Originally created in 1937 by the German Labour Front (Deutsche Arbeitsfront), Volkswagen rose from the ashes of World War II to become a leading world automaker, second only to Toyota in worldwide sales. Today, however, the future of Volkswagen remains uncertain as shockwaves were sent throughout the automotive industry when the company confessed on September 3, 2015, that it had been rigging diesel emission tests using so-called “defeat device software” in the manufacturer's TDI turbo diesel cars going back to 2009. Such defeat devices were used to circumvent failing U.S. emissions results in a costly new line of diesel engines that were being introduced. Some vehicles were reportedly found to be emitting up to forty times the U.S.-allowable levels of pollutants. The software installed in the engine electronic management systems was rigged to detect when the cars were being tested for emissions standards. When activated, the system reduced the cars' performance and engine output in order to temporarily meet strict emissions standards. When the engines operated normally, excess pollutants were emitted into the atmosphere, violating federal emissions standards.

Even though the extent of the cover-up is not fully verified, based on Volkswagen's own confession, as many as 11 million diesel engines in the U.S. and Europe may have been subject to such cheating devices. Effected vehicle brands include Volkswagen, Audi, Skoda, and SEAT.

Interestingly, this is not the first time Volkswagen has run afoul of attempting to hoodwink emission regulations. In 1974, Volkswagen agreed to pay $120,000 to settle a complaint filed by the Environmental Protection Agency (EPA) that the company failed to disclose the existence of devices that modified emissions controls on about 25,000 1973 models. Similar regulatory actions have snared General Motors, Ford, Honda, and other manufacturers, but Volkswagen's latest hijinks are notable for the number of potential vehicles involved, the long period of deception, and the fact that Volkswagen self-confessed to its wrongdoing prior to being uncovered by increasing pressures from various agencies investigating emission abnormalities in the companies vehicles. Even though Volkswagen admitted its actions, it is widely felt in the automotive industry that it would have been impossible for any automaker to indefinitely conceal efforts to falsify vehicle emissions data in such a manner.

The financial and operational fallout from these revelations has been rather abrupt considering just weeks before Volkswagen management boasted about receiving a 91 out of 100 sustainability score from Dow Jones Sustainability Index, taking first place among thirty-three major automobile manufacturers. Since then and in addition to a severely tarnished reputation such fallout has included, but is not limited to, the following:

·Resignation of Volkswagen's CEO and suspension of numerous high ranking corporate executives.

·Stock prices plummeting some 20-35 percent in the wake of the scandal.

·Numerous governmental investigations, including those by the United States, Germany, the United Kingdom, Korea, China, Switzerland, the European Central Bank, and many others. Many more investigations are expected.

·A halt in sales of 2015 and 2016 Volkswagen and Audi models equipped with TDI clean diesel engines in the United States.

·Hundreds of thousands, if not millions of cars worldwide that are subject to a costly and potentially long-term recall/retrofit programs expected to begin next year and could extend into 2017 or 2018 before the offending cars are all compliant.

·The company has preliminarily set aside nearly $7 billion cover recall efforts

·The EPA could bring fines of up to $18 billion for violations of the Clean Air Act.

·As of early 2016, more than 500 private lawsuits have been filed in the U.S., which are being consolidated in San Francisco Federal Court.

·Consumer Reports has suspended its recommendation of the Volkswagen Jetta diesel and Passat diesel, along with the Audi A7 TDI and Volkswagen Touareg TDI.

In addition, the EPA is reportedly investigating a second defeat device software program that may be implicated in the scandal, which was not disclosed by Volkswagen when the noncompliance was first learned.

Potential Liability Considerations

Volkswagen and its directors and officers can be expected to face criminal and regulatory investigations in the U.S., Europe, and other jurisdictions. Primary areas of potential director and officer and other liability include—but are not limited to—the areas presented in the following paragraphs.

Possible Permanent Share Price Impairment

Volkswagen and its executives face myriad civil claims globally, including class action claims by investors alleging that a failure to disclose the emissions rigging to the financial markets led investors to buy, or retain, Volkswagen stock. On September 21, 2015, the first day of trading after the EPA's Notice of Violation to Volkswagen became public, share prices of Volkswagen fell 20 percent on the Frankfurt Stock Exchange. On September 22, the stock fell another 12 percent for a two-day cumulative decline of 32 percent. On September 23, the stock fell 10.5 percent, to a record four-year low before regaining some lost ground. Qatar, one of the biggest Volkswagen shareholders with a 17 percent stake in the company, lost nearly $5 billion as the company stock value fell. As of this writing, VW shares are down over 32 percent from their pre-debacle trade value, with an uncertain future.

Because most U.S.-held shares in Volkswagen are in the form of American Depository Receipt shares (ADRs) and represent only a small portion of overall Volkswagen shares outstanding, the total ultimate U.S. liability for Volkswagen should prove far less costly than suits brought against the company in Germany where most of Volkswagen shares were sold. Because U.S. securities laws apply only in connection with shares purchased on an American stock exchange or other purchase in the United States, suits by persons or organizations purchasing shares outside the United States are disallowed in U.S. courts.

An additional twist is that because Germany has a dual board structure consisting of a management board and a separate supervisory board composed of union representatives, pension fund investors, and other stakeholders, it is expected that the supervisory board will bring one or more allegations of wrongdoing against the management board.

Over one quarter of Volkswagen's sales in the U.S. are diesel-powered vehicles. The corporation has chosen a market strategy that emphasizes so-called clean diesel over electric cars or hybrid electric vehicles.

Fines and Penalties

The EPA has stated that Volkswagen could face fines for breaches of the Clean Air Act. The maximum fine is $37,500 per vehicle, and on the basis that Volkswagen has said that 11 million vehicles may be affected, the fine could theoretically be as much as $18 billion. It is unclear, however, whether EPA fines could be assessed only on U.S. import vehicles, which would significantly reduce this preliminary estimate. It should be noted that the EPA has recently revealed that affected vehicles may have been fitted with multiple types of defeat device software, and it may be possible for additional per-vehicle fines to be assessed.

Distributors and Competing Car Manufacturers

Volkswagen distributors globally may have substantial claims against the manufacturer relating to lost profits on cancelled contracts and lost sales due to misrepresentation and puffing related to performance and mileage. Although proving causation and determining valuations may be problematic, some competitor car companies might allege that Volkswagen's actions were anti-competitive because they allowed Volkswagen to wrongly take a significant share of the clean-diesel car market.

Companies that Volkswagen may have used to design, manufacture, and install defeat device software, and their directors, may also find that they are the subject of similar investigations and civil claims.

Deceptive Vehicle Marketing

For many years Volkswagen has marketed its clean diesel technology to the public, advertising their vehicles as being green and environmentally friendly. The low emissions levels of Volkswagen vehicles tested with the defeat device in operation enabled the company to receive green car subsidies and tax exemptions in the U.S., to which it was most likely not entitled. Volkswagen may find itself liable to customers for misrepresentation and loss of value from affected vehicles. Typical claims that have already been filed include allegations that

·individuals overpaid between $1,000 and $6,800 for affected vehicles.

·the resale value of affected vehicles will be drastically reduced.

·vehicle horsepower and fuel efficiency will be greatly reduced to make the vehicles compliant with federal emissions standards.

·vehicle owners will ultimately pay more in fuel costs to operate affected vehicles.

Director and Officer Liability Insurance Considerations

There has been significant speculation as to the extent of director and officer liability insurance available to Volkswagen to respond to the avalanche of anticipated director and officer and related claims. The consensus, however, appears that there is probably between approximately $500-600 million in coverage. The structure is believed to be led by Zurich Insurance Group, AXA, Arch, and XL, with excess layers written by AIG, Liberty International, and others.

Some D&O coverage issues that are likely to arise include but are not limited to the following:

·Volkswagen has publicly admitted that it was dishonest. Most D&O policies require as a condition precedent to coverage that no admissions of liability are made without insurers' consent.

·Most D&O policies contain standard fraud and dishonest conduct exclusions that could apply. Although such exclusions are usually triggered by a finding of dishonesty, they can also be triggered by an admission of dishonesty.

·Given the potential that Volkswagen's key executives and officers were aware of the use of defeat device software since 2009, it is likely that application disclosure statements, submitted documents, and other facts will be highly scrutinized by insurers. Multiple policy periods may therefore be affected, and insurers may even attempt to rescind coverage.

·Although the conduct of one insured person cannot normally be imputed to another insured person, actions by top executives such as the CFO and CEO can and are normally imputed to the corporation.

·Regarding possible fines, it appears that any such action would be focused against the company, rather than its directors. Fines and penalties are usually excluded by standard D&O policy wording.

·Regarding product recall costs, it may be unlikely for Volkswagen to claim coverage under any insurance policy for product recall or for product liability. Clearly any recall shown to have arisen from a dishonest or intentional act or omission on the part of an insured, or circumstances known to the insured prior to inception, will raise issues relating to the presentation of the risk and coverage available under a product recall policy if such a policy exists.

Until all relevant facts are known, insurers will likely advance defense costs, at least for insureds who do not admit to having been involved in a deliberate deception. Such defense and investigation costs will be significant, especially if multiple legal teams are appointed because of conflict of interest issues, which are typical in high profile D&O claims.

Effect of Litigation Financing

The phenomenon of so-called litigation financing or litigation funding may have an accelerating effect of the number and intensity of lawsuits of all types being brought against Volkswagen and its corporate officers and directors. Litigation funding is a transaction in which a third party provides the financial resources to enable costly litigation or arbitration cases to proceed. The litigant obtains all or part of the financing to cover legal costs from a private commercial funder that has no direct interest in the proceedings. In return for providing the upfront costs for the litigation, the funder receives a portion of the settlement or judgment, which is typically 20-40 percent of the gross judgment or settlement of the case. If the case is lost, the funder generally recovers nothing. These lucrative opportunities in litigation finance have drawn an increasing number of market participants with at least one major funder currently organizing actions to be brought against Volkswagen and possibly others.

Latest Revelations

On April 21, 2016, Volkswagen proposed a plan to buy back nearly 500,000 cars fitted with emissions defeating software sold in the U.S. between 2008 and 2015. For owners wishing to keep their cars, Volkswagen will repair them and provide an addition undetermined cash settlement. Announced in federal court in San Francisco, numerous legal and financial issues were left open which Volkswagen has until to June 2016 to resolve. Although Volkswagen has set aside close to $8 billion to fund resolution of claims, the ultimate final cost is expected to far exceed this safety net when fines, penalties, and other costs and compensation are considered. To date it is believed that Volkswagen has spent in excess of $18 billion related to investigations and defense related to its confessed emissions rigging.

Many experts have long predicted that VW would not be the only automaker to become entangled in similar emission-rigging allegations and that the problem is industry-wide with VW being the tip of the iceberg.

On January 15, 2016, French automaker Renault admitted that three of its production facilities in France—Lardy, Guyancourt, and Boulogne-Billancourt—were raided the previous week by French anti-fraud investigators, sending shares in the carmaker crashing more that 20 percent before recovering somewhat.

Unlike VW, however, no cheating software or devices had been discovered in the cars examined. French environment minister Segolene Royal admitted that the preliminary results from the tests did however show that emissions on vehicles inspected did exceed minimum standards.

These most recent revelations appear to be reverberating throughout the industry as shares of Peugeot, Fiat Chrysler, and BMW also experienced at least temporary share instability even though these manufacturers have denied the use of emission defeating software or devices.

Conclusion

It is likely to be some time, perhaps many years, before the full scope and costs of Volkswagen's emissions-rigging scandal is known. For now, as the issues unfold, insurers are likely scrambling to evaluate their potential aggregate exposures, hopeful that such emission-rigging is not a systemic phenomenon across the whole automobile industry. Some comfort may be taken, however, in the fact that, BMW, Ford, Nissan, and others have formally issued public announcements that they have not used defeat device software to rig emissions tests. Others, such as Mercedes Benz parent company Daimler, recently announced they are launching an internal investigation into the emissions certification process for diesel-powered vehicles. This action is apparently in response to a lawsuit filed by a U.S. Mercedes vehicle owner claiming that Mercedes designed its diesel engines to shut off emission controls in cooler start up temperatures to help protect the engine from damage.