EU regulators on Wednesday overturned Spanish conditions on E.On AG's $48.64 billion bid for Spain's biggest electricity company Endesa SA, saying Madrid must withdraw them by Jan. 19.
If Spain fails to act, the European Commission says it can take it to court.
Seeking to avoid a high-profile with the EU's executive arm, Spain's industry minister scrapped earlier restrictions to the German company's takeover offer but set out a new list of conditions on Nov. 3.
Spain's Socialist government strongly backs a competing bid for Endesa from Spain's Gas Natural SA worth about $26.82 billion, arguing that it is in the national interest to have a strong global energy company owned by Spaniards.
The new conditions would force E.On to keep Endesa's brand name for five years, forbid it from selling Endesa's electricity assets outside mainland Spain and keep Endesa's coal-powered plants using Spanish fuel.
E.On also had to promise not to adopt "strategic decisions" on Endesa and Spain's security of supply that would be "contrary to the Spanish legal order."
But EU regulators said those conditions broke EU rules on the free movement of capital and the freedom to set up business anywhere in the 25-nation bloc.
"I regret that the Commission has once again been obliged to intervene to avoid that a member state places unjustified conditions on a major European takeover," EU Competition Commissioner Neelie Kroes said.
But the Commission did not rule for or against Spain's insistence that buying Endesa shares should be governed by Spanish law and that Endesa fulfills all existing obligations on its nuclear power plants.
It said these did not impose any extra duties beyond general Spanish law and Madrid had given "explicit assurances" that it would not act to void its approval to the deal if these conditions were not kept.
Regulators said a previous EU ruling that said Spain's energy authority CNE was wrong to attach conditions to the deal still stood and it was still evaluating if Spain had obeyed its Sept. 26 order to remove them. The CNE required E.On to sell about a third of Endesa's power generation assets.
"The Commission's assessment of the conditions imposed by CNE remains valid insofar as the decision by the Spanish Minister has not modified or has only slightly modified the CNE's decision," they said.
The EU's executive arm said it has the exclusive right to rule on large takeovers that affect the European market and cleared E.On's offer in April. Governments cannot apply national law to European deals, it says, and cannot place conditions that could block or deter such deals.
Endesa favors E.On's all-cash bid to a cash-and-stock offer from Gas Natural but a final decision will be made by Endesa shareholders. Both bids were effectively frozen after Endesa filed more than 30 lawsuits, which resulted in two separate courts granting injunctions on the Gas Natural offer.