After a two-year legal battle, the NSW Court of Appeal ruled in favour of the owner of the Simmer on the Bay restaurant at Walsh Bay, who challenged the project on the ground that it had not been lawfully approved.

The 3-0 decision represents a setback for a government which, for the past five years, has been working on and touting plans to redevelop the wharf area between the Barangaroo headland and Dawes Point Park.

But the decision also represents a relief for Brigid Kennedy, the restaurant owner and manager who took on the money and muscle of the state to halt what the court has now found was an invalid planning process.

"I had everything to lose," said Ms Kennedy. "I borrowed 110 per cent finance 11 years ago and made this into a great success," she said, adding that her restaurant would not have survived two years of construction.

"I put absolutely everything into this."

In April, Arts Minister Don Harwin announced an extra $68 million in funding, on top of $139 million already committed to Walsh Bay, which would be spent partly on refurbishing space used by the Sydney Theatre Company.

The impact of the decision on the government's aim of opening the redeveloped Walsh Bay by 2019 is uncertain. The plan is for the refurbished wharves and new linking decks between them to be home to the Sydney Theatre Company, the Australian Theatre for Young People, the Bangarra Dance Theatre, the Sydney Dance Company, the Philharmonia Choirs and the Gondwana Choirs.

But the Court of Appeal's decision on Thursday ruled that the planning consent granted in 2015 that had underpinned the project was invalid, meaning chunks of the planning and consultation process will need to be redone.

In May, 2015, a delegate for then planning minister Rob Stokes granted development consent for the project, but did not look at its "construction-related impacts". The delegate claimed the Environmental Planning and Assessment Act did not require examining construction impacts because the project was a "staged development application".

Ms Kennedy, who realised the threat to her business when the planning proposal was first released in 2014, unsuccessfully challenged the delegate's approval in the Land and Environment Court but lost.

But the Court of Appeal this week overturned that decision. The court rejected both the delegate's categorisation of the development as staged, and also that a staged development did not require the consideration of construction impacts.

"Speaking hypothetically ... a local business may be expected to benefit from the development as constructed; but if, through an extended and disruptive construction process, the business fails, it will not be there on completion to reap any benefits," Justice John Basten wrote in his judgment.

The Greens' planning spokesman, David Shoebridge, was scathing of the government's process: "They have wasted two years, hundreds of thousands of dollars in legal costs and all because they didn't know how the Planning Act works.

"Any government that is considering a major urban redevelopment needs to carefully consider what its impacts will be on the locals, and if they don't then the courts will judge them harshly," he said.

A spokesman for Create NSW, the government's arts and culture funding division, said the government remained committed to developing the precinct at Walsh Bay "to deliver state-of-the-art rehearsal and performance spaces", and was "still working expeditiously towards starting the development".

The spokesman said the government was working with the tenants of the arts precinct, and "a new Development Application will be submitted shortly".

Ms Kennedy acknowledged that, if the government completed a new development application according to law, it could still result in a significant impact on her business. But she said this time she would be consulted.

"The courts decided today they must work with the stakeholders, and that's where the win is," she said.