Attorneys for the plaintiffs considered the ruling a victory for survivors of the four slain Blackwater Security Consulting contractors. North Carolina allows financial compensation in wrongful death lawsuits.
The death of Stephen S Helvenston, Mike R Teague, Jerko Gerald Zovko and Wesley JK Batalona on 31 March 2004, made worldwide headlines, when crowds dragged their charred bodies through the streets of Falluja and strung two of them up from a bridge.
The guards' families sued the company in state court in January, alleging Blackwater cut corners that led to the men's deaths.
The workers were sent into Falluja without proper equipment and personnel to defend the supply convoy they were guarding, the lawsuit said.
The company, based in Moyock, quickly moved to have the case heard in federal court, and then dismissed.
Blackwater argued the federal courts had jurisdiction in the case because of the Defence Base Act, a federal law limiting death benefits for contractors working overseas.
Company lawyers also argued that there was a "unique federal interest" in deciding the remedies available to contractors in war zones.
Crowds dragged the four men's
charred bodies through Falluja
In a ruling issued on Thursday, US District Judge Louise Flanagan declined to move the lawsuit to federal court, but agreed that the case raised "novel and complex" issues.
A spokesman for Blackwater did not return calls seeking comment on Monday.
A California-based attorney representing the estates of the four men said the federal law did not apply because the men were independent contractors, not Blackwater employees.
The Defence Base Act also applies to negligent contact, while Blackwater's actions were intentional, said attorney Marc Miles in Santa Ana, California.
Blackwater "knew they were cutting corners and they sent these gentlemen out without the needed tools, protection and information. This was not an accident", Miles said.
The plaintiffs will be entitled to compensatory and punitive damages if they win their case in state court, Miles said. The ruling and the case could set important precedents in US courts.
Miles said his firm believed the lawsuit was the first involving private US contractors in Iraq, although others have since been filed. Blackwater contracted with ESS Support Services Worldwide to guard food shipments to US bases in Iraq.
Under armed guard
According to the lawsuit, the contract called for security teams to have two armoured vehicles and a minimum of six people, as well as a heavy machine gun that could fire up to 850 rounds a minute.
The four men who died were sent out in unarmoured vehicles, without the heavy machine gun and without a map and got lost, the lawsuit said.
"[Blackwater] knew they were cutting corners and they sent these gentlemen out without the needed tools, protection and information. This was not an accident"
Having lacked time to become familiar with their weapons or routes around Falluja, they went directly through the violent city.
The lawsuit claims Blackwater's failure to live up to the terms of the contract amounted to fraud. No specific damages are listed in the suit, as is routine in North Carolina civil suits.