In a 2-1 decision, a three-judge panel of the 5th US Circuit Court of Appeals issued a preliminary injunction that blocked the Trump administration from removing a group of Venezuelans under the seldom-used 18th-century law.
The Fifth Circuit is the first federal appeals court to rule directly on a March 14 presidential proclamation invoking the 1798 law to justify rapid deportations.
Circuit Judge Leslie Southwick, writing for the two-judge majority, rejected the Trump administration's assertion that the Venezuelan gang Tren de Aragua had engaged in a "predatory incursion" on US soil.
The Act gives the government expansive powers to detain and deport citizens of hostile foreign nations, but only in times of war, or during an "invasion or predatory incursion".
Southwick was appointed by former President George W Bush. He was joined by Circuit Judge Irma Carrillo Ramirez, an appointee of President Joe Biden.
Circuit Judge Andrew Oldham, a Trump appointee, dissented.
The Trump administration could ask the entire 5th Circuit to rehear the case. It is expected to eventually reach the Supreme Court.
"The Trump administration's use of a wartime statute during peacetime to regulate immigration was rightly shut down by the court," said American Civil Liberties Union lawyer Lee Gelernt, who represented the Venezuelans.
"This is a critically important decision reining in the administration's view that it can simply declare an emergency without any oversight by the courts."
A White House spokeswoman did not immediately respond to a request for comment.
The case before the 5th Circuit was brought by a group of alleged Tren de Aragua members being held at the Bluebonnet Detention Facility in Anson, Texas. The ACLU, which represents the men, has disputed the claims of gang membership.
In his March 14 proclamation, Trump said he would use the 1798 law to swiftly detain and deport members of Tren de Aragua. Trump asserted that the gang is a state-sponsored international terrorist organisation that has invaded United States territory.
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