The decision, issued by a three-judge panel, is a foreign policy setback for the administration of President Barack Obama, who currently has a number of groups to add to the list of foreign terrorist organizations.
The PMOI, also known as the MEK (Mujahedin-e Khalq) has appealed the U.S. decision for years to take it off from the blacklist of the State Department.
It maintains that it was listed in 1997 by former President Bill Clinton’s administration to curry favor with the Iranian government, which considers the PMOI a threat.
In its ruling, the court indicates that the State Department violated due process protections of the group because it did not give it the opportunity to challenge non-confidential information used to justify the listing.
Former Secretary of State Condoleezza Rice in January 2009 reinstated the listing, in what was one of her last decisions in office, although at the time for the Coordinator of Counterterrorism at the State Department, Dell Dailey, advocated removing the PMOI from the list.
The case of the PMOI has also drawn the attention of a bipartisan group in Congress, including Rep. Brad Sherman, the chairman of a panel on terrorism of the Foreign Relations Committee of the House of Representatives.
In June Rep. Sherman said he had "trouble understanding what the MEK could have done lately to be on this list", according to the Washington Post.
The group has argued that it ceased its military campaign against the Iranian regime in 2001, voluntarily surrendered its weapons to U.S. forces in 2003, providing a wealth of information to U.S. intelligence services on the Iranian regime’s nuclear program.
It has also convinced the United Kingdom and the European Union (EU) to remove it from the list of terrorist organizations.
However, the State Department has resisted, essentially relying on intelligence information, some of which was declassified during the trial.
The State Department argued that the PMOI has not stopped its military operations and still tries to use violence to achieve its political goals, has trained women as suicide bombers and most of its information about the nuclear program has proven to be wrong.
However, the court had doubts about some of those arguments and said the group should have the opportunity to refute the allegations.
A spokesman, Alireza Jafarzadeh, said after the ruling that this "is a great opportunity for Secretary (Hillary) Clinton to correct a wrong, and it would have the support of Congress," according to the Washington Post.
The State Department, meanwhile, said it has received the order of the court and will study it "carefully."
However, it stressed that the court has left in force the designation of the PMOI as a foreign terrorist organization until the State Department completes its review.
"The U.S. government still sees MEK as a terrorist organization," it said in a statement.