HOME Secretary Theresa May will not appeal against the ruling that top secret evidence cannot be heard in closed sessions during the July 7 inquests, the Home Office said.
MI5's argument that the coroner for the inquests has powers to hold closed sessions to hear top secret evidence was dismissed as "hopeless" by a senior judge last month.
Coroner Lady Justice Hallett had rejected calls from MI5 and Mrs May for the families of those killed in the 2005 London bombings to be excluded from hearings while she examines highly sensitive intelligence material.
Lord Justice Maurice Kay and Lord Justice Stanley Burnton agreed with Lady Justice Hallett's interpretation of Rule 17 of the Coroners Rules 1984, which allows a coroner to exclude the public from hearings in the interests of national security.
But they said this did not include "interested persons" who are legally entitled to be represented at an inquest, such as the relatives of the 52 victims of the July 7 attacks.
Lord Justice Stanley Burnton noted that agreeing to the Home Secretary's argument that the coroner could choose who to exclude from closed hearings would involve "rewriting Rule 17".
He said: "The contention that the coroner has an implied power to hold secret sessions when she considers that it would be in the interests of national security to do so is hopeless.
"Rule 17 prescribes the power of the coroner in such circumstances."
The Government could now employ rarely-used powers to transform part of the inquest into a public inquiry, which could examine the secret documents in closed hearings.
Section 17A of the Coroners Act 1988, as amended in 1999, gives the Lord Chancellor power to adjourn an inquest if the death is being investigated by a public inquiry.
This provision was controversially used in the case of Azelle Rodney, 24, who was shot dead by police in London in 2005, after the inquest into his death stalled over the release of secret evidence.
But Lady Justice Hallett has warned that adopting this route could lead to lengthy delays and extra heartache for the bereaved families and survivors of the attacks.
"If the decision was taken to announce a judicial inquiry, it should not be thought that I can move seamlessly into the role of inquirer," she said.
"There remains a very real possibility that these inquests would have to be adjourned and the whole process restarted – I emphasise the word 'restarted', not 'resumed' – at a much later date under a different person.
"The bereaved families and survivors have waited over five years since the bombings and I have promised them an end to these proceedings by next spring.
"Many witnesses have been through the ordeal of giving evidence, and I am sure would not wish to repeat that experience.