Sheikh Ali Salman, head of Bahrain's largest and now banned Shia opposition group al Wefaq was found not guilty along with two of his aides, who were tried in absentia, a judicial source said on condition of anonymity.
Groups including the Bahrain Institute for Rights and Democracy, and the Bahrain Center for Human Rights, confirmed his acquittal.
"Sheikh Ali Salman was found innocent," Sheikh Maytham al-Salman of the Bahrain Center for Human Rights. "We hope this ruling opens the way for dialogue and reconciliation."
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Bahraini attorney general Ousama al-Awfi said he would appeal the verdict in a statement released by the public prosecutor's office.
Sheikh Ali Salman has been behind bars since 2014 serving a four-year jail sentence on charges of inciting hatred.
He is now expected to be released on December 28, according to Amnesty International.
In November, Sheikh Ali pleaded not guilty to charges of communicating with a foreign state to commit acts hostile to the state of Bahrain specifically Qatar.
The charges came after Bahrain and its Gulf allies cut ties with Qatar last June over allegations the emirate supported extremist groups and was too close to Iran. Qatar has denied the allegations.
Tiny but strategic Bahrain has a Shia majority but is ruled by a Sunni royal family that dominates all top government posts.
It has been gripped by civil unrest since 2011, when authorities bloodily crushed protests calling for a constitutional monarchy and an elected prime minister.
Both religious and secular opposition groups have since been banned and dozens of high-profile clerics and activists thrown behind bars.
Al-Wefaq was the largest bloc in parliament before the 2011 protests. When they were crushed, all its members resigned their seats.
The group was dissolved by court order in 2016.
Bahrain's main secular opposition group, the National Democratic Action Society (Waad), has also been outlawed.
Waad's leader Nabeel Rajab is currently serving jail time in two separate cases linked to criticism of Bahrain's three-year-old military intervention in Yemen alongside its Gulf allies and of its treatment of prisoners at home.
Bahrain's courts have come under heavy criticism from human rights groups, including Amnesty and Human Rights Watch, for failing to meet the standards of fair trials.
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The groups identify Salman and other dissidents as prisoners of conscience.
King Hamad last year ratified a constitutional amendment that gives military courts the authority to try civilians charged with terrorism, a term that is loosely defined in the Bahraini penal code.
Bahrain accuses Shia-ruled Iran of fanning the protests in a bid to overthrow the government.
Iran says it is merely criticising the repression of peaceful protests, as Bahrain's Western allies have also done.
Bahrain is home to the US Fifth Fleet and also houses a British naval base that opened in April.
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