The fortune of HK$330m ($NZ60m) was was seized at the urging of the United States in January 2012, two days before the raid which saw Megaupload crushed. It was done in line with similar actions across the world, including one in New Zealand which saw about $20m seized.
Deputy High Court Judge Garry Tallentire said a restraining order was a "draconian" measure before a conviction.
"It is a weapon of necessity that blows away individual or corporate freedoms for the greater good," he said. It should not be made lightly and required those seeking the order to completely open.
Judge Tallentire said there was an issue over how a summons would be served on Megaupload. The law in the US required it to be mailed to the company's last known address in Eastern Virginia, where the charges were laid, or elsewhere in the US.
The problem arose with Megaupload never having offices in the US. The issue had been raised in the US court hearings but had been put off until Dotcom's extradition was complete with the possibility he could then be served.
Judge Tallentire said "no one can say when that process of extradition will be completed give the appeal paths open to the various accused. Indeed, no one can say if it will ever be completed".
The Hong Kong Secretary for Justice - Senior Counsel Wong Yan-lung at the time - acted as the agent for the United States in applying to the court for the restraining order and was obliged to tell the court if there were issues which might impact on the case, the judgment stated.
But Judge Tallentire said the real obligation was on the US because the Secretary for Justice who "could only disclose what was known" in his dealings with the US.
It emerged the Hong Kong authorities had not been told "on the contention that they are irrelevant". It was not a decision to mislead the court, he said, but a "somewhat dogmatic and short-sighted response". He said it was a "serious and demonstrable error of judgment" by the US.
He said it was possible the US could seize Megaupload's assets and "even at some uncertain time in the future bring criminal proceedings" against the company.
But at the time the restraining order was granted it could not because the company could not be served a summons, he said.
Judge Tallentire ordered a full hearing over the restraining order.
Dotcom's was represented by Hong Kong lawyer Senior Counsel Gerard McCoy, who is also adjunct Professor of Law at Canterbury University.
Dotcom tweeted: "The sad reality is that there is no justice if you can't afford it. That's why the US government seized all of our assets from the start."
Bloomberg quoted a statement from the Hong Kong Department of Justice saying: "The court has found sufficient grounds to re-grant the restraint order after hearing the parties' submissions, notwithstanding the finding of non-disclosure."
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