The case had pitted women's reproductive rights advocates against the Roman Catholic Church, whose supporters say the law violates the state and federal constitutions, the Los Angeles Times reports.
On Monday, the court ruled that the church must provide contraception benefits if it offers drug coverage to workers it employs in secular jobs, such as at hospitals and universities.
The Catholic Church considers contraception a sin.
California lawmakers voted in 1994 to require employers to offer contraception methods as part of their prescription drug benefits. The bill was vetoed three times by Republican Gov. Pete Wilson before being signed into law by Democratic Gov. Gray Davis in 1999. It took effect on Jan. 1, 2000.
According to the Times, the law exempts church-based organizations, but not policies for their secular workers.
Other states have adopted similar laws, but their so-called conscience clauses have been broader and acceptable to the Catholic Church. New York, however, is considering narrow exemptions similar to those in California.
The U.S. Equal Employment Opportunity Commission and a federal court in Washington state recently ruled that an employer's failure to offer contraceptive coverage in its prescription policy is discriminatory.
"This is an important victory for women's equality and reproductive freedom," said attorney Margaret Crosby of the American Civil Liberties Union of Northern California, which drafted the Women's Contraception Equity Act and helped defend it in court.
Crosby said the exemption was intentionally narrow to cover workers employed in a religious organization's secular activities.
"Workers should not have their contraceptive decisions made by their employers - unless they are priests," she said, recognizing the need to balance reproductive health care with religious freedom.
San Francisco attorney James F. Sweeney, who represented Catholic Charities of Sacramento in the case, said his clients are considering an appeal.
"I am disappointed and seriously troubled by the court's opinion in this case," Sweeney said. "This substantially burdens the religious freedom rights of the Catholic Church in California."
The church does not divide its ministries into secular and nonsecular portions, he said, and neither should the state.
Under the law, employers must provide "federal Food and Drug Administration-approved prescription contraceptive methods."
The law exempts nonprofit religious groups whose purpose is the inculcation of religious values and which employ and serve primarily people who share their religious beliefs.
A lower court had ruled that applying the law to one of the church's main charitable arms, Catholic Charities, did not violate federal or state constitutions.
The appellate court upheld that decision, ruling that the law and its exemptions do not discriminate against the Catholic Church. Catholic Charities USA also had filed briefs challenging the law.
"Requiring the policies to cover prescription contraceptive methods - so as not to discriminate against women - cannot be said to inhibit religion, even if its parent entity is a religious organization that believes the use of contraceptives is a sin," wrote Presiding Justice Arthur G. Scotland in the court's 58-page opinion.
To view the Los Angeles Times story, click here.
the first decision of its kind in the U.S., California's appellate court has found no infringement on religious freedom in a state law that requires employers to offer contraceptives in their prescription drug plans.