The European Court of Justice on Thursday rejected an appeal brought by the bloc against a lower court ruling. The move could allow other Iranian firms to launch suits.
It was the first ruling in favor of an Iranian company since international sanctions were lifted on the Islamic Republic last month as part of a nuclear deal with world powers.
The European Council, the grouping of the EU's 28 member states, froze the funds of a number of Iranian financial entities from 2010.
In Bank Mellat's case, the Council claimed that it engaged in conduct that supported and facilitated Iran's nuclear and ballistic missile programs.
The second-tier General Court accepted Bank Mellat's challenge in 2013, prompting an appeal to the European Court of Justice, which has now dismissed the appeal.
The top court found that there had been "an error of law" made.
"Since all the measures concerning Bank Mellat have been annulled, its funds are deemed not to have been frozen between 26 July 2010 (date of first freezing measure) and 16 January 2016 (date on which the freeze was lifted)," the court said.
A European Commission spokeswoman said it had "taken note" of the ruling, adding that restrictive measures against the bank had been lifted last month with the removal of sanctions.
"There is no further action to be considered," she said.
Bank Mellat's lawyer, Sarosh Zaiwalla, said the judgment "should have a significant impact on the principle of the rule of law ... This strengthens our $4 billion claim for damages."
"The significant aspect of this ruling is that anybody who has been a victim of unlawful listing, or who considers themselves, can now bring a claim," Zaiwalla told Reuters.
The EU's General Court last year annulled sanctions on Bank Tejarat and a series of shipping companies, although they were mostly re-imposed.
The Bank Mellat case began in 2013. In February 2014, the bank filed a damages claim in London's High Court after Britain's Supreme Court quashed UK sanctions imposed on the bank over alleged links with Tehran's nuclear program. The British government filed a defense in response.
Bank Mellat, which is 80 percent owned by private Iranian investors with Iran's government holding the remaining 20 percent stake, would press for damages from the UK with a hearing scheduled in October, Zaiwalla said.
Britain's Treasury did not immediately respond to a request for comment, according to Reuters.
Zaiwalla said Bank Mellat could consider damages against the European Council.