A B.C. Court of Appeal five-member panel on Thursday upheld a ruling by the province's Supreme Court that struck down parts of the act that pertain to lawyers.
The legislation required lawyers, financial institutions and others to keep records on money transactions in an attempt to stop terrorists and criminals from laundering cash.
All 14 of Canada's law societies, represented by the Federation of Law Societies of Canada, challenged the legislation in the lower court and defended the victory in the appeal court.
The panel dismissed the federal government's appeal, ruling the law interferes with the independence of lawyers.
"One of lawyers' primary roles is to stand between the state and the individual and advise and protect the individual within the law from state activities that might intrude on matters unfairly or unreasonably," John Hunter, legal counsel for the federation, said in an interview.
"Just as it's important to have an independent judiciary, it's important to have an independent bar, one that isn't at the beck and call of the state."
Hunter said the ruling gives constitutional status to the principle of independence for the bar and should reassure clients their counsel won't be informing on their activities to the government.
It's not yet known whether the federal government will appeal the court ruling to the Supreme Court of Canada.
Lyse Cantin, a spokeswoman for the federal Department of Justice, said lawyers have 60 days to appeal, or until June 3 with holidays taken into account.
"The government is carefully reviewing the decision and will consider it's next steps," she said.
The legislation was introduced by Parliament in 1989 and was amended in late 2008, making the regulations applicable to legal counsel and law firms in all provinces and territories.
The federation conceded that requiring lawyers and notaries to take steps to deter criminals from employing them to launder money and finance terrorism is a valid societal goal, but it argued the regime failed to respect Canada's fundamental constitutional principles.
In the B.C. Appeal Court's written ruling released Thursday, Justice Christopher Hinkson said he largely agreed with the lower court's ruling, but noted the case didn't turn on the principle of solicitor-client privilege, which he noted was a "secondary concern."
"In my opinion the independence of the bar is a principle of fundamental justice with which the regime interferes to an unacceptable degree," said Hinkson. "I would dismiss the appeal."
--with files from Keven Drews in Vancouver