Federal regulators just suffered a major setback in their efforts to help cities build Internet services that compete with large providers such as Comcast and Time Warner Cable.

In a federal-court decision Wednesday, the Federal Communications Commission was told that it doesn't have the power to block state laws that critics say hinder the spread of cheap, publicly run broadband service.

The ruling marks a significant defeat for a federal agency that for the past several years has turned "competition" into a literal mantra, with its chairman, Tom Wheeler, repeating the word at almost every possible opportunity.

Under the court decision, large Internet providers will continue to enjoy certain benefits that insulate them from the threat of popular city-owned broadband operators such as the Electric Power Board of Chattanooga, Tenn., and the city of Wilson, N.C.

Through EPB, residents of Chattanooga have access to download speeds of 1 Gbps at rates of about $70 a month. People outside of EBP's service area have "repeatedly requested expansions" from the public utility, according to Wednesday's ruling from the U.S. Court of Appeals for the Sixth Circuit, but due to a geographic restriction put in place by the Tennessee state legislature, EPB is prohibited by law from reaching more customers.

Last year, EPB and other so-called municipal broadband providers asked the FCC to intervene on their behalf, and the agency agreed. Invoking a part of its congressional charter that it said would allow it to act against the states, the FCC tried to neutralize those state laws. The states responded by suing the agency, claiming it had no right to come between the historical relationship between states and the cities within their jurisdiction. This week's ruling, then, rolls back the federal government's attempt to intervene.

Wheeler, a Democrat, said Wednesday that the outcome of the case "appears to halt the promise of jobs, investment and opportunity that community broadband has provided in Tennessee and North Carolina. In the end, I believe the commission’s decision to champion municipal efforts highlighted the benefits of competition and the need of communities to take their broadband futures in their own hands."

Wheeler's opponents, including from within his own agency, said the outcome was an obvious one.

"In my statement last year dissenting from the commission's decision, I warned that the FCC lacked the power to preempt these Tennessee and North Carolina laws, and that doing so would usurp fundamental aspects of state sovereignty," said Republican FCC Commissioner Ajit Pai. "I am pleased that the Sixth Circuit vindicated these concerns."

Berin Szoka, president of the right-leaning think tank TechFreedom, said the issue was "federalism 101."

“The FCC was unconstitutionally interfering with the division of power between state legislatures and municipalities without a ‘clear statement’ from Congress authorizing it to do so.”

The court ruling represents a turning point for the legal tool the FCC tried to use as a weapon against Internet providers. First deployed in earnest by the FCC as an attempt to justify its net neutrality regulations on Internet providers, Wheeler again invoked Section 706 of the Communications Act to defend his moves against state limits on municipal broadband.

Section 706 calls on the FCC to promote the timely deployment of broadband across the country. The state laws targeting EPB and Wilson, N.C., Wheeler argued, amounted to a legal roadblock to meeting that goal, so preempting those state laws was consistent with Congress's marching orders.

In rebuking Wheeler's FCC, the Sixth Circuit has now effectively put some new constraints on what Section 706 may be invoked to accomplish. That is a significant step: Not long ago, policy analysts were saying that there were so few limits on the relatively vague language of Section 706 that the FCC could in theory use it to justify almost anything Internet-related. In effect, the court took what some analysts viewed as an unbounded grant of legal authority and imposed some bounds on it.

There are signs, however, that municipal broadband proponents were anticipating Wednesday's outcome — and are already moving to adapt. One approach? Focus on improving cities' abilities to lay fiber optic cables that then any Internet provider can lease; so far, only one state, Nebraska, has banned this so-called "dark fiber" plan, said Christopher Mitchell, who directs the Institute for Local Self-Reliance's Community Broadband Networks Initiative.

"We're pursuing strategies that are harder for the cable and telephone companies to defeat," said Mitchell.