In a 31-page opinion, the U.S. Court of Appeals for the District of Columbia Circuit also ruled that Norton's actions, which a lower court had labeled fraud against the court, did not rise to the level of a criminal offense.
"Because Secretary Norton cannot be held criminally liable for contempt based upon the conduct of her predecessor in office, her contempt conviction cannot stand," Chief Judge Douglas Ginsburg wrote for a unanimous three-judge panel.
The case stems from a lawsuit filed in 1996 on behalf of 350,000 American Indians who ancestors received money under the Dawes Act. In 1887, Congress passed the Dawes Act to set up a "trust" or formal system of paying Native Americans money the government earned from the use of their land.
Lawyers for the Native Americans say the government has mismanaged funds paid after the government took over portions of tribal lands and rented them to ranchers, miners and loggers.
However, as family members died and married, it became harder for the government to account for who owns what land. And the Department of the Interior, which oversaw the trusts, lost or destroyed many of the original documents. About 47 million acres of tribal land is now held in government trust, mostly in the Dakotas, Montana, New Mexico and Arizona.
In September, U.S. District Judge Royce Lamberth ruled that Norton and Assistant Secretary for Indian Affairs Neal McCaleb had failed to comply with his 1999 order to account for more than a century of proceeds from oil, gas, mining and timber royalties.
In his decision, Judge Lamberth said the Interior Department did "virtually nothing" to fix the ongoing problems and named a new special monitor to oversee the status of the trust reform and provide the court with periodic progress reports.
The appeals court on Friday cleared McCaleb and furthermore objected to the appointment of the special monitor, Joseph Kieffer III, who had harshly criticized the Interior Department's management of American Indian money. His work was suspended in April after oral arguments at the appeals level.
"In this case, the district court's appointment of the monitor entailed a license to intrude into the internal affairs of the department, which simply is not permissible under our adversarial system of justice and our constitutional system of separated powers," Ginsburg wrote for the three-judge panel.
The case now returns to the lower court.
Justice Department officials, who have criticized Judge Lamberth's handling of the case, praised the appeal court's decision.
"We are pleased that the court of appeals took note of the significant positive steps taken by Secretary Norton to address the issues presented in this case and that the court vacated the unwarranted contempt rulings against the Secretary and Mr. McCaleb," said Peter Keisler, assistant attorney general for the Civil Division.
Norton was not the first Cabinet official held in contempt since the class-action lawsuit was filed; former President Clinton's Interior Secretary Bruce Babbitt and Treasury Secretary Robert Rubin were found in contempt in 1999.
Earlier this month, Judge Lamberth wrapped up a 44-day trial aimed at straightening out the accounts, but a decision in the case may not be made for several months.