The apex court also faulted the Governor saying she "misjudged her role" for appointing Mehta without holding consultations with the state government.
Sharp differences over Mehta's appointment between Modi and the Governor had triggered a constitutional crisis in the state. The Modi government moved the Gujarat High Court contending that the governor could not appoint Lokayukta without aid and advice of the Council of Ministers.
The Governor held her ground asserting that her decision was based on consultations with the Gujarat High Court Chief Justice.
A bench of justices B S Chauhan and F M Ibrahim Kalifulla dismissed Modi government's plea that the appointment was illegal as it was done without consulting it.
It also expressed displeasure over the post of Lokayukta remaining vacant for more than nine years.
"The facts of the case reveal a very sorry state of affairs, revealing that in the State of Gujarat, the post of the Lokayukta has been lying vacant for a period of more than nine years," the bench said.
The apex court, which said that Lokayukta can be made by the Governor only with the aid and advice of the Council of Ministers, rejected the plea to quash Mehta's appointment saying that the Chief Minister had full information and was in receipt of all communications from the High Court Chief Justice.
"The present Governor has misjudged her role and has insisted, that under the Act, the Council of Ministers has no role to play in the appointment of the Lokayukta, and that she could therefore, fill it up in consultation with the Chief Justice of the Gujarat HC and the Leader of Opposition. Such attitude is not in conformity, or in consonance with the democratic set up of government envisaged in our Constitution," the bench said.