Indigenous people present at the court said they were devastated by the ruling, while activists said it could encourage the government to requisition more land on Malaysia's part of Borneo and create "internal refugees".
"It is an unfair decision. I have not been fully compensated," said Ngajang Midin, 50, of the Ukit tribe, as tears rolled down his face. He has already moved to higher ground and the multi-billion-dollar dam has begun operations.
"My cocoa and pepper trees are underwater. My ancestors' graves are buried under the sea of water," he said.
The fight, seen as a test case, began 12 years ago when the state government of Sarawak requisitioned land for the controversial Bakun hydroelectric dam and a timber pulp mill on Borneo, famous for its biodiversity.
About 15,000 people were forcibly relocated to make room for the dam and a reservoir about the size of Singapore, which began generating power last month.
Many have made an unhappy transition to life in drab resettlement areas, and representatives of the evicted indigenous people launched a series of legal appeals.
But these culminated Thursday in a unanimous dismissal by a three-judge panel from Malaysia's highest court, the Federal Court, which found the eviction had not violated the tribal peoples' constitutional rights.
"I hearby dismiss the appeal and uphold the orders of the courts below," chief justice Zaki Azmi, of the Federal Court, said in the capital Kuala Lumpur.
Colin Nicholas, founder and coordinator of the Center for Orang Asli Concerns, whose name uses the Malay term for indigenous people -- said the decision could turn the indigenous groups into "internal refugees."
"Natives use blockades and negotiations (and when it fails) they come to court for justice. But that justice was not delivered. It is disappointing," he told AFP.
"The fear now is these people will become internal refugees because they can be forced to relocate," he said.
Ngajang, who has moved to higher ground with his family, said he was afraid for the future. "I fear we will be driven out from our own land. I will end up like a squatter," he said. "Our lives are only filled with darkness and uncertainties."
The case was brought by members of indigenous tribes including the Iban, Dayak, Kayan, Kenyah and Ukit peoples, some of the many ethnic groups living on Borneo, which is split between Malaysia, Indonesia and the sultanate of Brunei.
A lawyer for the group, Baru Bian, said that more tribal people in Sarawak might now be forcibly moved in the name of development. “There is a possibility the move to displace natives in Sarawak will gain momentum," he said. About 200 cases of indigenous people fighting state acquisition of their land are ongoing in lower courts.
Transparency International has labelled Bakun a "monument of corruption", and analysts have questioned how the Malaysian government can ever recover the money it has sunk into the project.
The dam, one of the world's tallest, has been dogged by problems since its approval in 1993, and the delays have incurred large cost overruns.
The construction costs for Bakun have added up to at least $2.6 billion, making it among the most expensive infrastructure projects in Malaysian history.