementation will be down to ISPs, content providers and Ofcom and is likely to be watered down," he said.
In private agreements with copyright holders, several law firms have begun writing to thousands of people identified as illegal file-sharers asking them to pay a fine or face court.
In September it emerged that activisits had targeted some of these firms and posted lists of those accused on the web
ACS:Law had the names and addresses of more than 5,000 people, alongside the pornographic films they were accused of downloading, published on the web.
It faces fines of up to £500,000 for the data breach.