Phone companies faced off against consumer groups on Monday, in a debate over whether $7.2 billion in federal broadband spending should come with a mandate that Internet networks remain open to all traffic.

As the government prepares to set rules for doling out the funds, public interest groups say providers vying for money should abide by network neutrality, the notion that Internet service providers not discriminate based on content or applications.

The federal government is not a charity for broadband providers. It is an investor, Ben Scott, policy director for the consumer group Free Press, told a public meeting on the government's plans.

Telecommunications, Internet firms and others are lobbying to shape the still unwritten rules that will govern how regulators distribute the money. The law calls for nondiscrimination but largely leaves it up to regulators to define and enforce such a policy.

The U.S. Departments of Commerce and Agriculture will disperse the broadband funding, intended to bring technology to unserved and underserved areas.

Industry has long contended that a network neutrality requirement ties their hands and have argued that they need to be able to manage their network. Such a requirement would discourage investment, say industry officials.

Layering on those types of conditions I think are only going to drive would-be applicants out of the pool of people that you want to extend service to these really hard to reach places, said Chris Guttman-McCabe, a vice president of CTIA, the wireless trade group that represents companies like AT&T Inc and Verizon Communications.

Net neutrality backers have high hopes for the new administration in this area, as President Barack Obama has publicly backed net neutrality.

I can't imagine a better time, when the government is doling out $7.2 billion, to have this conversation, said Gigi Sohn, president of Public Knowledge, another public interest group.

She cited the strong interest generated from the broadband program. The first meeting at the Department of Commerce was packed, as have subsequent conference calls, she said. If the big guys don't want the money fine there will be other people beating down the doors.

(Editing by Tim Dobbyn)