Places at Cams Hill in Fareham must now be given in the first instance to children in care, the Office of the Schools Adjudicator said.
The decision marks the culmination of a year-long dispute between the foundation school and Hampshire county council over its admissions policy.
Foundation schools are able to set their own admissions policy. There are 20 foundation schools in the county, but Cams Hill was the only one to give priority for places to children of staff. Its roll shows 12 children whose parents work at the school. At least one teacher has said he may have to leave if his son is denied a place.
David Wilmot, head of the 1,040-pupil school, said: "He cannot take his child to a different school and then make the 35-minute journey to here in time."
He said no pupil over the past four years had been denied a place to accommodate a child of a staff member.
Two years ago, the adjudicator ruled in favour of Cams Hill on the grounds that local children were not disadvantaged by the policy. But this week June Brown, another adjudicator, upheld the council's objections on the grounds that it was unfair to other children. Changes to the admissions policy must be implemented for the 2005 intake.
Mr Wilmot said he was disappointed with the judgement. "The reality is that any child who wants a place here gets one," he said.
"We have 210 places and had 265 applications this year. But we are competing with local independent schools and by the time parents decide they have found the money to send their children there we can accommodate everyone else through the appeals process.
"Cared-for children is not an issue either as we already have a handful at the school. The council is taking a dogmatic approach. It wants all schools to have the same arrangements."
At the moment top priority for places at Cams Hill is medical reasons.
Children of staff have the second-highest priority for places.
Ms Brown said: "I do not believe that in this case according admission priority to children of staff acts in the best interests of all local children." She ruled that the criterion be "deleted from the school's arrangements" and that children in local authority care should now receive top priority.
A Hampshire spokesman said: "The council has a responsibility to lodge objections against schools who are going against the recommendations of the code of practice. And our objection has been upheld by the schools adjudicator."