Thousands of people in Bhopal died in December 1984 after a gas leak at a chemical factory owned by Union Carbide, a company which has since been taken over.
The Indian Government wanted the culpable homicide charge against the American former chief of the company, Warren Anderson, to be reduced to negligence.
That would have brought the case against Mr Anderson in line with Indian former company officials, who have already succeeded in getting their charges watered down to negligence.
But a judge in Bhopal rejected the government's application on Wednesday, arguing that Mr Anderson had not applied to any Indian court to have his charges reduced.
The judge, Rameshwar Kothe, said steps to extradite Mr Anderson should now be speeded up.
The ruling has been welcomed by those representing the victims.
"We're delighted... proceedings should be now undertaken to expedite the extradition of Warren Anderson," said S Muralidhar, a lawyer who has represented victims for years.
Best-selling author Dominque Lapierre, who wrote a book on the tragedy, told BBC News Online that the Indian judiciary deserved the highest praise for the verdict.
"I've always considered it a crime-within-a-crime, the move to dilute the verdict of a man who is responsible for the death of six times as many people who were killed in the WTC incident."
Mr Anderson faces up to 20 years in prison if found guilty of culpable homicide. Negligence carries a maximum sentence of two years.
His whereabouts are currently unknown, and he is defined in Indian law as an absconder.
The court hearing heard from witnesses who used to work at the factory.
One affirmed prosecution charges that key machinery there was malfunctioning at the time of the disaster.
That included filtering equipment and a cooling system, both of which would probably have prevented the gas leak or softened its effects.
'Government pressure'
Nearly 18 years on, the disaster at the Union Carbide pesticide factory is a continuing nightmare for the people of Bhopal.
More than 3,000 people died within hours, mostly in agony, when a storage tank burst, sending tonnes of deadly gases over the sleeping city.
In all, more than 20,000 deaths have been linked to the disaster.
More than 100,000 people are ill, including babies still being born to victims today.
Gas leak victims and their supporters believe that Delhi succumbed to pressure from Dow Chemical, the company which took over Union Carbide.
They believe the government is anxious not to scare away foreign investors and they say it is right that Mr Anderson, as the overall company leader, should continue to be accused of homicide
Union Carbide paid $470 million in compensation in an out-of-court settlement in 1989.
The company accepted "moral responsibility" for the disaster but maintained that a disgruntled employee sabotaged the plant, Reuters news agency reported.