Paul Hodgson: How ‘Dieselgate’ governance failures led to legal feeding frenzy

The scandal occurred despite a ‘stakeholder’ governance structure

The latest case to be filed in the long-running Volkswagen “Dieselgate” saga is a class action on behalf of VW salespeople in California who claim they lost commission income when the emissions cheating scandal emerged.

It claims “interference with economic relationships, fraud, breach of contract, breach of the covenant of good faith and fair dealing, and violations of the federal Racketeer Influenced and Corrupt Practices Act” according to the press release announcing the launch of the case.

It is the latest in a string of cases related to the scandal of VW’s emission’s test cheating devices that were installed in millions of its cars over years, a scandal that has really brought out ‘ambulance chasing’ lawyers. The company has denounced this case as “nonsensical”.

Just the day before this announcement VW was attempting to stop the US Ninth Circuit court from allowing one county in Utah and one in Florida to restart litigation that claimed its use of emissions-cheating devices violated anti-tampering laws. The company wants the US Supreme Court to resolve conflicting rulings on whether it violated the US Clean Air Act.

And it’s not just private lawyers getting in on the act. The SEC filed a suit, claiming that the company defrauded investors by failing to disclose the cheating devices, which a Californian judge denied – against the company – but said former CEO Martin Winterkorn would be the better target.

Earlier – and we are still in August 2020 – lawyers for 52 VW drivers who had opted out of earlier settlements asked another California judge to sign off on $1.5 million (€1.27 million) in fees and expenses after they negotiated $2.3 million (€1.69 million) in settlements to avoid another round of trials involving individual consumers seeking damages from the emissions cheating scandal.

In another case development, again, still in August, VW told the US Ninth Circuit court that “there will be a surge in abusive securities fraud litigation as a result of a district court decision keeping alive claims it duped a pension fund into buying overpriced bonds by not mentioning its emissions-cheating scandal in offering documents”.

Then there was the decision in April on the Dieselgate class action payment of €830 million to consumers in Germany; customers will receive compensation of between €1,350 and €6,250 depending on the age and model of their vehicle. And, in May, the German Federal Court of Justice (Bundesgerichtshof) ruled that Volkswagen car owners are entitled to further damages in the emissions scandal.

The court said that owners could return their car and receive the price paid minus a share for using the car in the meantime. In total, the car owners could extract more than €5bn if they oblige the company to take back their vehicles for the original purchase price with individual lawsuits. A single law firm represents more than 17,800 Dieselgate clients (that’s not all of them) and was responsible for winning the first individual Dieselgate case at the Federal Court of Justice in Karlsruhe, where pensioner Herbert Gilbert received €25,600 in damages.

At the same time, in the US, judges heard that VW had lied to Congress and ordered engineers to destroy documents.

And this is not the first time. VW was also convicted of installing cheating devices as far back as 1974, and again in 2005.

What happened here?

Clearly the German system of governance, featuring split management and supervisory boards, is not perfect. Or someone, somewhere, who was not already complicit would have spotted the deceit and done something about it.

You’d have thought, nevertheless, that lessons might have been learned. But only this June, current VW Group CEO Herbert Diess bounced into the spotlight again after accusing members of the supervisory board’s executive committee of leaking information to the press, calling them criminals. An accusation for which he then had to apologise.

As a result, VW replaced Diess as the CEO of its main VW brand and appointed Chief Operating Officer Ralf Brandstaetter to work through cost cutting efforts at the company’s largest plants in Germany. According to some reports, Diess’s clash with the supervisory board was about the cost cutting, which would involve some employees losing their jobs.

He is not the first VW head to fall foul of the company’s works council if management actions lead to job cuts. Bernd Pischetsrieder, CEO from 2002 to 2006, and Wolfgang Bernhard, VW’s brand chief from 2005 to 2007 were both fired over the same issue.

Of course, the management turmoil continues. Winterkorn resigned over the scandal in 2015, and Diess, who has, of course, been indicted, along with chairman Hans Dieter Pötsch, for complicity in the scandal. And a fair number of executives have been sent to jail and/or fined. It’s a mess. And the legal losses will continue. Was it really worth it?

The principle of Germany’s corporate governance is codetermination.

It’s a principle that seeks to balance capital, shareholder wealth and the needs of employees, including trades unions. Sound a bit like stakeholderism? That’s because it is.

But while VW followed the structural requirements of German corporate law, directors clearly failed in their supervisory roles. And there are additional governance problems that are present at VW that are not present at all German corporations. For example, there is the dual-class stock held by the controlling shareholders, the Porsche and Piech families, and the presence of family members on the supervisory board.

But even without these additional governance problems, the oversight failures could have happened. Unless effective practices are in place at a company with processes that ensure directors are awake and informed, the best governance structure in the world is just that, a structure.

As Nell Minow, vice chair of ValueEdge Advisors, is fond of saying: “I am endlessly fascinated that the most accomplished and experienced people lose half of their IQ points and all of their courage as soon as they sit around a board table. Eleven people who have succeeded by adapting to norms are no match for a visionary, dynamic CEO who controls not just their access to information but their continued service on the board.”