The taxpayer has been left to foot a £220m bill after a tribunal ruled that a government contract awarded to a US defence firm to deliver the e-borders programme was unlawfully terminated.

The contract to put in place an electronic system to check travellers leaving and entering Britain was ended by the government in July 2010 because the Home Office said it had no confidence in Raytheon, the company that won it in 2007 and which had fallen a year behind schedule on delivery.

However, an arbitration tribunal has now awarded the Massachusetts-based company £49.98m in damages after it found that the processes by which the now-defunct UK Border Agency reached the decision to scrap the agreement were flawed.

The Home Office must also pay Raytheon £9.6m for disputed contract-change notices, £126m for assets acquired through the contract between 2007 and 2010, and £38m in interest.

The e-borders programme, devised by the Labour government in 2003, was designed to vet travellers entering or leaving the country by checking their details against police, security and immigration watchlists.

On Monday the government defended its decision to end the contract, saying the situation it inherited was "a mess", and announced that the National Audit Office would conduct a full review of e-borders from its inception.

A letter from the home secretary, Theresa May, to the Labour MP Keith Vaz, chair of the Commons home affairs select committee, said the Treasury would work with the Home Office to make sure that costs were met without any impact on frontline services.

"We are looking carefully at the tribunal's detailed conclusions to see if there are any grounds for challenging the award," it said. "The government stands by the decision to end the e-borders contract with Raytheon. This decision was, and remains, the most appropriate action to address the well-documented issues with the delivery and management of the programme."

May said key milestones had been missed by Raytheon in 2010 and parts of the programme were running at least a year late. "The situation the government inherited was, therefore, a mess with no attractive options. All other alternatives available to the government would have led to greater costs than the result of this tribunal ruling."

She said the Home Office permanent secretary Mark Sedwill had asked the National Audit Office to conduct a full review of e-borders from its inception.

David Hanson, the shadow Home Office minister, said: "This is a crushing verdict on a Home Office decision made by David Cameron's government, which has cost the taxpayer hundreds of millions of pounds over the last four years.

"Theresa May must now make clear what legal advice she took before taking a decision that has cost the taxpayer £224m. She must also set out how much the taxpayer has had to pay out to foot the bill for the Home Office's legal fees. The home secretary needs to make clear when the e-borders programme will be back on track. As a result of this stalled process, we are still far away from counting people in and out of the UK."

The head of the UK Border Force, Sir Charles Montgomery, told MPs this year that the scheme had been terminated in its current form.

May said that since 2010 the government had adopted a policy of separating and breaking down larger, longer-term contracts worth more than £100m. The original e-borders requirement – to record advanced passenger information for checking against terrorist and crime watchlists – was being delivered, the home secretary said.

The minister for immigration and security, James Brokenshire, said: "The government stands by the decision to end the e-borders contract with Raytheon. The situation we inherited in 2010 was a mess. Key milestones had been missed and parts of the programme were running at least a year late. The contract, signed in 2007, had already cost the taxpayer £259.3m and yet wasn't delivering."

In a statement to the New York stock exchange, Raytheon said: "The tribunal's ruling confirms that [Raytheon] delivered substantial capabilities to the UK Home Office under the e-borders programme. Raytheon remains committed to partnering with the UK government on key defence, national security and commercial pursuits."