Sir Richard had mounted a legal challenge to the decision by the Department for Transport (DfT) to award a new 13-year franchise for the West Coast not to Virgin Rail but to rival transport company FirstGroup.
The DfT had intended to contest the matter in court and was still hoping FirstGroup would take over the London to Scotland route as planned on December 9.
But early today, in an embarrassing U-turn for the Government, Transport Secretary Patrick McLoughlin said he was cancelling the competition for the running of the West Coast franchise "because of deeply regrettable and completely unacceptable mistakes made by my department in the way it managed the process".
Three DfT officials involved in the franchise competition have been suspended, the department said today.
Mr McLoughlin said the DfT would no longer contest the judicial review and had paused all outstanding franchise competitions pending two independent reviews he has set up.
Sir Richard, who had described the bidding process as "flawed" and "insane", welcomed the decision and said he was hopeful Virgin would carry on running the franchise which it has been operating since 1997.
FirstGroup said it was "extremely disappointed" at the news, saying it had submitted "a strong bid, in good faith and in strict accordance with the DfT's terms".
House of Commons Transport Committee chairman Louise Ellman MP said she was "astonished" by the development and said it put the whole franchising process "in disarray".
Shadow transport secretary Maria Eagle MP said the West Coast franchise process had been a "fiasco" which had "yet again exposed the shambolic incompetence of this Tory-led Government".
Liberal Democrat party president Tim Farron, who is MP for Westmorland and Lonsdale in Cumbria, said "people must be held accountable" for the errors.
Bob Crow, general secretary of the RMT transport union, said: "The whole sorry and expensive shambles of rail privatisation has been dragged into the spotlight this morning and instead of rerunning this expensive circus, the West Coast route should be renationalised on a permanent basis."
Scottish Transport Minister Keith Brown is demanding an urgent meeting with the UK Government in the wake of the "shambolic" cancellation of the franchise award. It is "not acceptable" that ministers north of the border were not informed of the decision in advance, he said.
The u-turn by the UK Government on the controversial franchise award "leaves so much up in the air", Mr Brown said.
He said: "I am calling for an urgent meeting with the UK Transport Secretary, and currently trying to make contact by telephone, and will be demanding an explanation of the impact of this decision for Scotland's rail users. This is a shambolic situation that affects thousands of passengers in and out of Scotland.
"I will do everything I can within our current limited powers to help minimise any uncertainty and disruption for them and I urge the Department for Transport to sort out this horrendous mess and do the same.
"Despite the fact that this franchise provides services to and from Scotland, we were not advised of the findings nor of the fact that they would be announced today and therefore not included in planning how best to protect the interests of Scottish passengers."
Labour's shadow Scottish Secretary Margaret Curran also said more clarity is needed about the future of the line, with business leaders too demanding more information.
"The West Coast main line is of vital importance to Scotland and people who use the line for business and to visit family across the UK.
"This decision demonstrates again the incompetence of the Tory-led Government. They now need to tell us clearly how this happened and what the cost is to the taxpayer. Hundreds of thousands of people every year use this route and what Scots need now is clarity about the future of the West Coast main line."
Liz Cameron, chief executive of Scottish Chambers of Commerce, said that as a "matter of urgency" the UK Government must provide more information.
"The fact that the Department for Transport has blundered on this scale is simply not good enough and the cost both to the public purse and to the private sector bidders is unacceptable.
"It is essential that the Department for Transport acts decisively to ensure stability in the provision of West Coast main line services and to ensure that the monumental mistakes made during this tendering process are never repeated."
Businesses need to have "confidence that the civil servants responsible for developing and assessing bids have the professional knowledge and experience to do so properly", Ms Cameron said.
"Equally we need to know that, as we enter the winter period, Scotland's cross-border rail connectivity with England will be secure and reliable. Connectivity is essential for Scottish business and we need clarity from government on this issue as a matter of urgency."
Mr McLoughlin has inherited what has become a messy problem, having just taken over at the DfT from Justine Greening.
Until today, he and Ms Greening had said they were satisfied with the West Coast bidding franchise which culminated with the award, following a four-company bidding battle, to FirstGroup in August.
In an announcement put out at midnight last night, Mr McLoughlin said: "I have had to cancel the competition for the running of the West Coast franchise because of deeply regrettable and completely unacceptable mistakes made by my department in the way it managed the process.
"A detailed examination by my officials into what happened has revealed these flaws and means it is no longer possible to award a new franchise on the basis of the competition that was held.
"I have ordered two independent reviews to look urgently and thoroughly into the matter so that we know what exactly happened and how we can make sure our rail franchise programme is fit for purpose."
He added: "West Coast passengers can rest assured that while we seek urgently to resolve the future arrangements the trains that run now will continue to run, with the same drivers, the same staff and timetables as planned.
"The tickets that people have booked will continue to be valid and passengers will be able to make their journeys as planned."
Officials have been asked to examine options for the operation of the service after December 9.
The other outstanding franchise competitions that have been halted are Great Western, Essex Thameside and Thameslink.
DfT permanent secretary Philip Rutnam said: "The errors exposed by our investigation are deeply concerning. They show a lack of good process and a lack of proper quality assurance.
"I am determined to identify exactly what went wrong and why, and to put these things right so that we never find ourselves in this position again."
The first "urgent" independent review will focus on what lessons are to be learned from the DfT's handling of the flawed competition process.
It will be conducted by independent advisers and overseen by Centrica chief executive Sam Laidlaw and former PricewaterhouseCoopers strategy chairman Ed Smith, both DfT non-executive directors.
An initial report is expected to be delivered by the end of October.
The second review, undertaken by Eurostar chairman Richard Brown, will examine the wider DfT rail franchising programme and look in detail at whether changes are needed to the way risk is assessed.
The bidding and evaluation processes will also be examined, with a report expected by the end of December.
Evidence of significant flaws in the DfT's approach emerged while officials were gathering evidence for the High Court legal proceedings involving Virgin Rail, the department said.
It said the flaws stemmed from the way the level of risk in the bids was evaluated.
Mistakes were made in the way inflation and passenger numbers were taken into account and how much money bidders were then asked to guarantee as a result, the DfT added.
The department said it could not be confident that the flaws would not have changed the outcome of the competition or that any of the four bidders would not have chosen to submit different offers.
All the bidders have been contacted by the DfT and will have their bid costs reimbursed, it added.
The Government said a fresh competition will be started as soon as "the lessons of this episode are learned".
Writing on his blog on the Virgin website, Sir Richard said: "From the moment we found out that FirstGroup had been made the preferred bidder with a completely unrealistic bid, we questioned the way the offers had been assessed, and asked the Government to review and explain how it came to its decision.
"We were convinced the process was flawed but despite our best efforts we were met with silence by the DfT.
"We also asked for the Government to appoint an independent adviser to look at the situation, which was turned down. Reluctantly we were forced to seek a judicial review."
Sir Richard continued: "At the House of Commons Select Committee we called for all franchise competitions to be paused and a thorough, independent review of the process. We are grateful that Patrick McLoughlin is now doing this.
"We also appreciate the DfT publicly acknowledging these errors, and are hopeful they will now accept that Virgin Trains should carry on running the West Coast line and ensure that passengers continue receiving our team's award-winning service."
FirstGroup said that until it was notified by the DfT last night, it had no indication there were any problems with the franchise process.
The firm said in a statement: "Until this point we had absolutely no indication that there were any issues with the franchise letting process and had received assurances from the DfT that its processes were robust and that it expected to sign the contract with FirstGroup soon.
"We are extremely disappointed to learn this news and await the outcome of the DfT's inquiries. The DfT has made it clear to us that we are in no way at fault, having followed the due process correctly.
"We submitted a strong bid, in good faith and in strict accordance with the DfT's terms."
Virgin said it would assist the DfT by continuing to run the service while the independent reviews were conducted.
Ms Eagle said: "Ministers have spent weeks refusing to listen to Labour's call to suspend the award of this contract to enable an independent review to take place.
"Only last week the Transport Secretary repeated his claim that the process was conducted properly and he would hand over the franchise to First on time, despite all the concerns that had been raised.
"The Government's belated admission that it ran a flawed tendering process will come as a surprise to no one."
She called on Mr McLoughlin to reveal the full details of what went wrong and "come clean on the full cost to taxpayers of this shambles".
Ms Eagle went on: "Passengers and staff deserve immediate reassurance about the future of the West Coast service.
"If the Government now transfers the running of this line to its own not-for-private profit rail company, as seems sensible and likely, then Labour will support that decision.
"Ministers must also now abandon the planned privatisation of the East Coast line (which is currently run by the DfT)."
Mrs Ellman said: "Only three weeks ago Mr McLoughlin assured the Transport Select Committee that the department's processes were robust and that they would be fighting Virgin's claims in court.
"I will be recalling him and his permanent secretary to the committee to give a full explanation of what happened and how they propose to put it right."
She continued: "The whole focus of our questioning was on the issue of risk and whether the bid put forward by FirstGroup was achievable over a 15-year period.
Mr Farron said: "I have always said that announcing the franchise decision in the recess when MPs are away from Westminster and not able to properly hold the Government to account is unfair and unacceptable.
"Now we know the bid from First Group was unacceptable and it really does show why we needed proper scrutiny of bids like this to begin with. Lessons must be learned and people must be held accountable."