Pamela Phelps, a single mother from west London, said her ambition was to be 'rich and famous' when she won the award at a high court hearing in September last year.
She became the focus of a test case which her lawyers said would bring hundreds of other claims from people who believe their schools failed them because of similar difficulties.
But last week the appeal judges said it was up to Miss Phelps to prove her learning difficulties had affected her earning capacity, and she had not done so. Hillingdon LBC education authority had not been negligent.
'This judgement flies in the face of previous decisions of the House of Lords. Schools and their advisers have to be responsible and if things go badly wrong it is not something which society will accept.
'The decision today gives carte blanche to schools to make mistakes and not pay the consequences.'
He said a total of£200,000 will be paid by the legal aid board which will cover the cost of the lawyers' research into the case and a team of barristers including Cherie Booth QC, who represented Miss Phelps and Edward Faulks QC who represented Hillingdon.
Mr Faulks told the appeal judges, lords justices Stewart-Smith, Otton and Tuckey, that Miss Phelps had already received£7,056 from Hillingdon which they would not be seeking to recover.
He said Miss Phelps, who has a young child, was not working at the moment and did not have to contribute to her legal costs.
The mother, who was not at today's hearing, said after her high court victory that she felt bitter toward the schools and she would be using her award for special learning tuition.
Ms Booth claimed at the high court hearing that Miss Phelps was of average intelligence but because her learning difficulty was not discovered until two months before she left school, she never learned to read and write properly.
Because she was denied the opportunity of further education, she was excluded from the chance of finding a job in the normal range of employment where she could have earned up to 20,000 a year. Instead she was condemned to a life of 'temporary menial tasks.'
Lord Justice Stuart-Smith said the high court judge had found that Hillingdon was liable for the negligence of an educational psychologist in failing to identify that Miss Phelps had a special learning difficulty.
But he said the psychologist's job was to advise the school and the LEA and this did not amount to 'an assumption of responsibility' to the child.
The judge said there were reasons why the LEA should not be made liable 'by the back door of vicarious liability.'
'There is a serious risk that vexatious claims may be brought, against many teachers oreducational psychologists many years after the relevant decisions were taken.'
He said this could lead to 'scarce resources' being directed from 'the proper function of the LEA - 'which is providing a free education for all those who wish to avail thyemselves of it' - to fighting such cases.
Decisions on Miss Phelps's education were taken after hearing the views of many professionals - 'it is likely to be invidious to single out one and make him or her a scapegoat.'
If Miss Phelps had been diagnosed as dyslexic at an earlier date, the judge said it would be 'impossible' to say whether different teaching techniques would have made any difference to her learning achievements.
Lord Justice Stuart-Smith said it was a 'virtually impossible task' for a judge to decide on the amount of damages and future loss of earnings and 'it is difficult to resist the conclusion that he simply plucked a figure out of the air.'
Lord Justice Otton commented: 'There is no history of employment, and the future is entirely speculation.'
He said anyone with Miss Phelps's condition 'faces formidable difficulties' in proving a link between failure to diagnose and treat and its effect on future earning capacity.
John Morrell, a partner in the firm of solicitors who represented the local authority, said: 'This is a very significant decision. Had the appeal failed, local education authorities would have been faced with investigating circumstances going back over a long period where relevant witnesses and documentation might no longer be available.'
A spokesman for Teacher, Stern, Selby, Miss Phelps's solicitors, said: 'Pamela Phelps and her family are obviously very disappointed that the decision of Mr Justice Garland has been overturned.
'Pamela brought her case to court in the first place because she had no alternative way of obtaining recompense for the failures of the school system.
'She never expected to excel in her ability to read and write, but she wanted the chance to have the right form of education to help her cope better with everyday life.'
He added: 'The court of appeal's decision will come as a very real disappointment to all those who suffer from special educational needs and who feel that the current educational system does not afford them sufficient protection when the system breaks down.'