The 71-year-old actor was accused Craig Nevius, a former associate of the 'Charlie's Angels' actress, of taking the valuable artwork by Andy Warhol without permission.
A 2nd District Court of Appeal has now reviewed the case and although they were divided they have ruled the matter should be allowed to proceed and that O'Neal may have a claim to some damages.
O'Neal sued Nevius in July 2011 insisting he was defamed and his reputation was damaged by the suggestions he had stolen the painting when in fact he was bequeathed the artwork by the late Warhol and he intends to leave his and Fawcett's son Redmond O'Neal.
Nevius's attorney Lincoln Bandlow intends to appeal against the panel's ruling to the California Supreme Court.
O'Neal wants up to $1 million in damages.
The veteran screen star is also embroiled in another lawsuit with the University of Texas over the artwork which claims Fawcett left the educational institute the portrait after her death in 2009.