U.S. District Court Judge Audrey Collins formalized an earlier tentative ruling during a hearing.
William Becker, the attorney for the Christian group, said he will appeal.
"The atheists won and they will always win unless we get courts to understand how the game is played and this is a game that was played very successfully and they knew it," Becker said after the hearing.
Christmas Nativity scenes had been erected in Palisades Park for decades. Last year, atheists overwhelmed the city's auction process for display sites, winning most of the slots and triggering a bitter dispute.
Santa Monica officials snuffed the city's holiday tradition this year rather than referee the religious rumble, prompting churches that have set up a 14-scene Christian diorama to sue over freedom of speech claims.
"It's a sad, sad commentary on the attitudes of the day that a nearly 60-year-old Christmas tradition is now having to hunt for a home, something like our savior had to hunt for a place to be born because the world was not interested," Hunter Jameson, head of the nonprofit Santa Monica Nativity Scene Committee, said in advance of the hearing.
The atheists were not parties to the legal case. Their role outside court highlights a tactical shift as atheists evolve into a vocal minority eager to get their non-beliefs into the public square as never before.
National atheist groups earlier this year took out full-page newspaper ads and hundreds of TV spots in response to Catholic bishops' activism around women's health care issues and are gearing up to battle for their own space alongside public Christmas displays in small towns across America this season.
"In recent years, the tactic of many in the atheist community has been, if you can't beat them, join them," said Charles Haynes, a senior scholar at the First Amendment Center and director of the Newseum's Religious Freedom Education Project in Washington. "If these church groups insist that these public spaces are going to be dominated by a Christian message, we'll just get in the game -- and that changes everything."
In the past, atheists primarily fought to uphold the separation of church and state through the courts. The change underscores the conviction held by many nonbelievers that their views are gaining a foothold, especially among young adults.
The Pew Forum on Religion & Public Life released a study last month that found 20 percent of Americans say they have no religious affiliation, an increase from 15 percent in the past five years. Atheists took heart from the report, although Pew researchers stressed that the category also encompassed majorities of people who said they believed in God but had no ties with organized religion and people who consider themselves "spiritual" but not "religious."
"We're at the bottom of the totem pole socially, but we have muscle and we're flexing it," said Annie Laurie Gaylor, co-president of the Wisconsin-based Freedom from Religion Foundation. "Ignore our numbers at your peril."
The trouble in Santa Monica began three years ago, when atheist Damon Vix applied for and was granted a booth in Palisades Park alongside the story of Jesus Christ's birth, from Mary's visit from the Angel Gabriel to the traditional crèche.
Vix hung a simple sign that quoted Thomas Jefferson: "Religions are all alike -- founded on fables and mythologies." The other side read "Happy Solstice." He repeated the display the following year but then upped the stakes significantly.
In 2011, Vix recruited 10 others to inundate the city with applications for tongue-in-cheek displays such as a homage to the "Pastafarian religion," which would include an artistic representation of the great Flying Spaghetti Monster.
The secular coalition won 18 of 21 spaces. Two others went to the traditional Christmas displays and one to a Hanukkah display.
The atheists used half their spaces, displaying signs such as one that showed pictures of Poseidon, Jesus, Santa Claus and the devil and said: "37 million Americans know myths when they see them. What myths do you see?"
Most of the signs were vandalized and in the ensuing uproar, the city effectively ended a tradition that began in 1953 and earned Santa Monica one of its nicknames, the City of the Christmas Story.
The Santa Monica Nativity Scenes Committee argues in its lawsuit that atheists have the right to protest, but that freedom doesn't trump the Christians' right to free speech.
"If they want to hold an opposing viewpoint about the celebration of Christmas, they're free to do that -- but they can't interfere with our right to engage in religious speech in a traditional public forum," said attorney Becker. "Our goal is to preserve the tradition in Santa Monica and to keep Christmas alive."
The city doesn't prohibit churches from caroling in the park, handing out literature or even staging a play about the birth of Jesus, and churches can always set up a nativity on private land, Deputy City Attorney Jeanette Schachtner said in an email.
The decision to ban the displays also saves the city, which had administered the cumbersome lottery process used to award booths, both time and money while preserving the park's aesthetics, she said.
For his part, Vix is surprised -- and slightly amused -- at the legal battle spawned by his solitary act but doesn't plan anything further.
"That was such a unique and blatant example of the violation of the First Amendment that I felt I had to act," said the 44-year-old set builder. "If I had another goal, it would be to remove the 'under God' phrase from the Pledge of Allegiance -- but that's a little too big for me to take on for right now."
The First Amendment of the U.S. Constitution guarantees freedom of speech and religion, but also states that "Congress shall make no law respecting an establishment of religion." That has been interpreted by courts as providing for separation of church and state, barring government bodies from promoting, endorsing or funding religion or religious institutions.
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