A community action group from Nyah, in northern Victoria, sought a judicial review of a federal government decision to approve construction of banks and spillways on the Murray River.
Construction on the Nyah floodplain is designed to retain natural flooding around woodlands that have been degraded by other changes to river flows at Swan Hill.
The project will involve clearing of 7.42 hectares of native vegetation, which is a critical breeding and foraging ground for the rare parrot.
A delegate for the federal environment minister approved construction in March 2024, with a condition that there be plans to offset damage to habitat.
The project plan said better environmental flows on the floodplain would create new breeding areas for the parrot.
But the Friends of Nyah Vinifera Park group argued the government approval was legally unreasonable, in part because the offset measures were "highly uncertain" and risky.
The government also failed to consider alternative projects that could achieve environmental outcomes under the Murray-Darling Basin Plan, the group said.
But Federal Court Justice Christopher Horan dismissed the application for judicial review on Tuesday, finding the government did not fail to consider principles of environmental precautions.
"It cannot be said that the approach adopted by the delegate was outside the bounds of legal reasonableness," Justice Horan said.
The group's chair Nicole McKay said she respected the ruling on the law, but concrete, pipes and pumps would not create a healthy river.
"Once the damage is done, there's no going back," Ms McKay said in a statement.
"We've seen what happens when rivers are engineered like this – blackwater, toxic algae and mass fish deaths."
Ms McKay said legal reform was needed, as offset measures allowed the government to "claim" river restoration.
The group, represented by Environmental Justice Australia, will consider options for further legal action.
The ruling comes a day after Inspector-General of Water Compliance Troy Grant found Victoria was meeting commitments to protect environmental water on the Murray, while NSW had more work to do.
NSW had not conducted compliance on annual long-term extraction limits, though it was working towards improvements, Mr Grant found.
"Without reliable measurement, limits cannot be enforced, planning becomes guesswork, and trust erodes," he said.
