UPDATE 1-US Steel loses challenge to Canadian lawsuit

* Government said US Steel broke job protection pledges

* Company claimed rights violated by investment act (Adds details from ruling, reaction)

VANCOUVER, June 14 (Reuters) - A Canadian judge on Monday rejected United States Steel Corp's X.N bid to block the government from seeking penalties for allegedly breaking promises made when it won Ottawa's approval to buy Stelco.

The federal government sued U.S. Steel in 2009, claiming its decision to temporarily shut down two former Stelco plants in Ontario violated promises it made about maintaining employment levels.

U.S. Steel took over Hamilton, Ontario-based Stelco in 2007, and the decision to idle the facilities affected about 1,500 jobs. The company blamed weak demand for the shutdowns and denies it broke any promises.

Federal Court Judge Dolores Hansen in Ottawa rejected U.S. Steel’s claim that its rights were violated by provisions of the Canada Investment Act, which gives the government the power to oversee foreign investment in the country.

Under the act, the government must decide if the foreign takeover will be a “net benefit” to the country. In approving the Stelco’s takeover, the government cited job protection as one of the benefits

The act gives the government the authority to ask the courts to fine U.S. Steel up to C$10,000 ($9,700) a day until the commitments on job protection are honored.

The Pittsburgh-headquartered company argued the size of the penalty -- which it termed a “King Kong fine” -- was one of the ways in which the act violated its rights.

“I find that the purpose of the monetary penalty is to encourage and promote timely compliance with any undertakings and provisions of the legislation,” justice Hansen wrote in her 38-page ruling.

U.S. Steel’s lawyer said the company was still studying the decision and preparing reaction statement.

The United Steelworkers union praised the court’s decision, and urged the government to use the law to go after other foreign companies who buy Canadian rivals but then idle factories or cut jobs.

“This is a victory for our members and all Canadians,” Ken Neumann, the union’s national director in Canada, said in a statement.

The union complains Vale SA's VALE5.SA purchase of Inco Ltd. and Xstrata PLC's XTA.L takeover of Falconbridge both ended up costing Canadian workers their jobs.

$1=$1.03 Canadian Reporting Allan Dowd; editing by Rob Wilson, Gary Hill