The decision by the European Court of Justice also is expected to have wider ramifications across Europe, where many governments have tried to protect companies they see as vital to their economies from takeovers, particularly foreign ones.

German politicians and labor unions had argued that the law was needed to protect local jobs but the court, the EU's highest, said it was illegal. It ruled that the law limited "the free movement of capital."

The court also ruled that it discourages foreign investors from taking a stake in Volkswagen because the German federal government and the region of Lower Saxony — a major shareholder — are able "to exercise considerable influence" over the company.

"This situation is liable to deter direct investors from other member states," a court press statement said.

The law caps a shareholder's voting rights at 20 percent, whatever the size of its holding.

In its ruling, the court also rejected the right of both the German federal government and the region of Lower Saxony, which holds 20.36 percent of Volkswagen, to appoint two members of the board as long as they are shareholders of the company.

For Porsche, which has built-up a 31-percent stake in the company over recent years in anticipation that the VW law would be struck down, the ruling gives it carte blanche to take a wider stake.

Porsche AG Chief Executive Wendelin Wiedeking said his company was "naturally very interested in being able to fully exert our voting rights" in Volkswagen. However, he did not refer to the possibility of a takeover — which many analysts expect.

Between them, Porsche and Lower Saxony already hold more than 50 percent in Volkswagen — meaning the door is closed for any would-be foreign suitors.

The court said Germany did not explain why it needed to protect workers by keeping "a strengthened and irremovable" stake in Volkswagen. It also rejected German government arguments that its special position protected minority shareholders.

Lower Saxony's conservative governor, Christian Wulff, said the state government accepted the decision.

He said that Lower Saxony would stand by its stake in Volkswagen and that its aim was "for VW to be a successful company with high sales and satisfied employees with secure jobs, particularly at sites in Lower Saxony."

"The state government wants to ensure this along with the other major shareholder, Porsche," Wulff said.

The ruling is a triumph for the European Commission, which has fought several battles against European governments and their "golden shares" in critical companies.

European Union regulators take their cue from rights enshrined in the EU's founding treaty that proclaim basic economic freedoms such as the right to do business anywhere in the 27-nation bloc.

That right is blocked if governments interfere with companies, the EU executive said.

It took Germany to court in 2005, and has since lined up or threatened cases against Spain over allegations it is protecting energy companies like Endesa SA, Italy for blocking a takeover attempt of highways company Autostrade SpA, and against Poland for hindering Italy's UniCredit SpA from consolidating its grip over a local bank.

Volkswagen — German for "people's car" — is one Germany's best-known companies, renowned for providing well-paid blue-collar jobs. From the ashes of World War II, it has become Europe's largest automaker, with brands from the more affordable Seat and Skoda to the upscale Audi and the stratospherically priced speedsters hand-built by Lamborghini.

Thomas' new autobiography, "My Grandfather's Son," shows how the second black justice on the Supreme Court came to oppose affirmative action after his law school experience. He was one of about 10 blacks in a class of 160 who had arrived at Yale after the unrest of the 1960s, which culminated in a Black Panther Party trial in New Haven that nearly caused a large-scale riot.

The conservative justice says he initially considered his admission to Yale a dream, but soon felt he was there because of his race. He says he loaded up on tough courses to prove he was not inferior to his white classmates but considers the effort futile. He says he was repeatedly turned down in job interviews at law firms after his 1974 graduation.

"I learned the hard way that a law degree from Yale meant one thing for white graduates and another for blacks, no matter how much any one denied it," Thomas writes. "I'd graduated from one of America's top law schools, but racial preference had robbed my achievement of its true value."

Thomas says he stores his Yale Law degree in his basement with a 15-cent sticker from a cigar package on the frame.

His view isn't shared by black classmate William Coleman III.

"I can only say my degree from Yale Law School has been a great boon," said Coleman, now an attorney in Philadelphia. "Had he not gone to a school like Yale, he would not be sitting on the Supreme Court."

Coleman's Yale roommate, Bill Clinton, appointed him general counsel to the U.S. Army, one of several top jobs Coleman has held over the years.

Thomas said he began interviewing with law firms at the beginning of his third year of law school.

"Many asked pointed questions unsubtly suggesting that they doubted I was as smart as my grades indicated," he wrote. "Now I knew what a law degree from Yale was worth when it bore the taint of racial preference."

He said it was months before he got an offer, from then-Missouri Attorney General John Danforth.

Steven Duke, a white Yale law professor who taught when Thomas attended Yale, said Thomas is right to say that the significance of someone's degree could be called into question if the person was admitted to an institution on a preferential basis. However, he said that could be overcome by strong performance, noting that two Yale graduates — Danforth and President Bush — put Thomas into top jobs.

"I find it difficult to believe he actually regrets the choice he made," Duke said. "It seems to me he did pretty well."

Some classmates say Thomas — who was raised poor in Georgia and stood out on campus in his overalls and heavy black boots — faced a tougher transition than black students who came from middle-class or privileged backgrounds.

Frank Washington, a black classmate and friend of Thomas who also came from a lower-income background, said he had 42 interviews before he landed a job at a Washington law firm.

"It seemed like I had to go through many more interviews than a lot of my other non-minority classmates," said Washington, now an entrepreneur who owns radio and television stations.

Other black classmates say their backgrounds didn't matter.

Edgar Taplin Jr., raised by a single parent in New Orleans, said he landed a job after graduation at the oldest law firm in New York, and does not recall black graduates struggling more to get jobs than their white classmates.

"My degree was worth a lot more than 15 cents," said Taplin, who retired in 2003 as a global manager with Exxon Mobil.

Thomas has declined to have his portrait hung at Yale Law School along with other graduates who became U.S. Supreme Court justices. An earlier book, "Supreme Discomfort," by Washington Post reporters Kevin Merida and Michael Fletcher, portrays Thomas as still upset some Yale professors opposed his confirmation during hearings marked by Anita Hill's allegations that Thomas sexually harassed her.

Yale Law School Dean Harold Koh turned down requests for interviews about the justice's book, but said in a statement that he and his predecessors have invited Thomas to have his portrait done and the offer still stands.

Koh said they met for several hours about a year ago. "He made it clear that he had greatly enjoyed his time at Yale Law School, and that he had great affection for his fellow students and for several professors who are still here," he said.

Unlike two other security companies operating in Afghanistan and Iraq, Blackwater has said it designates its workers contractors, not employees, because it is a "model that works" and because its guards prefer the "flexibility" of the contractor relationship.

The arrangement has, according to Mr Waxman, wrongly allowed Blackwater to avoid paying social security and Medicare taxes, as well as federal income and unemployment tax - or $32m (£16m) in taxes from May 2006 to March 2007.

The IRS ruling was issued after a single security guard approached the tax authority after a dispute over back pay and other compensation. Although the ruling, which is based on Blackwater exercising control over its worker, applied only to the individual, the IRS alerted Blackwater that it could apply to others.

Blackwater, which has classified 604 security guards as contractors, agreed a settlement with the employee after the ruling. That included a confidentiality agreement that prohibited the employee from contacting "any politician" or "public official" about its details.

"It is deplorable that a company that depends on federal tax dollars for 90 per cent of its business would even contemplate forbidding an employee to report corporate wrongdoing to Congress," Mr Waxman said in a letter to Erik Prince, Blackwater chairman and CEO.

He further alleged that the confidentiality agreement was "particularly suspect" because it was signed by Blackwater general counsel Andrew Howell just as Mr Waxman's committee was stepping up its investigation into Blackwater's activities.

Blackwater said that Mr Waxman's assertions were "incorrect" and took issue with his use of the IRS decision, against which the company has appealed.

The company said the IRS had not made a final determination on the employee and the Small Business Administration had decided Blackwater security contractors were not employees.

According to documents filed in Court, from 1996 through at least 2003, Brown was the owner and sole stockholder of Excell Personnel, Inc., which “leased” employees to companies that did not want to directly hire their own workers.  Excell would locate, hire and train employees, and then provide them to the businesses that were Excell’s customers. 

The customers did not directly pay the employees that Excell provided, but rather paid a fee to Excell that included the gross wages that would be owed to the employees for their labor, plus an administrative fee from which Excell received its profit and out of which Excell was obligated to pay indirect costs of the employees and Excell’s overhead expenses. 

Excell, in turn, paid the employees their wages, making deductions for the required withholding of income taxes, Federal Insurance Contribution Act (FICA) taxes and Medicare taxes that were required to be paid to the United States.

Brown admitted that he was aware of the legal obligations and that he knowingly and deliberately chose not to pay over to the IRS the required withholding taxes, social security taxes and Medicare taxes.  During the fourth quarter of 2002, Brown, on behalf of Excell, wilfully failed to pay over to the IRS approximately $297,384.41 in federal income taxes withheld as well as all FICA and Medicare taxes due and owed to the U.S.

U.S. Attorney Roper praised the investigative efforts of the Internal Revenue Service - Criminal Investigation.  The case is being prosecuted by Assistant U.S. Attorney Phillip C. Umphres.

The review panel found poor communication between diplomats and military officials and too little oversight of contractors like Blackwater USA, two people familiar with the report's findings told the AP on Monday.

The State Department risks another incident like the Sept. 16 Blackwater shooting of 17 Iraqi civilians unless it quickly installs closer management of the private army guarding diplomats in Iraq, the independent panel privately told Secretary of State Condoleezza Rice.

Rice said she wants to discuss the findings with Gates face to face and intends to act quickly.

"The recommendations point a very good way forward," Rice told reporters Monday night. She provided no details but said she and Gates would "discuss how we will carry out better coordination, how we will make certain that the United States government moves this forward with one voice."

The group strongly recommended that Rice coordinate her next move with the Pentagon, and she plans to speak with Gates by phone before he returns from an overseas trip late this week, a State Department official said. A face-to-face meeting would follow.

The panel, named by Rice in the wake of the Sept. 16 killings, made no specific recommendations about what should happen to Blackwater, whose guards were escorting an official from the U.S. Embassy when they fired on civilians in a Baghdad square, those familiar with the report said. The killings have outraged Iraqis and focused attention on the shadowy rules surrounding heavily armed private guards.

"There needs to be unity of effort so that whatever's moving in the battle space is coordinated, and it needs to be understood, especially, by the military out in that battle space," one person said.

Those familiar with the recommendations in the report spoke on condition of anonymity because Rice has not yet decided what changes she will make.

The recommendations would apply to management of all private security contractors in Iraq, and recognize that it is impractical to eliminate such protection altogether. The military has resisted assuming responsibility for guarding large numbers of U.S. officials, and the State Department's own security force is too small and already stretched too thin.

The group's closely held report also identified a gap that left private guards for diplomats in Iraq outside the direct control of U.S. civilian or military law, and outside Iraqi law, a U.S. official said. It was not clear whether the report recommends placing private contractors squarely under U.S. civilian law, but Congress has already acted to place such guards under military law when working for the Pentagon.

The Iraqi government is demanding that Blackwater be expelled from the country within six months and that its employees be subject to Iraqi law.

One person familiar with the report said the group did not focus on the specific events of Sept. 16, looking instead at the rules of engagement, responsibilities and oversight for all security contractors.