Microsoft (MSFT) on July 31 lost the latest battle in a legal war against government demands that it turn over copies of e-mails it stores in Ireland.

Last year the U.S. applied for a search warrant for e-mails of an unnamed user of Microsoft’s msn.com related to a drug investigation. The contents of the e-mails were stored on a server in Ireland. Microsoft refused to comply on the basis that the U.S. has no authority to issue a search warrant outside its territory, arguing that the government should instead act through its mutual legal assistance treaty with Ireland. The Electronic Frontier Foundation, which supports Microsoft’s position, has a good rundown of events in the case, including various filings.

A magistrate ruled for the government in April, and Microsoft appealed. Yesterday, U.S. District Judge Loretta Preska upheld the April decision, endorsing the view that it was a question of control, not location, of the information and Microsoft must turn it over.

This may seem like a narrow issue, but Microsoft, other technology companies, and privacy advocates believe it’s a very big deal. Microsoft argued in a court filing in June that this is an extremely slippery and dangerous slope, for constitutional protections against unreasonable search and seizure, for privacy, and definitely for its business:

“Over the course of the past year, Microsoft and other U.S. technology companies have faced growing mistrust and concern about their ability to protect the privacy of personal information located outside the United States. The Government’s position in this case further erodes that trust, and will ultimately erode the leadership of U.S. technology companies in the global market.”

Microsoft’s challenge was supported by amicus briefs from, among others, AT&T and Verizon. The latter is all too familiar with a foreign government’s mistrust over such issues: Germany recently ended a contract with Verizon, citing the cooperation of American companies in U.S. government surveillance.

Microsoft is continuing to fight. “The only issue that was certain this morning was that the District Court’s decision would not represent the final step in this process,” Executive Vice President and General Counsel Brad Smith said in a statement posted on the company’s website. “We will appeal promptly and continue to advocate that people’s e-mail deserves strong privacy protection in the U.S. and around the world.”

(Bloomberg Businessweek)