(Adds background to case, quotes from argument)
By Andrew Chung
WASHINGTON, Feb 26 (Reuters) - Liberal U.S. Supreme Court justices on Monday sharply questioned American Express Co over its policy of forbidding merchants from encouraging customers to use rival credit cards with lower fees, a practice that some states and the Trump administration have concluded violates federal antitrust law.
The high court heard about an hour of arguments in an appeal by the states, led by Ohio, of a 2016 ruling by a lower court in New York that cleared American Express of unlawfully stifling competition through its so-called anti-steering provisions in contracts with merchants.
While liberal Justices Elena Kagan, Sonia Sotomayor and Stephen Breyer signaled hostility toward the company's policy, conservative Justice Neil Gorsuch indicated support for American Express. It was less clear how the other conservative justices would vote. The court has a 5-4 conservative majority.
Merchants like a local coffee shop might be able to pass lower transaction fees on to customers in the form of cheaper prices, except that the anti-steering measures prevent them from doing so, Kagan said.
"That sounds like a market that is not working the way it's supposed to," Kagan told Evan Chesler, the attorney for American Express.
The case could have major implications for the credit card industry and particularly American Express, whose business model is closely tied to the fees it charges to merchants for each transaction. These fees, it said, fund the additional benefits it offers its cardholders compared to competitors.
American Express said its system has allowed it to compete against the dominant networks, Visa Inc and MasterCard Inc. The states, backed by President Donald Trump's administration, argued that the anti-steering policy violates antitrust law, blocks lower-fee rivals, raises fees for merchants and inflates retail prices for everyone, including those who do not use credit cards.
The legal issue centered on how courts find antitrust violations when businesses cater to two groups at the same time and limits on competition for one side might offer benefits for the other.
The two groups in this case are cardholders and merchants but the ruling would likely reverberate more widely because the dynamic is common in other industries, such as advertising and e-commerce.
Gorsuch expressed doubts about the states' arguments.
"Do you have any evidence that, on a net basis, consumers pay more?" he asked Ohio State Solicitor Eric Murphy. "I don't believe you have."
Breyer said the key question was whether there is an anti-competitive aspect to the American Express conduct.
"It seems to me obvious, of course, there is," he said.
Merchants annually pay more than $50 billion in so-called swipe fees to process credit card transactions. New York-based American Express charges merchants higher fees relative to the other credit card networks, and generates more revenue, according to the states' legal papers. The company accounts for about 26 percent of all U.S. credit card transactions.
The Justice Department and 17 U.S. states sued American Express in 2010, alleging that the company's anti-steering contract requirements obstruct merchants from using competition to try to keep credit card fees from increasing. Visa and MasterCard settled similar lawsuits in 2010 by agreeing to change their rules.
Reporting by Andrew Chung; Editing by Will Dunham