After four months of consideration, the appeals court decided that the original trial judge, Thomas Penfield Jackson, had engaged in "serious judicial misconduct" by conducting secret interviews with the media and making derogatory remarks about Microsoft.
The court concluded that the earlier judgement had been tainted by the judge's behaviour, and disagreed with the decision that the company should be broken up.
However, the court upheld Judge Jackson's finding that Microsoft had an effective monopoly of the computer software market and that this should be remedied.
Yesterday's decision followed a two-year trial in which Microsoft was accused of using its dominance in the PC market to stamp out rivals in other areas, such as the web browser market.
Microsoft's chairman Bill Gates said he was "very pleased" about the latest decision, and said his company would now seek an out-of-court settlement.