One by one, car giants have been drawn into a global emissions scandal. Global Insight goes back to the beginning as Volkswagen faces an uncertain future and a major reputational repair. Its handling of the crisis will offer valuable lessons for multinational businesses.

The revelation last September that Volkswagen had installed sophisticated software in its diesel engine models to cheat US emissions tests prompted ‘we always suspected it’ outrage among environmental groups, and brought high-profile scandal to one of the world’s leading car manufacturers.

For VW, the immediate consequence was the tarnishing of its stellar brand and the swift resignation of chief executive Martin Winterkorn. But the ramifications are likely to be felt for years to come, say lawyers. The company faces the threat of fines running into billions of dollars and the potential for criminal and civil litigation extending beyond the US, into Europe and further afield. VW is reportedly working hard to reach settlements with the authorities and plaintiffs’ lawyers.

For product liability and litigation lawyers, the scandal presents legal, management and PR lessons for other businesses that find themselves under regulatory investigation or uncover wrongdoing within their own ranks.

‘With product recalls, the usual approach is from a safety perspective – the product must be recalled so as not to endanger the health or life of users. So it is often a matter of determining how best to manage and mitigate the risk,’ says John Doherty, Senior Vice-Chair of the IBA Product Law and Advertising Committee, and a partner at Penningtons Manches in London. ‘In this instance, VW is facing multiple issues. There is a mandatory recall in the US and in Germany, but across most other markets in Europe it is instigating a recall more from a reputational perspective – the company is very clearly stating that it wants to right the wrong.’

Defeat devices

The publication of findings by the California Environmental Protection Agency (EPA) that VW had installed so-called defeat devices to modify the performance of its diesel engines under test conditions led to the recall of 482,000 vehicles across its Jetta, Beetle, Golf and Passat ranges, as well as the Audi A3 model. According to the agency, outside of test conditions, the vehicles emitted nitrogen oxide pollutants up to 40 times above the US limit.

VW’s response was seemingly unequivocal. The president and CEO of Volkswagen Group of America, Michael Horn, was quoted as saying: ‘We’ve totally screwed up.’ Within a few days, global CEO Winterkorn had stepped down, stating that VW had lost the trust of consumers, and was replaced by Matthias Mueller, previously CEO of Porsche.

The US has been a major target market for VW, where it has focused much advertising on the environmental credentials of its models, especially the low emissions of its diesel engines. However, perhaps more shocking was the company’s admission that defeat devices had not only been fitted to the 482,000 vehicles sold in the US, but potentially 11 million cars worldwide – including eight million vehicles in Europe alone.

Civil and criminal target

‘The California EPA and national US EPA are now involved in investigations, as is the US Department of Justice,’ says Gregory Fowler, Co-Chair of the IBA Product Law and Advertising Committee and a partner with Shook Hardy & Bacon in Kansas City. ‘One of the key operative pieces of legislation involved is the US Clean Air Act, under which there is potential to bring both civil and criminal prosecutions. So what does all this mean for VW? In short, the threat of criminal actions and the strong potential for heavy fines for the business.’

Possible fines of up to $18bn by the US EPA alone have been reported, calculated at $37,500 for each vehicle that breaches standards. Such costs could increase dramatically if European regulators follow suit and VW faces successful claims from the aggressive civil actions that have already emerged in the US.

Global Insight approached VW – including the General Counsel for VW Group of America and VW AG’s Board Member for Integrity and Legal Affairs – but they were unavailable for comment. The law firms that VW has reportedly retained – Kirkland & Ellis and Sullivan & Cromwell in the US and Freshfields Bruckhaus Deringer and Jones Day in Europe – also declined to comment, as did Mayer Brown, which is advising VW with respect to class action matters in California.

‘For the plaintiff class action and litigation bar, VW is a very attractive target, given the scale of the scandal, the number of possible claimants, breadth of the company’s assets and the fact there is the potential for punitive damages to be awarded, on top of the very high legal fees that they will also be seeking,’ suggests Fowler.

But it is not just in the US that VW will face serious legal challenges. German authorities have instigated a series of investigations to determine the extent of any emissions cheating and how far up the management chain knowledge of the devices reached.

In Germany, one local public law and litigation partner familiar with the case explained that the authorities are currently taking a three-pronged approach to their investigations. This encompasses the car and sales tax implications related to the misstating of the emissions levels of its diesel vehicles – lower emission cars have lower tax levies; the potential for fraud in relation to the higher sales prices attainable by more environmentally friendly vehicles; and the violation of the country’s environmental laws. As in the US, a major investigatory focus is on the violation of strict emissions standards, which has already led to a mandatory vehicle recall.

In January, the US District Court for the Northern District of California appointed US litigation firm Bernstein Litowitz Berger & Grossmann as lead US counsel (alongside Allen & Overy in Germany) to the Volkswagen Investor Settlement Foundation, a Netherlands-based entity providing a non-litigation and no cost vehicle for predominantly investors to recover damages as a result of Volkswagen securities held, under the Dutch Collective Settlement Act.

The Act enables parties to resolve international disputes by allowing a Dutch foundation representing largely institutional investors worldwide and the company to jointly petition the Amsterdam Court of Appeals to approve a settlement providing for payment to investors and a release of claims against the company; with the proviso that investors who are not satisfied with the settlement can opt out and are not bound by its terms.

The liability outcome, says Doherty, is that virtually everything that occurs in the US will likely also arise in Europe, where domestic national environmental protection legislation is largely derived from the overarching EU Environmental Liability Directive.

‘Criminal prosecutions across the EU are possible, based on Member States’ legislation imposing liability for environmental offences, among others. So in the UK, for example, we may see exactly the same challenges facing VW as in Germany and the US – substantial fines and the potential for criminal proceedings against individuals. The plaintiff bar may not be as well developed here as in the US, but we are already seeing considerable efforts being made to gather group claims on behalf
of consumers.’

Crisis management

Any fines and litigation costs will, however, be in addition to the cost of remedial actions announced by VW. This includes the recall, starting this spring, of 8.5 million cars in Europe, as well as the potential buyback of all vehicles sold in the US. Last October, the company posted its first quarterly loss in 15 years, having put aside €6.7bn to cover costs resulting from the scandal.

But the damage for VW is far more than financial. The revelations have damaged the reputation of what was arguably regarded as one of the world’s most reliable car brands. Nonetheless, its response may well provide useful guidance for other companies facing regulatory and public scrutiny, suggest lawyers.

VW has announced that its internal investigation has involved an initial analysis of 65 million documents, of which ten million were forwarded for review by its lawyers, with around 450 interviews also conducted. Based on the current assessment, its adviser, Jones Day, expects the investigation to conclude in the fourth quarter of 2016.

‘From the outside, VW seems to have taken a common-sense approach to the scandal, presumably on expert advice,’ says Doherty. ‘Once the issue of deceit was uncovered, the CEO openly acknowledged it before resigning. From a crisis management perspective, it was a positive thing to do. To give any chance of maintaining its reputation – or even surviving it – a business often has to start from a new, blank canvas.’

Fowler agrees that a change of leadership can be vital. ‘A new CEO will usually not be associated with the scandal in the same way as their predecessor. A business does not want “death by a thousand cuts”. So, in the case of VW, on discovering the potential wrongdoing, it made a definitive statement on the issue and a decisive change of leadership – these were definitely good actions to take. By acting positively, the business is better able to put itself on the front foot.’

Brand contamination

Lawyers also note the often subtle differences in approach required for the different markets in which a company operates. If there is no imminent safety risk or harm to consumers, then a manufacturer may not be obliged to recall its products – even if found to be defective. But, even so, a coherent response must still be guided by a mix of legal, commercial and reputational considerations.

Doherty explains: ‘Often, a client will identify an issue and ask the lawyer what to do. The usual process is to go through an analysis and plot the likelihood of harm versus the severity of harm that may be caused by a defective product, with the measure of harm increased if used by vulnerable users. So, if a manufacturer is looking at a potentially very serious outcome, even though the probability of harm is quite low, they are nonetheless in the “recall zone”.

‘Equally, where the probability of harm arising from the fault is high, despite its likely severity being low, you are again in the corrective action/recall zone,’ Doherty continues. ‘In the most serious cases, manufacturers will have to remove the product from sale, and begin a process of communication along the supplier and distribution chain. A full-scale product recall is invariably the “nuclear” option – rightly alerting consumers and the entire market to a potential fault.’

The further danger is that a manufacturer’s wider brand begins to unravel as a result of a wrongdoing. As with chaos theory, seemingly unrelated events have the potential for dramatic outcomes. For example, the shredding of documents in the Houston office of Arthur Andersen in 2001 relating to audit client Enron notably led to the collapse not only of Andersen worldwide, but also the nascent – and totally separate – Andersen Legal.

‘The challenge is always to avoid brand contamination. If there is an error and it needs to be fixed, the company should fix it. But the danger is of an error in one part of the business damaging other unconnected parts,’ says Mariano de Estrada, Chair of the IBA Consumer Litigation Committee and a partner with Bulló Abogados in Buenos Aires.

Longer-established companies are perhaps better able to deal with such shocks than newer brands, he suggests, but for all businesses the emphasis must be on the need for clear and well-communicated internal policies and behavioural guidelines – your internal communication inevitably becomes your external communication in times of crisis.

‘Of course, we never know when a company will face an issue and the actions of rogue employees will always be difficult to prevent, but by establishing clear policies upfront a company defines what behaviour is or isn’t acceptable. A responsible approach also impacts on consumers’ perceptions once issues do arise,’ adds de Estrada. ‘For trust to be retained in a brand, the company has to show it is, and has always been, serious about avoiding problems. A positive and transparent response to a product liability issue may even help reaffirm peoples’ trust in the brand.’

The worst thing a business can do is cover up such a situation, agrees Fowler.

‘As regards VW, we don’t yet know who may have sanctioned the use of the emissions software, but clearly at some level it was thought a good idea – it obviously wasn’t.
In my view, one of the most dangerous things a company can do from a reputational perspective is cover up or manifestly deny the obvious, because once the company loses the trust of the consumer it is very difficult to win it back. People invariably start to ask, “what else is it covering up?”.’

Cross-border concerns

If a company cannot change what has happened, they have to deal with a situation as best they can and manage the crisis. At the least, they should not make matters worse. Often, what businesses fail to appreciate is the management time that can be consumed by a product crisis scenario.

Lawyers agree that simply responding to the fallout can be an incredibly testing endeavour, and one that involves the board and senior executives around the world, together with large teams of in-house and external legal counsel, communications and risk management professionals.

‘The most valuable advice doesn’t come cheap and it needs to be global in scope. In a “bet the company” situation involving multiple jurisdictions, cost may be less of a concern, but even in relatively straightforward issues there may be jurisdictional nuances that have to be well coordinated. That is on top of the coordination demands in dealing with different national and potentially transnational regulators,’ says Fowler. ‘From a legal perspective, the aim is to make sure everything flows in the same direction, to try and keep the solutions and the remedies in line with one another across jurisdictions.’

The law firms coordinating matters for VW in the US and Europe will now have to field a raft of claims across multiple markets involving regulators and civil law plaintiffs often vying for the lead role in prosecuting their claims.

Companies may have brand presence and sell their products globally, but they operate in accordance with national and state laws jurisdictionally – be that across the US or within the EU – and lawyers taking a very strict approach may make the mistake of trying to ensure compliance along jurisdictional lines alone. That is not usually the best strategy, cautions Doherty, as a company’s reputation and brand value will depend on it treating all consumers of its products equally.

‘Also, regulators may take an extra-territorial approach, coordinating with their counterparts elsewhere, despite their apparent national jurisdictional remit, especially if there are to be criminal investigations or they are searching for “smoking guns”. For plaintiffs, the starting point will be the individual company at the national level. Experienced lawyers will often attempt to make a connection with the parent companies or shareholding companies higher up the chain, to make the argument that they ought also to be in the proceedings, thus opening up a deeper liability pool.’

In addition, many products are nowadays a combination of components manufactured or assembled across multiple jurisdictions and which are themselves marketed internationally – meaning liability issues may spread very far, very rapidly.

But the prevailing pressures can mean that different markets require different approaches. VW’s proposal to buyback up to 600,000 cars in the US is at odds with its offer to perform software upgrades in Europe, says Sebastiaan Van Doorn, Associate Professor of Enterprise at Warwick Business School.

‘Such a strategy clearly risks alienating its customers in the EU, which is by far its largest market, but it is in the US that the company faces the fiercest legal challenges and where the regulators have the biggest bite. Inevitably by offering variable remedies it is undertaking a risky strategy and looking to perform a difficult balancing act, both from a financial and reputational point of view.’

Multinational lessons

‘Going forward, these kinds of cases will be more common, due in part to the fact that product and consumer regulation is increasingly tough across the US, Europe and Latin America. The result is that wrongdoing in one market can lead to a multinational company facing investigations and claims all over the world,’ notes de Estrada.

VW has to date largely avoided any public comment about the ongoing or pending litigation, but in a statement issued by its German communications team to the IBA, it said: ‘We have noted the content of the class action lawsuits filed in the US and will be conducting a legal review. That applies to the legal challenges in Europe as well. Please accept that we cannot make any comment on the content because the lawsuits are ongoing. But Volkswagen takes these issues very seriously and we are dealing with these questions in an objective, professional and calm manner. Volkswagen is committed to making things right and regaining the trust of our valued customers.’

Multinationals therefore need to be more aware of different sources of risk, and develop strategies to manage or mitigate such risks in a coordinated way so as to avoid contradictions in the regulatory attitudes they encounter, he adds. ‘The key is for companies to ensure there is a clear flow of information between operational entities, because we are seeing national regulators increasingly sharing data and investigation findings, which increases the chances of an issue in one market rapidly spreading to another.’

In product liability cases, there may also be a race among claimants to initiate proceedings. The plaintiff with the prior claim may be in the best position to exhaust the funds available from the local operating company. Subsequent plaintiffs, finding themselves with limited remedial options, may try to move up the corporate chain.

‘A significant issue in large recalls is how to take the plaintiff bar/litigation into account – this will be very different from country to country,’ says Fowler. ‘In litigious jurisdictions like the US, this can be a very important consideration and challenge for companies. While the company may be dealing with regulators to organise the recall, the plaintiff lawyers may be working to aggregate claims and instigate a class action or multiple class actions. Class action claims could seek very different remedies than those considered adequate by the regulatory authorities, not to mention significant compensatory and punitive damages – things can get very complicated in a real hurry.’

Indeed, litigation trends in the US and EU are already being adopted elsewhere. ‘Latin America is an example of a region in which strategies are evolving. It inevitably takes time, but we are seeing more jurisdictions accepting class actions or imposing punitive damages for cynical wrongdoing,’ says de Estrada. ‘For multinational companies, the ability to learn wider lessons and adapt their response to different local legal systems is perhaps simpler than for national businesses, which don’t have the same levels of international management or legal sophistication – but who may nonetheless find themselves facing very sophisticated claims at home and
potentially abroad.’

Business survival

But lawyers emphasise that, despite the threats a business may face as a result of a product liability issue or regulatory investigation, it need not be fatal. Deals can be done with the authorities, and these can also tie in plaintiffs’ claims.

Indeed, as Global Insight went to press, VW had announced a deal in principle in the US with the Department of Justice, EPA, and the California Air Resources Board, with the approval of the Federal Trade Commission. In addition, it reached an agreement on the basic features of a settlement with the class action plaintiffs in San Francisco that it hopes will be incorporated into a comprehensive US settlement.

‘In the current situation, it’s hard to conceive that VW will go out of business,’ says Doherty. ‘It has historically been a responsible company and a good corporate citizen, paying its taxes and providing significant levels of employment. As such, national regulators and plaintiffs’ lawyers are likely to seek a pragmatic settlement, to ensure the survival of the business in some form.’

Again, lawyers point to the importance of a credible and transparent response in helping to encourage regulators’ and the courts’ willingness to find creative solutions. Notable also, some say, are the master settlement models agreed in the tobacco industry litigation: these enable companies to continue to trade while paying off multibillion dollar costs, albeit over a period of years – a strategy VW looks to be replicating with the US authorities.

‘My closing thought – and which comes from someone well outside the case – is that, for VW to reach a solution to the recall, regulatory issues and litigation will likely be a long and expensive proposition,’ says Fowler. ‘But from a reputational point of view, it seems to have so far handled the matter quite responsibly and come out of things relatively well. The ultimate test will be what, if any, further information about the reported test-rigging comes to light and in what kind of light it puts the company.

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Scott Appleton is a freelance journalist and can be contacted on scott@954consulting.com