The German state of lower Saxony has long held a de facto veto over any potential takeovers or other strategic decisions by Volkswagen, which has its headquarters in the region. But Germany has ingored a European Union court order to do away with the law. In fact, the government wants to pass a new law which will protect public control over Europe's biggest car maker.

"If the current situation is formalized, the European Commission has to start a procedure for non-respect of a court ruling on this matter," spokesman Oliver Drewes told journalists in Brussels.

Drewes was referring to an October, 2007 ruling from the European Union's top court which threw out Lower Saxony's right to block company decisions.

After the 2007 ruling, German officials removed provisions limiting voting rights of shareholders and set guidelines for who would sit on the VW supervisory board. But they exploited ambiguous terms within the court ruling regarding the level of holding required to block major decisions.

Lower Saxony holds 20 percent of Volkswagen's shares. Normally, a blocking minority needs to own at least 25 percent of the company.

"We want to conserve as much as possible the existing Volkswagen law and therefore to remove only the provisions declared contrary to European law," a government statement quoted Justice Minister Brigitte Zypries as saying Tuesday.

The EU is concerned that the proposed law restricts the free flow of capital in Europe.

EU sees no "wiggle room"

"There is not room for wiggle," Drewes said. "Basically what the commission would expect is that the court ruling is fully respected and implemented."

Chancellor Angela Merkel's ruling coalition discussed options for several months before deciding to support Lower Saxony. The move is also backed by the trade union IG Metall. Beyond preventing a hostile takeover, the law preserves the goverment's ability to block strategic decisions such as plant relocations and job cuts.

Drewes said that after seeing a final version of the German law, it might leave the EU with no other choice than to go back to court.

The original German "Volkswagen Law" dates back to 1960 when the company was being privatized. The law aimed to protect it from hostile takeovers by foreign companies and ensures that workers play a significant role in decision making.

Defiance could be short lived

Porsche, which wants to bring both companies under the aegis of one holding company, also opposes the law. Porsche plans to raise its stake in VW from the current 31 percent to over 50 percent.

In a parallel case, Porsche has also asked a norther German court to reject the state's blocking minority power out of respect for european law. And lower Saxony has filed its own petition in yet another court to try and change the VW bylaws that would preserve the strategic veto.

If Germany goes ahead with the new law, the European Commission will give Berlin two months formal notice to amend the legislation before returning to court. That might be enough to kill the draft bill. Germany's Economy Minister Michael Glos managed to attach a protocol to the bill which states that the text would be modified if Brussels renews legal action.