diff --git a/src/vs/base/common/uri.ts b/src/vs/base/common/uri.ts
index f6a8959a04c..19f89eec626 100644
--- a/src/vs/base/common/uri.ts
+++ b/src/vs/base/common/uri.ts
@@ -267,10 +267,10 @@ export class URI implements UriComponents {
 		}
 		return new _URI(
 			match[2] || _empty,
-			decodeURIComponent(match[4] || _empty),
-			decodeURIComponent(match[5] || _empty),
-			decodeURIComponent(match[7] || _empty),
-			decodeURIComponent(match[9] || _empty),
+			percentDecode(match[4] || _empty),
+			percentDecode(match[5] || _empty),
+			percentDecode(match[7] || _empty),
+			percentDecode(match[9] || _empty),
 			_strict
 		);
 	}
@@ -648,3 +648,26 @@ function _asFormatted(uri: URI, skipEncoding: boolean): string {
 	}
 	return res;
 }
+
+// --- decode
+
+function decodeURIComponentGraceful(str: string): string {
+	try {
+		return decodeURIComponent(str);
+	} catch {
+		if (str.length > 3) {
+			return str.substr(0, 3) + decodeURIComponentGraceful(str.substr(3));
+		} else {
+			return str;
+		}
+	}
+}
+
+const _rEncodedAsHex = /(%[0-9A-Za-z][0-9A-Za-z])+/g;
+
+function percentDecode(str: string): string {
+	if (!str.match(_rEncodedAsHex)) {
+		return str;
+	}
+	return str.replace(_rEncodedAsHex, (match) => decodeURIComponentGraceful(match));
+}
diff --git a/src/vs/base/test/common/uri.test.ts b/src/vs/base/test/common/uri.test.ts
index 3255575ae57..6b35d6afc9c 100644
--- a/src/vs/base/test/common/uri.test.ts
+++ b/src/vs/base/test/common/uri.test.ts
@@ -439,6 +439,10 @@ suite('URI', () => {
 		assert.equal(uri.path, uri2.path);
 	});
 
+	test('Unable to open \'%A0.txt\': URI malformed #76506', function () {
+		assert.equal(URI.parse('file://some/%.txt'), 'file://some/%25.txt');
+		assert.equal(URI.parse('file://some/%A0.txt'), 'file://some/%25A0.txt');
+	});
 
 	test('Links in markdown are broken if url contains encoded parameters #79474', function () {
 		this.skip();