A federal appeals court yesterday ruled that the Environmental Protection Agency violated the law when it decided in 1982 not to order the recall of 700,000 Pontiacs found to be out of compliance with air-pollution standards.

The decision means that the EPA cannot accept General Motors' offer to make up for the unlawful pollution by reducing emissions in later-model cars more than would otherwise be required.

In a 3-to-0 ruling, the U.S. Court of Appeals here rejected the agency's argument that the proposed offset was a "remedy" under the Clean Air Act.

"It seems to us that this argument overlooks the basic principle that . . . a word cannot be construed in isolation from its context," the court wrote. " . . . When speaking of remedying the problem of international terrorism, for example, one would hardly have in mind the provision of adequate monetary compensation for its victims."

EPA officials said they were "still looking at the appeals options." If the decision is not appealed, however, the agency will likely have to recall the cars or impose a financial penalty on GM.

The ruling preserves what environmentalists and consumer groups consider an important enforcement tool to curb automobile pollution. By agreeing to the offset instead of ordering a recall, they argued, the EPA was destroying an incentive for manufacturers to build durable cars.

"The question is not so much the 700,000 cars, but the next 7 million," said David Doniger, an attorney with the Natural Resources Defense Council, one of several groups that challenged the EPA's action.