David Brearley – Australia's Timorese community was celebrating a victory last night it hopes will open the nation's doors to 1500 asylum seekers and free them from legal limbo.

Lay Kon Tji, who came to Australia from East Timor in 1992, succeeded in his Federal Court bid to overturn a finding by the Refugee Review Tribunal that he was a Portuguese national and therefore ineligible for refugee status. Justice Ray Finkelstein dismissed Mr Lay's first two grounds for appeal, but found the tribunal was wrong in concluding his Portuguese nationality was "effective".

"It is clear enough, indeed it is an inevitable finding, that the decision of the tribunal was based upon erroneous findings of fact," Justice Finkelstein said.

Mr Lay arrived in Australia on an Indonesian passport. In 1994, a delegate of the immigration minister rejected his claim that he had a well-founded fear of persecution if he was sent home. The tribunal found otherwise, ruling that Mr Lay would face detention and torture if he were returned because of his race and political activism, but said the problem was effectively Portugal's.

In setting aside this finding yesterday, Judge Finkelstein called for the parties to inform him by Friday of appropriate orders, or to make individual submissions.

Mr Lay's wife, Kathy Lay, said she was encouraged by the judgment and confident her family would eventually win the right to stay in Australia. "I do think that, yes," she said. "I'm hoping that."

Refugee lobby groups hailed Judge Finkelstein's decision as an important precedent, but expressed fears it would be overturned on appeal. "My reaction is very mixed," said Etervina Groenen, Mr Lay's caseworker.

"I'm quite thrilled, because I know these people are quite traumatised. Every time I see them they ask if there's any news – their lives have been in the balance for so long – and finally I have some news for them, some very good news. "I guess I just hope the Government won't appeal."

A spokesman for Immigration Minister Philip Ruddock said yesterday the Government would not decide its response until legal experts had studied the judgment.

Tribunal chief Peter Nygh doubted the finding would set a precedent for all Timorese asylum seekers because each application had to be decided on its merits. "The East Timor situation is probably one of the most litigated parts of the tribunal's work. Whatever the tribunal decides, the party aggrieved is likely to appeal," Dr Nygh said.

At Collingwood College in Melbourne, which has more than 40 Timorese among its students, news of Mr Lay's victory caused spontaneous outbursts of tears and song. "The kids are unbelievably thrilled," said principal Frances Laurino. "They were all singing the Fretilin anthem. Teachers were crying."