Updated from 1:35 p.m. ET

A U.S. Circuit Court of Appeals panel has ruled that the major record labels challenging

Napster's

free music distribution network "have substantially and primarily prevailed on appeal," though the ruling won't be enforced immediately.

The three-judge panel ruled that an injunction granted against Napster in July by District Court Judge Marilyn Hall Patel was overly broad, but said it could be enforced once modified by the district court. Napster didn't rule out the possibility of eventually being shut down as a result of the decision, but said it plans to appeal the latest legal development.

"This is a clear victory. The court of appeals found that the injunction is not only warranted, but required. And it ruled in our favor on every legal issue presented," said Hilary Rosen, the president and chief executive of the

Recording Industry Association of America

.

In some cases, Napster can be held liable for copyright infringement, the appeals court ruled. The panel found that Napster's millions of users, who swap digitized music files by way of the Internet, are not "fair users" as described by the copyright act. But Napster can be held liable for copyright infringement only when it knows of specific copyrighted files that are available on its system and fails to prevent their distribution, the court ruled.

Patel's lower-court injunction barred Napster from allowing copyrighted music from five major record labels from being traded over its network until the case came to trial. The appeals court temporarily halted Patel's order pending its own decision.

Since the lower-court ruling, Napster has entered into an agreement with music and publishing giant

Bertelsmann

calling for music to be distributed on a subscription basis.

Napster, which has an estimated 50 million users, was sued by the major record labels as soon as the site started gaining momentum. The site allows users to access the computer hard drives of different users and download music in the form of mp3 files.

Napster was hoping to settle the dispute outside the courtroom, but the other record labels weren't as inclined to embrace this form of music distribution. "I want to take a moment at this time to note our surprise that we have been unable to resolve this case outside of the judicial process," Hank Barry, Napster's chief executive, previously said in a statement. "Napster users are the music industry's best customers and as evidenced by strongly increasing CD sales and the growing numbers of artists who support us, Napster is a tremendous promotional vehicle for emerging and established artists."