January 01, 2018

The VW Emissions Scandal: Cities as Trust Fund Beneficiaries

John K. Powell

Cars, trucks, and other transportation-related equipment account for approximately half of the air pollutant emissions in the United States. Common air pollutants from these “mobile sources” include carbon monoxide, volatile organic compounds, nitrogen oxides (NOx), and other hazardous air pollutants. Automobile manufacturers are subject to the requirements of the federal Clean Air Act (CAA), which regulates mobile source emissions with the overall goal of protecting public health with an adequate margin of safety. In September 2015, the Volkswagen Group (VW) admitted to evading those requirements by engaging in the sophisticated, purposeful, and widespread use of computer algorithms and defeat devices designed to detect when automobile emissions testing was being conducted, alter engine performance, and temporarily lower pollutants below CAA limits.

The subsequent claims and litigation brought by federal and state governments, consumers, and others resulted in the largest settlement with an automaker, for any type of claim, in U.S. history. The number and variety of legal issues associated with the scandal are staggering, complex, and still evolving. One important component of the settlement agreement is the establishment of a $2.7 billion trust fund that can be used by states and other eligible beneficiaries to implement transportation related NOx-reduction projects. Cities, many of which are constantly confronted with dual concerns of equipment maintenance and air quality, can reap benefits from this historic settlement agreement, if they are prepared.

This article explores one aspect of the overall VW emissions scandal: the creation of the Environmental Mitigation Trust Fund as part of the 2.0-liter diesel engine vehicle settlement agreement approved by the U.S. District Court for the Northern District of California in October 2016. This article briefly discusses the origin of the VW scandal, the relationship with the CAA, and the creation of the Environmental Mitigation Trust Fund, including eligible project categories, and outlines the process for cities to participate in the potential benefits.

Clean Air Act and Mobile Sources

The 1970 CAA was a major turning point in environmental law, coinciding with the creation of the U.S. Environmental Protection Agency (EPA) that same year. At a time when environmental practices largely were unregulated, the CAA manifested the frustration of a generation through the creation of uniform national ambient air quality standards (NAAQS). The foundation of the CAA, NAAQS were a novel approach to environmental regulation, establishing the maximum acceptable levels for several common outdoor air pollutants that posed a potential threat to human health and the environment: carbon monoxide, lead, ground-level ozone, nitrogen dioxide, particulate matter, and sulfur dioxide. See www.epa.gov/criteria-air-pollutants.

The primary NAAQS are health based and built upon protecting public health with an “adequate margin of safety.” Limits for air pollutants were set without regard to cost or even the feasibility of attaining them, reflecting both the seriousness of the issue and the optimism of the time that technology was rapidly progressing and certain to catch up quickly. Secondary standards were set to protect aspects of public welfare, such as soil, crops, buildings, and visibility.

Uniform in nature, the same NAAQS limit applied equally in smaller rural cities like Tallahassee, Florida, as in more densely populated or urban areas like Atlanta, Georgia. While this approach made it easier for EPA to administer and avoided a race-to-the-bottom mentality where industry relocates to cities with the most relaxed environmental requirements, it also placed areas with heavy traffic congestion, industrialized economies, or even unfavorable geography and lack of natural air dispersion capabilities at a disadvantage and with less chance of ever achieving full compliance. This seemingly inflexible, one-size-fits-all federal approach is tempered with a dollop of flexibility, with each state developing its own State Implementation Plan that details the specific ways a state proposes to achieve and maintain compliance with the standards and that is tailored to the state’s unique needs.

The original goal in the CAA was admirable and ambitious, designed to achieve all primary NAAQS by 1975. However, more than four decades later, many areas still are not in attainment. As of 2017, 36 states had one or more counties classified as “nonattainment.” The reason many areas remain in nonattainment can be traced directly back to mobile source emissions.

In 2016, the Federal Highway Administration estimated that U.S. driving exceeded 3.2 trillion miles. Press Release, U.S. Dept. of Transp., 3.2 Trillion Miles Driven on U.S. Roads in 2016 (Feb. 21, 2017), www.fhwa.dot.gov/pressroom/fhwa1704.cfm. There are now more than a quarter billion highway motor vehicles on U.S. roads (see U.S. Dept. of Transp., National Transportation Statistics, Table 1-11 (2017), www.rita.dot.gov/bts/sites/rita.dot.gov.bts/files/NTS_Entire_2017Q2.pdf)—millions of mini power plants on wheels if you will, continuously converting gasoline and diesel fuel to carbon dioxide, water vapor, and, based on the efficiency of the engine, a variety of different air pollutants. Depending on lifestyle, driving an automobile may be the single greatest source of air pollution caused by the average U.S. citizen.

The NAAQS program, while the foundation of the CAA, is just one of its major features. Another is Title II of the CAA, which is directed toward regulating these ubiquitous mobile source emissions, addressing issues such as fuel quality, vapor recovery, catalytic converters, and engine efficiency. It is not surprising that the U.S. Congress vested EPA with the primary authority to regulate mobile sources instead of the states, because manufacturing cars for different states with different efficiencies, fuel economies, and engine configurations would be inefficient and nearly impossible to enforce—California being the lone exception. More recently, the landmark 2007 U.S. Supreme Court decision in Massachusetts v. EPA, 549 U.S. 497 (2007), allowed EPA the clear authority to regulate carbon dioxide emissions from mobile sources, though it is not one of the six criteria air pollutants with associated NAAQS limits.

Emissions Scandal

Volkswagen, German for the “people’s car,” was a government-sponsored automobile company founded in the 1930s and headquartered in what is now Wolfsburg, Germany. With the goal of increasing car ownership, it was originally intended to be an affordable car for the German masses, in contrast to the more expensive luxury models of that time.

In the United States, VW may be best known for models like the Passat, Jetta, and the iconic Beetle (as more commonly referred to, the “Bug”), which symbolized a time in American culture that attracted the attention of surfers, college kids, and those searching for freedom and the open road—a far cry from its World War II–era roots. The VW Group, however, is much more. Today it is a global company that includes not just VW, but also Audi, Bentley, Lamborghini, Porsche, and more. In 2016, the VW Group for the first time became the world’s largest automaker, surpassing Toyota and General Motors and selling more than 10.3 million vehicles. Bertel Schmitt, It’s Official: Volkswagen Is World’s Largest Automaker in 2016. Or Maybe Toyota, Forbes (Jan. 2017).

In the mid-2000s, VW worked to increase diesel vehicle sales in the United States, promoting its new EA189 engine and touting its environmentally friendly “clean diesel” technology in various advertising campaigns. At the time, VW appeared to have cracked the code on meeting EPA’s strict air pollutant emission standards while preserving power and performance, something other diesel automakers had struggled to do. However, unbeknownst to the public and purportedly much of the top management at VW, a group of employees figured out a way to game the system by altering a vehicle’s computer software to sense when pollutant emissions testing was under way.

Generally, there are two types of automobile testing, the first of which is conducted on a new class of vehicles introduced into U.S. commerce to certify that they conform to EPA emissions requirements. The second is the responsibility of the end user or owner, and this requirement varies from state to state and depends on vehicle age and type. Testing often involves placing a sensor inside the exhaust pipe during vehicle operation, connecting a computer to the vehicle’s on-board diagnostic control system, or both.

However, by monitoring parameters such as speed, engine operation, barometric pressure, and steering wheel position, VW’s computer algorithm could identify when this required testing was taking place. The vehicle’s computer system would then automatically switch the engine into a different “test” mode, altering engine performance to lower pollutant emissions to below the applicable federal limits. Once testing was completed, and the parameters no longer reflected a controlled laboratory scenario, engine operation reverted. Under real world driving conditions, emissions could reach levels sometimes as much as 40 times above what is allowable under the CAA.

It was not long, however, before the public finally caught on. In 2014 researchers at West Virginia University, with funding from the International Council on Clean Transportation, published a study indicating there were significantly higher emissions in both a Jetta and Passat Turbocharged Direct Injection (TDI) vehicle under normal driving conditions versus during emissions testing. Dr. Gregory J. Thompson, et al., In-Use Emissions Testing of Light-Duty Diesel Vehicles in the United States, Center for Alternative Fuels, Engines & Emissions, West Virginia University (May 15, 2014), www.theicct.org/sites/default/files/publications/WVU_LDDV_in-use_ICCT_Report_Final_may2014.pdf.

By the summer of 2015, the issue gained more public attention. With litigation imminent, VW entered into formal discussions with both the California Air Resources Board (CARB) and EPA. On September 18, 2015, EPA issued a formal Notice of Violation to VW (Volkswagen AG, Audi AG, and Volkswagen Group of America, Inc.). The Notice of Violation stated that EPA was continuing to investigate VW for potential violations of the CAA and its implementing regulations. More specifically, it stated that EPA had determined that VW manufactured and installed defeat devices in certain model year 2009 through 2015 diesel light-duty vehicles equipped with 2.0-liter engines and that these devices bypassed, defeated, or rendered inoperative elements of the vehicles’ emission control system used to comply with requirements of the CAA. EPA Notice of Violation to Volkswagen AG, Audi AG, and Volkswagen Group of America, Inc., (Sept. 18, 2015), https://www.epa.gov/sites/production/files/2015-10/documents/vw-nov-caa-09-18-15.pdf.

VW responded by publicly admitting that the vehicles were in fact equipped with secret defeat devices. See Order Granting Mot. to Enter Proposed Am. Consent Decree, In Re: Volkswagen “Clean Diesel” Marketing, Sales Practices, and Products Liability Litigation, MDL 2672, 2016 WL 6442227 (N.D. Cal. Oct. 26, 2016) (Order). On September 23, 2015, the chief executive officer of VW AG, Martin Winterkorn, abruptly resigned, admitting no knowledge or culpability but rather offering the company a “fresh start.” Danny Hakim et al., As VW Pushed to Be No. 1, Ambitions Fueled a Scandal, N.Y. Times, Sept. 27, 2015, at A1.

In January 2016, the U.S. Department of Justice filed suit on behalf of EPA against VW alleging CAA violations for every diesel vehicle sold since the 2009 model year, covering more than 500,000 2.0-liter engine vehicles and 80,000 3.0-liter engine vehicles and seeking up to $46 billion in penalties. See Complaint, In Re: Volkswagen “Clean Diesel” Marketing, Sales Practices, and Products Liability Litigation, MDL No. 2672 CRB (Jan. 4, 2016). In March 2016, the Federal Trade Commission followed with a suit against VW for deceptive advertising in its former clean diesel advertising campaigns. By June 2016, the State of California, through CARB, had filed suit alleging various state and federal violations, including, but not limited to, the creation of a public nuisance as well as false advertising. Hundreds of additional actions were eventually consolidated and centralized into one multidistrict action before the U.S. District Court for the Northern District of California. Soon thereafter, VW posted a $4.1 billion operating loss for 2015.

Consent Decree

After months of intense negotiations, an agreement between the parties was reached. The agreement was determined by the court to be the result of noncollusive and adversarial negotiations, taking a multifaceted approach to both mitigate the harm caused by the 2.0-liter diesel engine vehicles and to reduce future NOx emissions. Finding it both procedurally and substantively fair, the court approved the proposed Partial Consent Decree (Consent Decree) on October 25, 2016. Order at 6–12. The Consent Decree partially resolved the claims asserted by the United States and California for the nearly 500,000 2.0-liter TDI VW and Audi-branded diesel engine vehicles, leaving the issues associated with the 3.0-liter engines to be addressed separately. Id.; see Second Partial Consent Decree, In Re: Volkswagen “Clean Diesel” Marketing, Sales Practices, and Products Liability Litigation, MDL No. 2672 CRB (Dec. 20, 2016) (addressing 3.0-liter engines).

The Consent Decree includes three main components. First, it requires VW to remove or modify at least 85 percent of the vehicles pursuant to a specified recall rate and offer every owner or lessee a buyback, lease termination, or an approved emission modification if approved by EPA and CARB. Order at 3; Consent Decree, App. A. If VW fails to meet the agreed recall rate, it must pay additional monetary penalties. Id.; Consent Decree, App. D. Second, VW must invest $2 billion over 10 years in projects that support zero-emission vehicles (ZEV), i.e., electric or hydrogen cell-powered vehicles. Id. at 4; Consent Decree, App. C. Projects include the development, construction, and maintenance of ZEV-related infrastructure.

Out of this $2 billion, $1.2 billion must be directed toward national ZEV investments and $800 million used specifically for ZEV investments in California. Id. This second requirement is not without controversy though, as competitors fear that through this level of investment, VW could gain an unfair competitive advantage, essentially establishing the standard for ZEV infrastructure with potential proprietary issues.

Finally, VW must establish a “mitigation trust” to fund NOx-reduction projects. Id.; Consent Decree, App. D. NOx reduction is at the core of the overall agreement because it is emitted in large quantities by mobile sources and diesel fuel combustion in particular, and is a known respiratory irritant. It also reacts with other compounds in the air to form particulate matter, ground level ozone, acid rain, and smog.

Environmental Mitigation Trust

Under the Consent Decree, VW agreed to pay $2.7 billion into an Environmental Mitigation Trust (Trust) to fund projects to reduce emissions of NOx where the 2.0-liter diesel engine vehicles were, are, or will be operated. Id. These projects are in addition to the emissions reductions achieved by requiring VW to buy back or modify the violating 2.0-liter cars. The purpose of the Trust is to fund projects that will fully mitigate the total lifetime excess NOx emissions from the subject vehicles.

In accordance with the process outlined in the Consent Decree, in March 2017 the court appointed Wilmington Trust as the official trustee. Eligible governmental entities including states, Indian tribes, Puerto Rico, and the District of Columbia that were interested in becoming beneficiaries to the Trust filed a Certification for Beneficiary Status form signed by the governor—or analogous chief executive if not a state—within 60 days of the Trust effective date. By applying to become a beneficiary, the entity waived any future claims for injunctive relief for environmental injury associated with the 2.0-liter subject vehicles and agreed to make all Trust-related documentation available to the public. Entities that elected not to submit a Certification for Beneficiary Status form are considered excluded entities and are permanently enjoined from asserting rights with respect to the Trust.

As part of the certification process, beneficiaries also were required to designate a lead agency or office for their jurisdiction. Most often, the designated agency or office is statutorily assigned with environmental- or transportation-related responsibilities—for example, the Florida Department of Environmental Protection or the Iowa Department of Transportation.

To be certified, beneficiaries also must submit a Beneficiary Mitigation Plan (BMP), which is subject to public review. The BMP demonstrates how the entity will utilize the funds, including (1) overall goal for the use of the funds, (2) categories of eligible mitigation actions appropriate to achieve the goal and the preliminary assessment of the percentage of funds anticipated for each action, (3) description of how the beneficiary will consider the potential beneficial impact of the selected actions on air quality in areas that bear a disproportionate share of the air pollution burden within its jurisdiction, and (4) a general description of the expected ranges of emissions benefits realized by actions identified in the BMP. The BMP is intended to provide the public with insight into a beneficiary’s high-level vision for the use of the mitigation funds. The BMP is nonbinding, allowing it to be adjusted by the beneficiary as needed with required updates provided to the Trustee. The BMP also outlines the process for soliciting and incorporating public input. Before the BMP due date and even before the Trust effective date, several states such as Virginia and Michigan issued Requests for Information to help determine the potential range of diesel emission-reduction and mitigation projects that might exist within their jurisdiction.

Once an entity becomes a beneficiary, it is entitled to request its share of the Eligible Mitigation Action funds. Initial allocation from the $2.7 billion is based on the number of subject vehicles registered in each jurisdiction, with a minimum funding allocation of $7.5 million per state. Indian tribes will receive a separate allocation totaling more than $49 million. California, Texas, and Florida had the greatest number of registered vehicles with approximately 14 percent, 7 percent, and 6 percent, respectively. In addition to the initial $2.7 billion, any penalties VW must pay for failing to meet the recall target rates will be placed into the Trust and distributed according to the allocation in the agreement. The share associated with any excluded entity will also be reallocated back to the pool for distribution to eligible beneficiaries.

Eligible Project Categories

Under Appendix D-2 to the Consent Decree, there are nine Eligible Mitigation Action (EMA) categories, all of which are transportation related and most of which involve repowering or replacing engines or vehicles with cleaner engines and power sources. A tenth option allows the funds to be used toward an entity’s nonfederal voluntary match pursuant to the Diesel Emissions Reduction Act Program (DERA) of the Energy Policy Act of 2005. In addition to direct project costs for any EMA, beneficiaries may also use Trust funds for administrative expenditures associated with implementing the projects, such as employee salaries, wages, benefits and travel, office supplies, and educational publications, not to exceed 15 percent of the total cost of the project. Partial Consent Decree, App. D-2 (June 24, 2016).

Both government-owned and privately owned equipment potentially are eligible for funding from the Trust; however, the cost-sharing eligibility can be significantly different depending on the type of project. Generally, government-owned projects may draw up to 100 percent of the eligible project costs, whereas draws for nongovernment projects, such as privately owned fleets, range from 25 to 75 percent. Government is broadly defined to include tribal governments or native villages, the District of Columbia, Commonwealth of Puerto Rico, states, local governments, school districts, municipalities, cities, counties, special districts, transit districts, joint powers authorities, and port authorities.

In most cases, the replacement of old vehicles, equipment, or engines requires scrapping of the original. Scrapping engines requires rendering them inoperable and available for recycling and, at a minimum, cutting a three-inch hole in the engine block. For vehicles, scrapping requires disabling the chassis by cutting the vehicle’s frame rails completely in half.

The 10 categories of eligible EMAs are as follows:

Large trucks. Repowering or replacing engine model year 1992–2009 local freight trucks or drayage with any new diesel, alternate fuel, or all-electric vehicle or engine. This category includes vehicles with a gross vehicle weight rating (GVWR) of greater than 33,000 pounds including passengers and cargo. For beneficiaries that have state regulations already requiring upgrades to model years 1992–2009, model years 2010–2012 also will be eligible under this category.

Buses. Repowering or replacing 2009 engine model year or older school buses, shuttle buses, or transit buses with new diesel, alternate fuel, or all-electric vehicle or engine. This includes buses with a GVWR of greater than 14,001 pounds and that are used for transporting people. For beneficiaries that have state regulations already requiring upgrades to model years 1992–2009, model years 2010–2012 also will be eligible.

Freight switchers. Repowering or replacing older switcher locomotives that operate 1,000 hours or more annually with new diesel, alternate fuel, or all-electric engines or switchers.

Ferries and tugs. Repowering marine engines with more efficient diesel, alternate fuel, or all-electric engines or with an EPA Certified Remanufacture System or an EPA Verified Engine Upgrade. Tug includes a dedicated vessel used to push or pull other vessels in ports, harbors, and inland waterways, such as tugboats and towboats.

Ocean-going vessels shorepower. Eligible marine shorepower includes systems that enable a vessel’s main and auxiliary engines to remain off while the vessel is at berth, including cables, cable management systems, shore power coupler systems, distribution control systems, and power distribution.

Medium trucks. Repowering or replacing engine model year 1992–2009 local freight trucks with any new diesel, alternate fueled, or all-electric vehicle or engine. This includes trucks with a GVWR between 14,001 and 33,000 pounds. For beneficiaries that have state regulations already requiring upgrades to model years 1992–2009, model years 2010–2012 also will be eligible.

Airport ground support equipment. Repowering or replacing diesel-powered airport ground-support equipment, as well as eligible spark ignition engine-powered airport ground-support equipment, with all-electric engines or equipment.

Forklifts and port cargo handling equipment. Repowering or replacing forklifts with greater than 8,000 pounds of lift capacity with all electric engines or equipment. Eligible types of forklifts include reach stackers, side loaders and top loaders; and port cargo handling equipment includes rubber-tied gantry cranes, straddle carriers, shuttle carriers, and terminal tractors, including yard hostlers and yard tractors.

Light-duty zero-emission vehicle supply equipment. Acquisition, installation, operation, and maintenance of new light-duty electric or hydrogen fuel-cell vehicle supply equipment located in a public place. Each beneficiary may use up to 15 percent of its allocation of the Trust for these projects.

DERA option. The tenth EMA allows states and tribes to use mitigation trust funds under specific DERA grants. DERA, part of the Energy Policy Act of 2005, provides federal and state grants to reduce emissions from older diesel engines through replacement or rebuilding. While diesel vehicle projects may be eligible under the other nine EMAs as well, there are some differences with respect to project eligibility and funding limits. Beneficiaries generally may split their mitigation trust funds among the first nine EMAs and the DERA option as they choose.

Cities as Beneficiaries

There are thousands of cities and other incorporated places in the United States, ranging in size from several million residents and covering thousands of square miles, to just a few. These cities are microcosms of our larger society, and the local governments that serve them provide a broad range of diverse services to their citizens and community, including police, fire, parks and recreation, housing, water and wastewater, solid waste management, and public works. Some cities also generate their own electricity, manage large convention centers, or operate airports providing domestic and international flights. As such, cities own and operate a significant amount of diesel-powered transportation equipment to support these customer services.

Because of this concentration of activity, cities are also often victim to poor air quality. Hot spots may develop with elevated levels of criteria pollutants such as ozone or particulate matter, resulting in a nonattainment classification. This is particularly true in areas with heavy traffic congestion and is exacerbated when natural topography and meteorological characteristics do not allow for good air dispersion and mixing capabilities. Whether or not a city is in attainment with the NAAQS, the use of the Trust to implement NOx-reduction projects will help improve air quality and provide an important funding mechanism to upgrade older equipment.

Cities and other eligible subbeneficiaries interested in obtaining funding from the Trust should maintain a detailed inventory of their equipment and potentially eligible projects. Information such as vehicle type, mileage, age, fuel usage, idling hours, emissions-control equipment installed, projected replacement date, and estimated cost of replacement will be required. Cities that have this information readily available, respond to their jurisdiction’s Requests for Information if issued, and maintain contact with their designated lead agencies will be better positioned to maximize their benefits under this historic settlement agreement.

The Proverbial Perfect Storm and Silver Lining

Environmental professionals live in a gray world, full of semantics and subtleties. We labor over a sentence in an agency rule, one word in a permit, and even the placement of a single comma. So it is a rare occasion that an environmental incident gathers such unanimity like the VW scandal did.

It was the proverbial perfect storm. The world’s largest automaker with hundreds of thousands of affected vehicles sold or leased across the country, clear and measurable exceedances of federally imposed pollutant emissions limits, corporate actions with a direct impact on the company’s profitability, and the requisite intent all combined to result in criminal enforcement and ultimately the settlement.

The storm cloud was the sophisticated, purposeful, and widespread use of computer algorithms and defeat devices designed to detect when vehicle emissions testing was being conducted, alter engine performance, and fraudulently depict temporary pollutant emission levels in compliance with CAA limits. The silver lining is billions of dollars being distributed to the states that can be used by cities and others to implement a variety of transportation-related pollution-reduction projects and potentially transformational upgrades to city services.

John K. Powell

Mr. Powell is the director of the Environmental Regulatory Services and Facilities Department for the City of Tallahassee (COT). He may be reached at john.powell@talgov.com. The views, opinions, and findings contained in this article are those of the author and should not be construed as an official COT position, policy, or decision.