The case began in 2008 when the employee returned from maternity leave to the Baby Loup nursery in the Paris suburb of Chanteloup-les-Vignes. She had started wearing a full body veil with just her face showing, which she refused to remove.
The crèche, which is open 24 hours a day, seven days a week, said it enforced a strict policy of non-religious symbols. When the employee insisted on continuing to wear her veil, she was dismissed.
The case was taken up in 2010 by the state-run authority that fights discrimination, HALDE (Haute Autorité de Lutte contre les Discriminations et pour l'Egalité). The body originally supported the sacked woman when it first heard the case in March 2010.
However, there was a change of heart later that year when a new leader, Jeannette Bougrab, was installed. Bougrab, who now works as the minister for youth, said the crèche had the right to choose a "philosophical option of secularism."
The employee took her case to an employment tribunal in December 2010 asking for €80,000 ($113,000) in damages. The tribunal also found in favour of the crèche, citing the "respect for the principle of secularism and also the vulnerability of children."
Thursday's decision followed an appeal by the worker to the Versailles court of appeal. The court ruled that the nursery had acted within a law allowing privately-owned kindergartens to forbid the wearing of religious symbols.
The director of the crèche, Natalia Baleato, said she was "relieved after three years of court cases."
"It's a huge victory for secularism but, above all, a victory for Baby Loup" said the nursery's lawyer, Richard Malka.
Bougrab said she was "very happy" about the decision.
"Many of us have supported Natalia Baleato who launched this scheme in a "difficult" area, allowing children to be looked after so their mothers can become autonomous" she said.
As well as the law allowing the banning of religious symbols in nurseries, France has also banned the full-face covering Islamic niqab veil and slapped fines on several women for wearing the garment.