DALLAS — A Connecticut appellate court will formally release a ruling next Tuesday that requires the state to submit to binding arbitration to resolve a dispute with tobacco companies over reduced 2006 payments made to states under the terms of the 1998 Master Settlement Agreement.
The ruling is the 14th handed down in favor of tobacco companies in a string of lawsuits filed this spring by 36 of the 46 attorneys general whose states signed on to the MSA. So far, only one attorney general — North Dakota Attorney General Wayne Stenehjem — has won a ruling in favor of litigation to resolve the payment disputes.
Tobacco companies are appealing the North Dakota decision.
In addition, the Connecticut decision affirms a lower court’s ruling handed down last year that states that arbitration, rather than litigation, is required under the language of the MSA.
Tobacco bond analysts say the push towards arbitration to resolve the payment disputes is not necessarily bad news for tobacco bonds.
“As we have stated previously, we don’t believe it is a negative for MSA backed bonds if diligent enforcement is determined via one nationwide arbitration panel,” stated a Bear, Stearns & Co. report released Aug. 29. “We believe that if a state could prove diligent enforcement in the court system they could also do it via an arbitration panel which according to the terms of the MSA is to be comprised of three former federal judges. Additionally, a single arbitration panel provides for one standard that could provide guidance for future periods.”
To date, courts in New Hampshire, Kentucky, Massachusetts, Idaho, Vermont, Colorado, Hawaii, Nevada, Illinois, Virginia, Iowa, Oregon, California, and Nebraska have ruled in favor of the tobacco companies.
“Certainly, this litigation is taking more time than moving straight to resolution,” said David Howard, a spokesman for R.J. Reynolds Tobacco Co. “We tried to resolve this matter with the attorneys general long before our payments were made, but those discussions were ultimately unsuccessful.”
Under the terms of the MSA, tobacco companies will compensate states for the cost of caring for sick smokers, a pay schedule that had been estimated at approximately $205 billion over the first 25 years of the settlement. In return, states must enforce statutes that require tobacco companies that did not sign the MSA — non-participating manufacturers, or NPMs — to make payments into escrow accounts that would ostensibly be tapped if any of those companies were sued in the future by sick smokers.
Attorneys general are protesting a decision by participating tobacco companies to withhold about $800 million from an anticipated $6.5 billion MSA payment on April 17. Those companies earlier this year announced their intention to withhold part of their 2007 payments as well.
Participating cigarette makers claim that the 1998 agreement gives them the right to lower their payments if they lose market share to non-participating manufacturers, or NPMs, by more than 2% per year. Most of the withheld monies were placed into so-called dispute accounts pending a determination that states have not diligently enforced model statutes that require NPMs to make payments into state-overseen escrow accounts.
The model statutes were written into the MSA to ensure that NPMs carried the same costs of doing business as the participating manufacturers.
Payments made under the terms of the agreement back nearly $30 billion of outstanding tobacco bonds issued by municipal issuers in more than 20 states.
So far, while an independent arbiter — the Boston-based Brattle Group — has ruled that participation in the MSA caused market share loss for participating manufacturers, no determination has been made about whether states have diligently enforced their model statutes.
If all states were found to have diligently enforced the model statutes, the $800 million of disputed payments would be distributed to states. However, that amount would be deducted from the payments of any states found to have not diligently enforced the statutes. In the case of some states, such a deduction could sap their entire 2006 payment.
If such a drastic reduction hit a state that has outstanding tobacco bonds, that issuer could be forced to tap debt service reserves to meet interest and principal payments.
Some analysts, however, believe that tobacco companies and states could ultimately opt to settle the NPM dispute rather than submitting to protracted arbitration or litigation. In 2003, tobacco companies won payment reductions in a settlement related to payments made from 1998 to 2002.
The tobacco bond sector appears to have taken the NPM dispute issues in stride. Tobacco bonds continue to trade, although not in large block sizes, in the low 5% yield range — the same levels, in fact, that they have traded for about a year.
In addition, the market has continued to absorb new and refunding tobacco settlement bonds, which analysts say indicates an appetite for the paper among investors.
