Justice Murray Wilcox delivered the landmark judgement in the Federal Court in Sydney today.
Outside the court, a spokesperson for Sharman Networks said the company would appeal the decision.
She stressed the record label's victory had not been comprehensive, citing the judge's dismissal of the labels' Trade Practices Act and conspiracy claims.
"Both parties have had a win, although neither side has had a complete victory.
"Sharman Networks is obviously disappointed that we have not been completely successful. But, we will appeal those parts of the decision where we were not successful and are confident of a win on appeal," the company said in a statement.
Spokesperson for the record labels, Michael Speck, said his side was disappointed in Sharman's decision.
"We're disappointed they won't accept the umpire's decision.
"It can't be fair to build a business on somebody else's work," he said.
However, the applicants were "absolutely delighted" with the judgement, according to Speck.
"It's a great day for artists, and music," he said.
"The consequence of this [judgement] will have global impact."
Importantly, Justice Wilcox had ruled that Sharman would have to make considerable change to Kazaa if it wished to continue its business, according to Speck.
"The court has made orders in that [Kazaa] has to be legitimate or disappear," he said.
"It is up to these people to honestly and decently stop ripping off music.
"If you're out there and you're ripping off music...sit up and take notice."
Asked how many millions of dollars the record labels might apply for in damages, Speck avoided giving a figure, but said: "These people have crowed for years about [the number of] their downloads."
The labels would ask the court that the damages awarded reflect those claims, he said.
The labels had already frozen AU$30 million worth of the respondents' assets, according to Speck, and so were confident they would receive full payment.
He described the cost of the long-running court action to the record labels as "a small investment".
"We made a small investment in protecting the future of the music industry.
"It's very small compared to what was ripped off from the industry."
Asked whether the record labels would pursue similar operators, he said: "It's not our preferred option".
The international record industry organisation, International Federation of Phonogram and Videogram Producers (IFPI), said the court's decision would lay down the law for future generations.
The Australian decision comes just ten weeks after the US Supreme Court ruled against file-sharing operator Grokster.
"Within the space of 10 weeks, two courts in different continents and hemispheres have given a huge boost to the efforts by music and technology companies to forge a legal online music business," said IFPI chairman and CEO John Kennedy.
"Today's judgement shows that Kazaa -- one of the biggest engines of copyright theft and the biggest brand in music piracy worldwide -- is illegal," he said.
"This is a milestone in the fight against Internet piracy worldwide. Today there is a resounding signal to other unauthorised file-swapping networks: they should adapt their systems and go legitimate now".
I wouldn't install kazaa anyhow. If you read thier EULA, Especially section 9, it is abundantly clear that (while it is not whitout your knowledge, supposedly, assuming you dug through the forty some odd page document) Kazaa does install spyware, such as cydoor, that if memory serves does collect personally identifiable information. I'm sure it installs other such items. imho, kazaa, and thier parent company, can take thier spyware-laden program, and EULA, and suff them. Bit torrent is a much better protocol anyhow. At least azeurus never forces spyware on me. Besides, if memory serves, i can't get a linux livecd, or BSD install media on kazaa as easily, or fast, as BT...