In a 6-1 decision, the New York State Court of Appeals, the state's highest judicial body, ruled that the museum was free to return the loaned works -- two paintings by Egon Schiele, considered Austria's greatest modern painter.
The paintings -- "Portrait of Wally" (1912) and "Dead City III" (1911) -- were part of a three-month MOMA retrospective on Schiele that closed in January 1998.
For the last 21 months, these two works have been held in museum storage, blocked from shipment due to claims that they were once stolen by Nazi brigades during World War Two. The rest of the show's 150 works loaned by the government-financed Leopold Foundation were shipped back to Vienna. The return of the disputed works was blocked by Manhattan District Attorney Robert Morganthau, who was investigating claims by New York area families that the Schiele paintings once belonged to them.
The family of Henri Bondi claimed that "Portrait of Wally" belonged to his aunt, Lea Bondi, a Jewish art dealer who was forced to flee Vienna in 1938. He maintains that his aunt was forced to sell her art at greatly undervalued prices and that the money was then seized when she left for England.
The family of Rita Reif claimed "Dead City" was looted from a relative, cabaret singer Fritz Gruenbaum, who died in the German concentration camp at Dachau. Reif is Gruenbaum's cousin by marriage and one of his heirs.
However, since the claim was made, documents have surfaced showing that the painting had gone to Gruenbaum's sister-in-law, who sold it to a Swiss art dealer in 1956.
Neither claim has been resolved.In the meantime, the museum argued that the "New York State Exemption from Seizure Law," originally passed in 1968, bars any seizure of art loaned to New York institutions.
The Court of Appeals agreed.
"The law protects lenders from any kind of seizure in New York state," wrote Judge Richard Wesley. His majority decision said the statute's intent was "to insulate non-resident lenders from seizures" and "to protect state cultural institutions that depend on the free flow of art."
Museum directors had feared the Schiele case would have a chilling effect on collectors' willingness to lend out their works because anything leaving home could be subject to scrutiny and possible detention.
"We fully appreciate the profound and opposing interests presented by this case. The District Attorney has a continued responsibility to identify and prosecute criminal activity, while the Museum seeks to make works of art from all over the world available to New Yorkers. These two significant interests have come into conflict as a result of Nazi atrocities," the decision said.The court reversed a lower court and granted the museum's motion to quash the Morganthau subpoena that halted the shipment.
"This is a victory for all of the people and museums of our state, because it means that New York will continue to be the cultural center of the world," MOMA said in a written statement. The museum said the decision means "a museum can't be prevented from fulfilling its responsibility to return borrowed art."
The Manhattan district attorney criticized the decision as "wrong as a matter of law and policy" that makes New York a "safe haven for stolen art."
"The exhibition of stolen paintings, or those of questionable provenance, does not advance the cultural life of the city," Morganthau said in a written statement. "How can museums claim they are the source of civilized values when they ignore questions of the legitimacy of the works held in their collections or exhibited in their displays?"
There is no timetable on the paintings' return.
"We intend to get them back as soon as possible," said Liz Addison, a MOMA spokeswoman.
The Leopold Foundation collection comes from Viennese eye doctor Rudolf Leopold, who maintains he acquired the two paintings from legitimate owners after the war. Leopold sold most of his vast art collection, including 250 Schiele works, to the Austrian government in 1994.
The Schiele uproar prompted Austria's cultural ministry to re-examine art acquired from 1945 to 1960 in 10 government museums. This has led to the return of numerous artworks to families such as the Austrian Rothschilds, who auctioned off their looted and finally returned belongings earlier this year for $90 million.
CNN's Phil Hirschkorn and Reuters contributed to this report.