A New York law banning merchants from surcharging customers to make up for credit-card swipe fees was halted by a federal judge who ruled the statute is unconstitutional.

U.S. District Judge Jed Rakoff in Manhattan today ordered the state not to enforce the ban during a legal challenge filed by several small businesses.

Businesses including a Vestal, New York, hair salon, a Brooklyn ice cream parlor and Lower Manhattan martial arts academy alleged in a lawsuit filed in June that the law violated free speech rights by penalizing them for adding surcharges while at the same time allowing them to provide discounts to customers paying with cash or debit cards.

"Alice in Wonderland has nothing on section 518 of the New York General Business Law," Rakoff wrote. "This virtually incomprehensible distinction between what a vendor can and cannot tell its customers offends the First Amendment and renders section 518 unconstitutional."

Rakoff said the law violated the First Amendment because it prevented merchants from calling the difference between prices charged to cash customers and credit-card users a "surcharge." The term "surcharge" communicates to customers that credit cards are costly for merchants, the businesses argued.

"We are reviewing the decision and considering our next step," Melissa Grace, a spokeswoman for New York Attorney General Eric Schneiderman, said in an e-mail.

Visa Inc. and MasterCard Inc. are awaiting a federal judge's decision on whether to approve a multibillion-dollar antitrust settlement with U.S. merchants over interchange fees that would lift prohibitions on surcharges.

Critics of the settlement have argued that at least 10 states, including New York, prohibit surcharging, limiting the usefulness of that part of the accord.

Merchants generally pay higher interchange, or swipe, fees when customers make purchases with credit cards than they do when buyers use debit cards. A provision of the 2010 Dodd-Frank law limits debit swipe fees, so some merchants want to use surcharging to deter customers from using credit cards.

Deepak Gupta, a lawyer for the New York businesses that challenged the law, said that merchants are preparing similar constitutional challenges in other states that prohibit surcharging.

"The other states' laws are indistinguishable from new York," Gupta, with Washington-based Gupta Beck Pllc, said in an interview. "They were enacted at the same time, had the same purpose and often use the same words."

The case is Expressions Hair Design v. Schneiderman, 1:13- cv-03775, U.S. District Court, Southern District of New York (Manhattan).

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