May 31, 2005
- State Monopoly - It's 46 state attorneys general, the 200 or so wealthiest trial lawyers in the world and the six largest tobacco companies against a bunch of very small businesses who are losing money
It's not about health care or safety; it's about market share.
It's not often that we praise the Associated Press but an article by business reporter Stephanie Stoughten is recommended reading for those who wish to understand what the "historic" 1998 tobacco settlement is all about. As time goes by it is increasingly clear that this deal is a massive scheme to transfer billions of dollars from smokers to state governments. On that level it is a privately-negotiated tax imposed by entities that have no authority to raise taxes. On another level it is an agreement between state attorneys and the big cigarette manufacturers to establish a state-sanctioned monopoly. The settlement has been financially rewarding for Big Tobacco, the tobacco control industry and trial lawyers. For the country it has been a disaster in that it entwined public and corporate greed, blurred the rule of law and relegated a huge number of Americans into cash cows for the rich.
FORCES
Grand River Enterprises Six Nations, Ltd., et al. v. United States of America
Grand River Enterprises Six Nations, Ltd., a Canadian corporation, Jerry Montour, Kenneth Hill and Arthur Montour have delivered a notice of arbitration under the UNCITRAL Arbitration Rules on their own behalf and on behalf of Native Wholesale Supply (collectively "Grand River"). Grand River is involved in the manufacture and sale of tobacco products. It seeks not less than $340 million for damages allegedly resulting from a 1998 settlement agreement between various state attorney generals and the major tobacco companies, and certain state legislation that partially implements the settlement.
Cigarette Makers Lose Bid To Arbitrate Lower Payouts
Daniel Wise
New York Law Journal
03-10-2005
A Manhattan Supreme Court judge has dealt a setback to cigarette makers in the opening round of a legal battle to lower by $1 billion a year tobacco industry payments reached under a historic settlement in 1998.
Justice Charles E. Ramos last week rejected the industry's position that its claims to a lower payment could be litigated in a single arbitration proceeding. Instead, he said, the cigarette makers must proceed in a more cost-intensive, state-by-state litigation.
As some cigarette makers press to lower their annual payments -- claiming an explosive growth in illegal Internet cigarette sales makes their participation in the pact unfair -- New York becomes a particularly inviting target. Under the settlement, annual payments to the state are roughly $800 million, according to the Attorney General's Office.
Should the industry prevail, the cigarette makers "would likely target the deep-pocket states that receive the largest payments" under the $206 billion settlement reached between 46 states and six territories, said Marc Violette, a spokesman for Attorney General Eliot Spitzer.
New York and California together receive about 25 percent of the $6.2 billion distributed annually under the settlement, which was crafted to resolve the states' claims for funds spent on treating smoking-related illnesses either through programs for the poor or for state employees.
Three small cigarette makers opened the battle in June to lower the annual payments for 2003 by taking legal action in five states, including New York. In motions seeking arbitration, they sought to invoke a provision in the settlement that requires the payments to be lowered if the states do not take required actions to create parity between the manufacturers that joined the agreement and those that did not.
Led by Commonwealth Brands, the three cigarette makers, all of whom joined the settlement after it was forged, claim they are entitled to a $33 million refund on payments made in 2003 under the agreement. King Maker Manufacturing and Sherman are the other two companies.
The trio are among 40 cigarette makers who joined the pact after it was signed by the nation's four largest manufacturers: Philip Morris, Lorillard Tobacco, R.J. Reynolds Tobacco, and Brown & Williamson, which last summer merged with R.J. Reynolds.
Philip Morris, Lorillard and R.J. Reynolds, which make about 85 percent of the nation's cigarettes, are not seeking a reduction in their 2003 payments, but agree with the three smaller makers that the industry is entitled to the estimated $1 billion reduction.
In addition to the annual payments, the companies bound by the settlement are obligated to abide by provisions restricting their advertising and marketing practices.
NON-PARTICIPANTS
Some 80 cigarette makers have not joined the pact. To insure they do not gain an advantage, the 1998 accord required each state to enact a "model statute," requiring the non-participants to pay into an escrow account an amount equivalent to what the participating makers must pay. So, all manufacturers ultimately are required to pay the states the same amount, two cents for every cigarette sold.
The settlement requires an estimated $1 billion adjustment in the amount the participating companies must contribute if two conditions are met: There is a finding that participation in the pact was a significant factor in market share loss for those that signed on, and the states failed to "diligently enforce" their statutes designed to put participating and non-participating companies on equal footing.
All the states and territories that signed on to the pact have adopted the model statute, but the participating manufacturers contend that the states' efforts to collect the two cents per cigarette from the burgeoning -- and often illegal -- Internet trade have been lacking.
The agreement further holds any state found not to have "diligently enforced" its model statute liable for the full amount of its payment for the year in question. That leaves New York with a maximum exposure of $800 million for any year in which that claim can be proven.
Last year, Commonwealth, King Maker and Sherman asked PriceWaterhouseCoopers, which both sides selected to carry out the complex calculations required by the agreement, to impose the penalty.
PriceWaterhouse found that since the accord was signed, the participating manufacturers had lost more than 6 percent of the market share in "significant" part because of their participation in the pact, the trio of small manufacturers claimed.
Though that finding was a legal predicate for the penalty, according to the three, PriceWaterhouse declined to impose it citing a presumption that all the states were diligently enforcing the other half of the bargain -- the laws requiring the two cent per cigarette assessment.
The three manufacturers then filed motions in New York, Connecticut, Virginia, New Mexico and Arkansas asking that the dispute be taken to arbitration, claiming that is the path required by the pact.
THE FIRST RULING
Litigation so far has only advanced in New York and Connecticut, with the first ruling coming when Ramos denied the arbitration request from the bench on March 1 after hearing 30 minutes of oral argument.
He agreed with New York state that the determination regarding diligent enforcement remains within the court's jurisdiction under the accord, and it was not the type of accounting decision that had been delegated to PriceWaterhouse, and thus subject to arbitration.
"This is not an arbitrable dispute under the [settlement agreement], not even close," Ramos said from the bench.
Robert J. Brookhiser, who represents the three small cigarette makers, said he was "disappointed" in the ruling and plans to appeal.
Stephen R. Patton, who took the lead role for the largest cigarette makers before Ramos, said the big three backed the arbitration request because the "pact creates a complex calculation to create a single nationwide payment obligation."
He added, "It is important to have a single forum to resolve disputes" and not 52 separate court systems with authority to rule on the issue.
But Violette, a spokesman for Spitzer, said that Ramos had correctly recognized the arbitration request "as a thinly veiled effort to circumvent his jurisdiction to determine whether New York state is diligently enforcing" its statute.
New York and the three small companies took fundamentally opposing views over how any fact-finder -- an arbitrator or a judge -- should decide whether the $1 billion reduction should be imposed.
Brookhiser of Howry Simon Arnold & White in Washington, D.C., said that his clients and the other participating manufacturers take the position that the settlement language requires PriceWaterhouse to impose the $1 billion payment adjustment once the accounting firm finds that participation in the settlement has been a "significant factor" in the companies' loss of market share.
The accord then allows individual states to demonstrate that they should not be held responsible for payment of the penalty because they had diligently enforced their statutes, he said.
Violette asserted that Brookhiser had it backwards.
"Over 100 years of case law provides that states are presumed to be diligently enforcing their laws until it is demonstrated otherwise," he said.
Patton, who represents R.J. Reynolds, said the three large companies have not joined the three smaller companies in seeking the 2003 adjustment because they disagree that PriceWaterhouse could have made "a significant factor" analysis for that year.
A "significant factor" finding can only be made by an economic firm selected by the parties to carry out analysis separate from that of PriceWaterhouse's role, said Patton, of the Chicago office of Kirkland & Ellis. While the parties have selected a firm, a contract has not been completed, he said.
Once the firm analyzes market developments, Patton said, the industry is confident the economists will issue "a significant factor" finding. He declined to identify the economic firm until the contract is finalized.
CLASH ON MERITS
Even though the first round has gone against the participating manufacturers on the arbitration question, they could still prevail in one of the other four states, or on appeal in New York. And Brookhiser declined to rule out suing individual states in their own courts should the effort to take the matter before the arbitration panel fail.
The evidence is "clear" that the states are not diligently enforcing the collection requirement, Brookhiser said. When the pact was signed in 1998, there were hardly any non-participating manufacturers. Since then, the number of new cigarette makers operating outside the pact has grown to 80, he said.
PriceWaterhouse's finding that the participating manufacturers have lost 6 percent of the market share since 1997 is actually 2 percent less than the total decline under the formula the pact requires, Brookhiser said.
When unreported sales over the Internet are added in, he said, the actual decline in market share "has to be at least 10 percent."
Violette countered that the agreement only requires a state to collect the two-cent assessment on cigarettes that are reported to the state and taxed.
To require states to collect the fee on cigarettes sold over the Internet without proper disclosure to the state is "an impossible task," he said.
Trustbuster
February 28, 2005
Scott Woolley
A tiny upstart in the cigarette business threatens to topple a comfortable cartel engineered by big tobacco companies and their strange bedfellows, the state attorneys general.
Big tobacco was supposed to come under harsh punishment for decades of deception when it acceded to a tort settlement seven years ago. Philip Morris, R.J.Reynolds, Lorillard and Brown & Williamson agreed to pay 46 states $206 billion over 25 years. This was their punishment for burying evidence of cigarettes' health risks.
But the much-maligned tobacco giants have subtly and shrewdly turned their penance into a windfall. Using that tort settlement, the big brands have hampered tiny cut-rate rivals and raised prices with near impunity. Since the case was settled, the big four have nearly doubled wholesale cigarette prices from a national average of $1.25 a pack (not counting excise taxes) in 1998 to $2.10 now. And they have a potent partner in this scheme: state governments, which have become addicted to tort-settlement payments, now running at $6 billion a year. A key feature of the Big Tobacco-and-state-government cartel: rules that levy tort-settlement costs on upstart cigarette companies, companies that were not even in existence when the tort was being committed.
The 1998 scheme came under legal attack almost from the start. While the cartel has fought off most of these challenges, it has just taken a palpable hit. A federal court in New York tossed out a key antidiscounter rule, and the entire settlement could yet crumble. This is due to the doggedness of one Jeffrey Uvezian, who sells cheapie cigs under such brands as Cobra, Boston and Tough Guy, through his company, International Tobacco Partners.
Uvezian has since 2002 been waging an antitrust attack on the big tobacco companies and their allies in the state attorneys general offices. The one academic study to measure the impact of the settlement on Big Tobacco backs up Uvezian: The deal raised both profits and stock prices of the big companies. This finding comes from economist Frank Sloan of Duke University--an institution founded, ironically, with tobacco money.
New York Attorney General Eliot Spitzer's office dismisses Uvezian as a dangerous renegade intent on undoing the "spectacular results" of the 1998 settlement. Spitzer's deputy counsel Avi Schick says the settlement is directly responsible for a 17% decline in cigarette consumption since 1997. He rejects Uvezian's charge that Big Tobacco has profited from the tort case and calls the Duke University study so flawed "as to be worthless." Regardless, Schick says, the higher prices and lower sales "directly translates into tens of thousands of longer, better and healthier lives."
"It is very common for vice to masquerade as virtue," Uvezian retorts. He stole that line from U.S. Judge Dennis Jacobs of the Second Circuit Court of Appeals in NewYork, who made the observation in a hearing related to Uvezian's case earlier this month. A second zinger came after a deputy attorney general for New York declared that to believe the states had sold out to Big Tobacco, you would have to assume that 46 attorneys general are liars.
"That's tempting," Judge Guido Calabresi shot back. "It may be that when the states were offered a stake in a monopoly, they took it."
In getting the four cigarette titans to agree to pay the states princely sums, which would require price increases, the states agreed to help the big brands avoid getting undersold by discounters. They did so by requiring even new off-price brands to pay roughly the same level of fees (now about 40 cents a pack). The states were disarmingly transparent about their intent: to "fully neutralize" the competitive advantage of the discounters, the settlement says.
The settlement took hold in November 1998, and the giants instantly raised prices by 45 cents a pack--this at a time when Marlboros retailed for about two bucks a pack. That was enough to cover payments to the states and then some, but the big brands continued with a spree of price hikes--up 18 cents a pack the next year, then up 19 cents the year after that.
The incessant price hikes created an opening for discounters, who spotted and then exploited a loophole in the fee rules. The settlement let them get refunds from states where they didn't do business, so a newcomer who sold cigarettes only in, say, Virginia would get back 98% of the state-imposed fees. And so a flood of new cut-rate brands popped up, including a handful of upstarts from Jeffrey Uvezian. The son of a well-known cigarmaker, he previously was running a cigar factory in the Dominican Republic and had begun importing cheap smokes from Armenia, his ancestral homeland.
Discounters sold less than 1% of the cigarettes in the U.S. in 1997, garnering a tiny share of the $49 billion smokers spent. The discounters hiked their take to 8% in 2003 and cost the states a cumulative $600 million in payments they otherwise would have received. William Sorrell, attorney general for Vermont, who was overseeing the settlement, urged state legislators to close the loophole by passing a new law to eliminate any refunds. In a confidential memo to fellow attorneys general, he noted that all states have an interest in reducing the sales of discount brands.
So far 39 states have passed this measure, requiring all discounters to pay the full fees even if they operate in only a few states. After Indiana passed the law, Uvezian was forced to hike his prices by 50%. His monthly sales in the state dropped from 20,000 packs to 11,600. Four months later he abandoned the state altogether. In August the nation's biggest discounter, General Tobacco, capitulated and joined in the settlement, agreeing to pay $1.7 billion to the states over the next ten years even though it had no part in the cancer coverup.
Uvezian hired a venerable antitrust lawyer, David Dobbins, 76, and in early 2002 sued in federal court to overturn the new law in NewYork State and derail the settlement itself. Dobbins says that in 50 years as a lawyer he had never seen a cartel so brazen: "If you're an experienced antitrust lawyer, this case just blows your mind."
Dobbins previously had sued to challenge the settlement, representing two tiny wholesalers in a federal lawsuit against the big brands filed in western Pennsylvania. The case was thrown out. Then the Third Circuit Court of Appeals in Philadelphia took on the matter.In June 2001 it declared that while "it is clear" the accord "empowers the tobacco companies to make anticompetitive decisions with no regulatory oversight by the states," the settlement was immune from antitrust laws.
Dobbins and his new client, Uvezian, similarly lost the first round in their case in early 2002, when a federal District Court judge in New York rejected it. They filed an appeal to the Second Circuit in New York, argued the case in August 2002--and won a surprising ruling in their favor in January 2004. The decision let Uvezian pursue his lawsuit on antitrust grounds, returning the case to federal trial court in New York.
Then last October the trial judge issued a split decision:He sided with Uvezian and enjoined the New York State law that eliminated the discounter refunds. "The state has failed to elicit any justification whatsoever for its passage," the judge said. The refund ruling was a landmark, the first settlement-related rule ever to be knocked down by a court.
Related challenges are under way in Kentucky, Tennessee and Idaho, filed by other cheapie-cig sellers. So far an Oklahoma judge has sided with the challengers while a Louisiana judge went with the states.
Spitzer's deputy warned that the ruling "will flood New York with cheap cigarettes." Dobbins responds that New York is perfectly free to levy a straightforward excise tax on all cigarette makers--it just can't get away with participating in a cartel.
But the judge refused to touch any of the settlement's other protections. So now Uvezian and his lawyer are back at the Second Circuit Court of Appeals, imploring a panel of judges to go even further and declare the deal a violation of federal antitrust law. The appeals judges bombarded Dobbins with procedural challenges in the hearing earlier this month, but also showed deep concern about what Dobbins says the $200 billion state settlement has wrought--a cozy oligopoly protected by state governments eager for tobacco cash.
