Mr Peterson was convicted of murdering his wife, Laci Peterson, and unborn child in 2002. He was sentenced to death and has been sitting on death row since 2004.
Ms Peterson disappeared from the couple's home in California on Christmas Eve. She was 8 months pregnant at the time of her disappearance.
Mr Peterson's murder conviction will remain in place. According to CBS San Francisco, prosecutors may pursue the death penalty again against Mr Peterson if they wish during the new penalty phase.
The court is ordering a new penalty-phase trial.
Peterson was convicted of first degree murder for killing his wife and second degree murder for killing his unborn son. He has consistently maintained his innocence in the matter. He claimed he was fishing in San Francisco Bay at the time his wife is believed to have died.
Cliff Gardner, Peterson's attorney, sought to overturn his client's death penalty sentence by arguing the publicity of the case, incorrect rulings related to evidence and other trial mistakes deprived Peterson of a fair trial.
The trial was ordered once from Stanislaus County to San Mateo County, but Mr Gardner believes it should have been moved again due to the publicity surrounding the case.
"Before hearing even a single witness, nearly half of all prospective jurors admitted they had already decided Mr Peterson was guilty of capital murder," Mr Gardner argued.
He cited an incident in which a radio station rented a billboard outside the courthouse where the trial was to take place. The billboard featured Peterson in an orange prison jumpsuit and asked people to call in to the station to vote on whether Peterson was a "man or monster."
"The publicity continued throughout trial," Mr Gardner said. "A mob estimated at more than 1,000 people gathered at the courthouse to await the guilt phase verdict. After the guilty verdict was announced, the 12 jurors departing to await the beginning of the penalty phase - and decide whether Mr. Peterson would live or die - were met with wild applause and cheering."
Mr Gardner said Peterson was convicted and sentenced to die even though the investigators never proved "how, where or when" Ms Peterson's murder took place.
The attorney also accused Judge Alfred Delucchi, who adjudicated the trial, with automatically eliminating jurors who were opposed to the death penalty.
The court did not accept Mr Gardner's claims that Peterson was denied a fair trial, but did note mistakes that were made and reversed the death penalty sentencing.
"Peterson contends his trial was flawed for multiple reasons, beginning with the unusual amount of pretrial publicity that surrounded the case. We reject Peterson's claim that he received an unfair trial as to guilt and thus affirm his convictions for murder," the court said.
It admitted that Mr Delucchi made "a series of clear and significant errors in jury selection that, under long-standing United States Supreme Court precedent, undermined Peterson's right to an impartial jury at the penalty phase."
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