U.S. District Judge Peter Messitte in Greenbelt, Maryland, refused a request by the Justice Department to throw out the case, although he narrowed the claims to include only those involving the Trump International Hotel in Washington and not Trump's businesses outside of the U.S. capital.
The lawsuit was filed by the District of Columbia and the state of Maryland last June.
The ruling marked a setback for the administration's efforts to quash claims Trump has violated the U.S. Constitution's "emoluments" provisions, claims that have dogged Trump since even before he took office last year. A U.S. judge in Manhattan in December threw out a similar case against Trump.
The provisions are designed to prevent corruption and foreign influence. One bars U.S. officials from accepting gifts or other emoluments from foreign governments without congressional approval. The other forbids the president from receiving emoluments from individual states.
The lawsuit said Trump has failed to disentangle himself from his hotels and other businesses, making him vulnerable to inducements by officials seeking to curry favor.
Trump, a wealthy businessman who as president regularly visits his own hotels, resorts and golf clubs, has ceded day-to-day control of his businesses to his sons. Critics have said that is not a sufficient safeguard.
This undermines democracy, the suit said, because Americans cannot be sure if Trump is acting in their best interest or that of "international and domestic business dealings in which President Trump's personal fortune is at stake."
The suit said Trump had received millions of dollars in payments and benefits through leases of Trump properties held by foreign government entities, the purchase of condominiums in Trump properties, as well as hotel accommodations, restaurant purchases and the use of venues for events by foreign governments and diplomats.
The District of Columbia and Maryland said their local residents who compete with Trump's businesses, such as Trump International Hotel in Washington, are harmed by decreased patronage, wages and tips.
Trump's attorneys said such claims were speculative and raised doubts that any harm to competition could be traced directly to Trump's status as president.
In his ruling on Wednesday, Messitte rejected that view, saying the plaintiffs' allegations were sufficient to allow the case to move forward.
"Their allegation is bolstered by explicit statements from certain foreign government officials indicating that they are clearly choosing to stay at the president's hotel, because, as one representative of a foreign government has stated, they want him to know 'I love your new hotel,"' the judge wrote.
Messitte also noted that since the 2016 presidential election, "foreign governments have indisputably transferred business from the Four Seasons and Ritz Carlton hotels in the District to the President's Hotel."
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