High Court judge Launcelot Henderson ruled that Branislav Kostic was mentally ill when he left the party more than 8 million pounds (US$16.3 million; EUR11.5 million) - one of the largest individual political donations in British history.
The judge said Kostic was "wholly unable to dispose of his property in the way he would have done if of sound mind."
He ruled that an earlier will leaving Kostic's fortune to his son Zoran should stand.
Belgrade-born Kostic, who made a fortune trading in pharmaceutical products and precious metals, died in October 2005 at the age of 80.
Lawyers for his family argued at London's High Court that Kostic was "deluded and insane" when he drew up a will leaving the money to the Conservatives.
Zoran Kostic's lawyer, Clare Montgomery, told the court hearing in July that Branislav Kostic became "gripped by delusions concerning conspiracies, dark forces and plots to kill him that ... came to distort much of his world view."
He had described Thatcher "the greatest leader of the free world in history" and said she would save the world from the "satanic monsters and freaks" who were conspiring against him, Montgomery said.
Montgomery said Kostic believed his wife, mother and sister were part of a "devilish organization."
The Conservative Party had contested the family's claim, saying Kostic's delusional disorder did not make him incapable of drawing up a will.
The party's lawyer, Andrew Simmonds, said the bequest was motivated by Kostic's "great and long-standing affection for the Conservative Party and his admiration for Mrs. Thatcher."