The federal government in Australia is seeking urgent legal advice after the High Court ruled its refugee swap agreement with Malaysia is unlawful.
Australia would have sent 800 asylum seekers to Malaysia and in exchange for 4000 refugees over four years.
But the High Court on Wednesday ruled 6-1 that Malaysia does not offer adequate protection for refugees in law.
The ABC reports officials will also not be allowed to send unaccompanied children from Australia without the written consent of the immigration minister.
Currently Malaysia does not legally recognise refugees under domestic law and is not a signatory to the UN Refugee Convention.
The ruling is being seen as a major policy setback for Prime Minister Julia Gillard.
But Ms Gillard says the decision won't diminish the government's determination to stop people smugglers.
''We are going to study this High Court decision, but nothing in it is going to diminish our resolve to break the people smugglers' business model. We will study the decision though,'' she said.