James suffered the injury in Bath's narrow win over Newcastle last weekend and is expected to be out of action for close to eight months.
As well as missing his club's attempt to claim the Guinness Premiership title, James is certain to have to watch the forthcoming Lions series a littler further from the action than he would have liked.
The 30-year-old World Cup winner had not featured in South Africa's autumn victories over Wales, Scotland and England but had made it clear that he was desperate to wear the No10 shirt for the first Lions tour to his homeland in 12 years.
James' injury setback makes it even more likely that current Springbok fly-half Ruan Pienaar will start at No10 in the first Test against the Lions on June 20.
"Butch started 20 Guinness Premiership matches for us this year and seven Heineken Cup matches," said Bath coach Steve Meehan after James had been criticised for some below par performances prior to damaging his knee.
"He has played more minutes than anyone else for Bath and has done a very good job."