Well that's fucking bullshit. I've never had to deal with this myself, but from what I found on google, it seems like the only option now is to either just re-apply or file for a "judicial review."
Administrative decision process for the cancellation and revocation of passports and the refusal of passport services
Quote:
Revocation of Passports and Refusal of Passport Services
Refusal and revocation decisions made by the Passport Program are considered final as of the date the decision is rendered. A person who chooses to challenge a decision may do so by filing an application for judicial review before the Federal Court of Canada within 30 days of the date of the decision.
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To file for a judicial review:
http://cas-cdc-www02.cas-satj.gc.ca/.../ApplicationJR
I didn't read through the whole thing, but seems like it will be a lengthy process, and there is a $50 processing fee. You guys might be better off just re-applying. I'm not legal expert, but from your post, it seems like you guys have a pretty solid case.
Good luck!