By David Ingram

WASHINGTON (Reuters) - A New York nonprofit that advocates for the mentally ill cannot sue on their behalf for better housing because of how the organization is structured, a court said on Friday.

The decision by a federal appeals court sweeps aside a trial judge's finding that the State of New York discriminated against thousands of people living in adult homes.

The case must now begin anew, possibly with the Justice Department taking the lead, the court said.

Disability Advocates Inc brought the case on behalf of people with mental illness, following a model that is common in U.S. courts for an association to file suit on behalf of its members or people who are closely related to its mission.

The appeals court said Disability Advocates could not do so here because it is not a traditional, member-based organization, nor does its "constituency" have the "indicia of membership."

For example, it is not clear that the mentally ill have the power to elect the directors of Disability Advocates, make budget decisions or direct litigation strategies, wrote Judge José Cabranes of the Court of Appeals for the 2nd Circuit.

The nonprofit does not have standing to sue, Cabranes wrote.

Disability Advocates called the ruling a setback and said it would continue pressing New York state officials.

"I am hopeful that the state will want to find a solution here that avoids future litigation and recognizes the rights of the residents to live in the community," said Cliff Zucker, executive director of Disability Advocates.

Zucker said he disagrees with the court's interpretation of how Disability Advocates operates. Adult-home residents with mental illness are capable of participating in the organization and the lawsuit and they have done so, he said.

No decision has been made about appealing the appellate court's ruling, either to the full 2nd Circuit or to the Supreme Court, Zucker said. His organization filed its initial complaint against the state in 2003. Continued...