Napster vowed to let the band play on Monday despite a federal appeals court ruling that said the company might be liable for enormous monetary damages if it continued to let Internet users download copyrighted music for free.

In rejecting almost all of Napster's legal defenses, a panel of three judges on the 9th U.S. Circuit Court of Appeals in San Francisco ruled Monday that Napster's service "knowingly encourages and assists" millions of people in violating the law.

The Napster case is the first big battle over how copyright law should be applied in cyberspace, and its ultimate outcome is likely to shape how music, movies, art and books will be distributed online.

The judges agreed with the record industry's arguments that Napster cuts into sales of CDs to college students and harms the recording companies' efforts to distribute music online.

Napster lawyers said Monday that they will appeal the panel ruling to the full 9th U.S. Circuit Court of Appeals.

"We look forward to getting more facts into the record," said Napster officials, contending that the court ruled with "an incomplete record before it."

Hilary Rosen, president of the Recording Industry Association of America trade group, said, "This is a clear victory."

However, the judges did not restore an earlier U.S. District Court injunction ordering the company to eliminate all copyrighted music from its files. Instead, the appeals court sent the case back to the lower court, saying that record companies have the obligation to first notify Napster specifically about which music is being illegally copied.

"Napster, however, also bears the burden of policing the system . . .," wrote Chief Judge Robert Beezer. If Napster refuses to take action, the District Court could then issue the injunction, which essentially would put Napster out of business.

"Napster is not shut down, but under this decision it could be," the company said in a prepared statement. "We will pursue every avenue in the courts and the Congress to keep Napster operating."

Consumer expectations

Napster users, which the company estimates to be about 10,000 per second at peak times, access digital copies of thousands of commercially released albums and songs without paying for them. Napster argues that it is not causing economic harm to the recording industry, only allowing music fans to sample music before deciding to purchase it.

This clash of business, culture and the First Amendment was unleashed in 1999 by Shawn Fanning, then an 18-year-old college student who wrote the source code for the program that allows computers to share files.

Both sides of the issue realize that public opinion about whether the same rules should apply to the Internet is just as important as the court decisions.

Even if Napster is stopped, it might be too late to change the expectations that online music should be free, said Nicholas Economides , a professor at New York University's business school. "There will be a proliferation of alternative programs, and to shut them down the music industry will have to start suing individual consumers, their own customers," he said.

Also, a renegade company could set up a similar operation overseas in a country that is not bound by U.S. copyright law. "Given the nature of the Internet, even if it is stopped in the U.S. it can survive someplace else," Economides said.

Some of the alternative programs such as Gnutella and FreeNet, which make it impossible to identify users, are expected to benefit if Napster is shut down.

Local reaction

Some of Napster's Twin Cities fans thought the ruling was the beginning of the end for the free Net music-sharing service. Scott Herold of St. Paul said he thinks Napster is in deep trouble.

"I'm in despair because I think Napster is cooked at this point," said Herold, who works for Llewellyn Worldwide, a St. Paul publishing company. "A lot of people who use Napster, including myself, do buy music as a result of being able to hear things on Napster. But the record industry has never been behind a Web-based media format."

Others are philosophical about Napster's troubles, but unmoved by the record industry's claims that it has been hurt. Evan Olcott of the Minneapolis-based band 12Rods, whose music is traded on Napster, said he didn't think Napster's free music would last forever. But he doubts that the music industry has been damaged by it.

"I don't think Napster has existed long enough to see if it would cause damage," Olcott said. "The record industry is still going strong. There have been no layoffs."

Still others said they believe Monday's ruling is just the latest development in the standoff between Napster and the music industry.

Bertelsmann's BMG music unit, has promised Napster capital to develop a subscriber-based service that would pay artist royalties.

Bertelsmann invited competitors in October to join it, but none has announced any intention to do so and the German company's plans remained vague after Monday's decision.

Steve Vonder Haar, an analyst with the Boston-based Yankee Group consulting firm, said Napster has plenty of legal maneuvering room that will allow it to survive until a final ruling in its court case, which could take another six to 12 months.

For instance, while Monday's court ruling gives record companies the right to demand that their music be taken off the Napster service, "I think Napster could ignore the requests to remove the music pending the outcome of the trial," Vonder Haar said.

Legal wiggle room

David Ulmer, CEO of earjam.com, a music player software company in San Jose, Calif., said Napster's battle for survival is far from over because Monday's ruling was vague. For example, if record companies demand that certain songs be dropped from the service, Napster might get around the requirement if its users rename their MP3 files so they don't match the original song titles, he said.

As a result, Napster is down but not out, Vonder Haar said.

"The court case is a battle over bargaining-table position. Right now the record companies are holding almost all the cards. But Napster is holding on to a pair of deuces, throwing away three cards and seeing what it gets on the draw," Vonder Haar said.

- Staff writer Steve Alexander contributed to this report.

What's next for Napster

- For now, napster.com is operating.

- The judge who issued the original injunction is expected to revise her ruling in the next few weeks; then Napster must stop unauthorized trading of copyrighted music.

- Napster is preparing another appeal to the entire 9th Circuit Court of Appeals.

- Napster's executives are trying to strike deals with record labels.