The Lord Chief Justice Lord Woolf rejected Mr Blunkett’s appeal against a previous decision that the man’s 16-month detention in Belmarsh high-security prison was unlawful and based on "wholly unreliable evidence".
The 37-year old man, known only as M, is the first terror suspect to appeal successfully against his detention under the controversial Anti-Terrorism Crime and Security Act (ATCSA).
Mr Blunkett, who launched an 11th-hour appeal to prevent M walking free last week, was refused the right to appeal the decision in the Lords.
In a written judgment, Lord Woolf acknowledged "the need for society to protect itself against acts of terrorism" but added that it remained of the "greatest importance" that an individual "should have access to an independent tribunal or court which can adjudicate upon the question of whether the detention is lawful or not. If it is not lawful, he has to be released".
Outside the court, M’s solicitor, Gareth Peirce, said that she had called the man’s wife with the news.
"She has had so many disappointments up to this point," she said, adding that she had arrived at "this exact same point" a week ago, when there was an emergency stay.
She said: "It’s our belief that the system is profoundly unfair and it is intended that nobody will get out - and that was demonstrated by the Home Secretary’s reaction to the appeal finding last week by SIAC [the Special Immigration Appeals Commission], when he just wouldn’t have it."
"There is no doubt that indefinite detention and a failure to inform people of the evidence presents the most Kafkaesque predicament in which it is most difficult for an individual to retain his sanity."
The director of Amnesty International UK, Kate Allen, said that Mr Blunkett’s challenge was "tantamount to appealing against an acquittal verdict" and should not have happened.
"The verdict highlights the very real dangers of legislation that allows the UK government to detain people without charge or trial on the basis of secret ‘evidence’ that would not stand up in a court of law."
In a ruling last week, SIAC said that M should be freed because, while there existed cause for suspicion, "reasonable suspicion" - all that is needed under the Anti-Terrorism Crime and Security Act 2001 to detain a foreigner without charge - had not been established.
Lord Woolf heard the first one-and-a-half hours of the case in public on Wednesday before excluding not only the media and public but also the detainee’s own lawyers.
Lawyers for Mr Blunkett said that SIAC had accepted M was a member of an extremist Islamic movement in Libya, the Libyan Islamic Fighting Group, and had fought with fellow mujahideen soldiers in Afghanistan. It had also accepted Mr M had been involved in procuring arms to attack Colonel Gadaffi’s regime and had provided money to an individual suspected of having links with al-Qaeda.
Ben Emmerson, QC, representing M, said SIAC had found the assessments of M on which the Home Secretary had relied were not supported by evidence.
In yesterday’s judgment, Lord Woolf said that Mr Wyn Williams, for Mr Blunkett, "had to concede that the manner in which the reliance was placed on M’s membership of LIFG was inappropriate. The cross-examination by the special advocate which obviously impressed SIAC weakened the case further."
The Home Secretary was ordered to pay the costs of the appeal.
A spokesman for the Home Office said: "We respect the court’s decision. It is vital that we put this ruling in perspective - in 12 out of 13 cases the Home Secretary’s decision to use the power of certification under the ATCSA was justified and upheld in a court of law."
M was the first of 13 people to be detained under the ACSA. The remaining 12 will now mount a legal challenge against their internment by appealing separately to the Appeal Court.
Ms Peirce said she had not yet considered whether to sue the government for compensation for M.