The Attorney General of Canada was seeking a stay, arguing that the Federal Court does not have jurisdiction to hear the case.
The court dismissed the application first last year, and the Federal Appeal Court has now upheld that decision.
"It is important to understand from the onset that what is in issue in the main is Canada's residential schools policy and not abuses that may have occurred in the course of its implementation," the court wrote.
"According to the statement of claim, the intent of this policy was to educate Indian day students in a manner which caused them to lose their language and culture. This is the alleged wrong...."
In 2006 — with dozens of residential school lawsuits wending their way through courts across the country — the federal government reached a national settlement for students forced to live at "Indian" residential schools.
But the settlement did not include students who attended but did not live at the schools. The class-action suit on behalf of those students was filed in August 2012 by the Tk'emlups Te Secwepemc and Sechelt bands against the federal government.
The statement of claim seeks a declaration from the court that Canada breached the aboriginal rights of those students, and that the residential schools policy caused irreparable cultural, linguistic and social harm.
Neither Sechelt Chief Garry Feschuk nor the lawsuit co-ordinator for Tk'emlups returned calls seeking comment Tuesday.
The lawsuit said Canada has already acknowledged the devastating impact of its residential schools policy on aboriginal peoples.
From 1920 to 1979, all aboriginal children aged 7 to 15 had to attend though they were not obliged to reside at the schools, the claim said.
But the purpose remained the same: to obliterate their traditional language, culture, religion and way of life.
The Kamloops Indian Residential School and the Sechelt Indian Residential School — both run by Catholic missionaries — were located in those aboriginal communities. Children did not have to leave the community to attend, but their attendance was mandatory.
"The children at the identified residential schools were indoctrinated into Christianity, and taught to be ashamed of their aboriginal identity, culture, spirituality and practices," said the statement of claim.
"They were referred to as, amongst other derogatory epithets, 'dirty savages' and 'heathens' and taught to shun their very identities."
In response to the lawsuit, the federal Attorney General filed a third-party claim against the religious organizations that ran the schools, including the Order of the Oblates of Mary Immaculate in B.C., the Roman Catholic Archbishop of Vancouver, the Roman Catholic Bishop of Kamloops and the Sisters of Saint Ann.
The federal government then applied for the stay of proceedings, arguing that the Federal Court didn't have jurisdiction over a claim against the religious orders.
Both levels of the court found that it did, and a judge is expected to hear arguments later this year on certifying the lawsuit as a class-action.
Fifteen former students are listed as plaintiffs on the lawsuit, but Tk'emlups Chief Shane Gottfriedson has said that he hopes the class-action, if approved, will eventually represent thousands of day students who attended schools across Canada.