SAN FRANCISCO (Reuters) - A U.S. appeals court lifted a preliminary injunction on Wednesday against Google Inc. from showing thumbnail-size photos from sexually explicit Internet sites, but said the company might be liable for allowing links to sites displaying pirated photos.

The logo of Google Inc. is seen outside their headquarters building in Mountain View, California August 18, 2004. A U.S. appeals court ended a preliminary injunction on Wednesday against Google Inc.'s . image-search service from displaying thumbnail-sized photos from a sexually explicit site. REUTERS/Clay McLachlan

The case is the latest in which courts are seeking to strike a balance between fostering the free flow of information on the Internet and protecting copyrighted content.

A lower court had found that Google’s thumbnail images violated the copyright of adult magazine and Web publisher Perfect 10 Inc., but said the Internet search company was probably not responsible for displays of the underlying images from Perfect 10’s Web site.

The U.S. 9th Circuit Court of Appeals based in San Francisco reversed those findings on Wednesday.

“We conclude that Perfect 10 is unlikely to be able to overcome Google’s fair use defense and, accordingly, we vacate the preliminary injunction regarding Google’s use of thumbnail images,” Sandra Ikuta wrote for a three-judge panel.

Perfect 10, which boasts of “The World’s Most Beautiful Natural Women,” first objected to Google about the thumbnail images in 2001, saying Google linked to Web sites that republished images of their nude models without authorization. Perfect 10 charges $25.50 per month for access to its site.

They sued in 2004, alleging copyright infringement and in 2005 filed a similar claim against Amazon.com Inc. and its A9.com subsidiary, saying they provided links to Google search results. A court granted a partial preliminary injunction in 2006.

The lower court’s ruling had threatened to bar Google from featuring thumbnail pictures -- small versions of photos that are linked to a bigger version of the same picture. But the injunction was stayed pending further legal review, which meant Google continued to display the thumbnail images.

A number of photographer associations and the Motion Picture Association of America made legal filings in support of Perfect 10.

TRANSFORMATIVE NUDES

Judge Ikuta found that the thumbnails were not an infringement as they fell under the category of “highly transformative” work.

“We conclude that the significantly transformative nature of Google’s search engine, particularly in light of its public benefit, outweighs Google’s superseding and commercial uses of the thumbnails in this case,” she wrote.

On a second issue of Google’s liability for copyright infringement by linking to full-size images, the appeals court left the door open for Perfect 10’s argument.

“There is no dispute that Google substantially assists web sites to distribute their infringing copies to a worldwide market and assists a worldwide audience of users to access infringing materials,” the ruling found.

“Google could be held contributorily liable if it had knowledge that infringing Perfect 10 images were available using its search engine, could take simple measures to prevent further damage to Perfect 10’s copyrighted works, and failed to take such steps.”

The ruling said a lower court should re-examine the issues against both Google and Amazon.

Google welcomed the 9th Circuit ruling.

“We are delighted that the court affirmed long-standing principles of fair use, holding that Google’s image search is highly transformative by creating new value for consumers,” the firm’s general counsel, Kent Walker, said in a statement. “Google services respect intellectual property and help people around the world find what they’re looking for.”