The European Court of First Instance on Tuesday said the rules were a fair penalty that didn't discriminate against low-cost carriers, dismissing the airlines' claims that the rules infringe on international agreements and breach existing legal principles.
The new rules came into force in February. They oblige airlines to pay passengers up to $725 if they are bumped off a flight, double the previous limit.
Similar compensation is on offer if the airline is held responsible for cancelling a flight.
Delays of two to four hours will require airlines to serve snacks or full meals, while delays over five hours entitle passengers to a refund and a hotel room if necessary.
Refunds for round-trip flights must be offered if the journey is no longer necessary, for example if a business meeting is missed.
The court said air passengers whose flights are delayed suffer more than train or ferry travellers.
"Because, in particular, of the location of airports, which are generally outside urban centres, and of the particular procedures for checking-in and reclaiming baggage, the inconvenience suffered by passengers when such incidents occur is not comparable," it said.
It rejected a complaint by the European Low Fares Airline Association that the rules were unfair to budget carriers because compensation levels were often much higher than the cost of their tickets.
All flight delays are equally painful and all airlines should be treated the same, no matter how much they charge, the court said.
"Higher costs for air transport with no added value does not pass the good regulation test, let alone the common-sense test".
IATA Director General
The International Air Transport Association - which represents 270 carriers worldwide - estimates that the regulation will cost the industry more than $725 million a year at a time when it is facing higher fuel costs and increased competition.
IATA Director General Giovanni Bisignani said the court had missed an opportunity to overturn an "absurd" regulation.
"Higher costs for air transport with no added value does not pass the good regulation test, let alone the common-sense test," he said.
ELFAA - whose members include Ryanair, Hapag-Lloyd Express and flybe - said late or cancelled flights are usually beyond the control of the airlines and the law gave passengers the expectation that they are entitled to "ridiculous amounts of compensation".
Airlines cannot be held responsible if delays or cancellations are caused by "extraordinary circumstances" beyond their control - such as strikes or security threats.
Ryanair Holdings PLC said most flight delays are caused by bad weather or Europe's "highly ineffective" air traffic control.
The European traffic control agency EUROCONTROL said air navigation delayed air journeys by an average of 1.9 minutes per flight last year.
It said on Tuesday that 2005 was a record year for aviation in Europe with over 9.2 million flights and more than 700 million passengers.
The number of flights grew by 4.5% last year and should grow by 3% in 2006. Some 2.5 million people will fly every day during summer 2006, it said. Traffic has grown by 15% since 1999.