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.