A panel of five judges wrote that the law banning common bawdy houses "is grossly disproportionate" if all it aims to do is keep public order in a neighborhood and maintain public health standards.
"The record is clear that the safest way to sell sex is for a prostitute to work indoors, in a location under her control," the judges wrote in a much anticipated ruling.
"The impact on those put at risk by the legislation is extreme," the judges added.
However, the court stopped short of allowing prostitutes to openly solicit customers on the streets. The court ruled that prohibiting solicitation remains a "a reasonable limit on the right to freedom of expression."
"It is so nice to see that we are now brought out into society. I feel a debutante at a ball. We're almost full citizens so this is wonderful," said Valerie Scott, a former prostitute.
Supporters of the ruling said the laws governing prostitution in Canada would now have to change.
"Any form of criminalization pushes the industry underground and gives opportunities to predators. You can see it through the world," said Nikki Thomas, executive director of Sex Professionals of Canada.