White-rot fungi, unlike bacteria in conventional activated sludge system, can degrade wide varieties of textile dyes. Their large scale implementation, however, has been impeded due to lack of appropriate reactor system that can sustain stable performance under non-sterile environment. In this study, contrary to virtually complete decoloration of an azo dye (Acid Orange II, 100 mg L−1) in pure culture batch test, a fungal membrane bioreactor (MBR) achieved 93% removal during long-term non-sterile operation at a hydraulic retention time (HRT) of 1 d. Through a set of novel observations made in MBR and parallel batch tests, the interrelated factors responsible for incomplete dye removal, namely, bacterial disruption, fungal morphology and enzyme washout were identified. As compared to the activity of pure fungus culture, the bacteria-contaminated disintegrated MBR-sludge demonstrated low decoloration and undetectable enzymatic activity, indicating detrimental effect of bacterial contamination. Additional observations suggested close relationship between fungal morphology and enzymatic/decoloration activity under non-sterile environment. This study also demonstrated the occurrence of enzyme washout from MBR and its HRT-specific detrimental influence on removal performance. Based on the observations, certain ways to enhance decoloration were proposed.