DALLAS — A South Dakota district court has ruled that the state’s attorney general must submit to binding arbitration, rather than litigation, to resolve a dispute with tobacco companies over reduced 2006 payments made to states under the terms of the 1998 Master Settlement Agreement.
The South Dakota ruling last Friday is the 15th 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.
As of Thursday, courts in New Hampshire, Kentucky, Massachusetts, Idaho, Vermont, Colorado, Hawaii, Nevada, Illinois, Virginia, Iowa, Oregon, California, and Nebraska have issued similar opinions, handing down rulings in favor of tobacco companies rather than their own attorneys general.
So far, only one — North Dakota Attorney General Wayne Stenehjem — has won a ruling in favor of litigation to resolve the payment disputes.
Tobacco companies have appealed the North Dakota decision, and a handful of attorneys general are mulling their own appeal options as well.
Additionally, appellate courts in New York and Connecticut have directed binding arbitration in cases filed last year by attorneys general in those states.
Annual payments to states made under the terms of the MSA back more than $30 billion of tax-exempt municipal bonds sold by issuers in 17 states.
Under the terms of the MSA, tobacco companies will compensate the 46 participating states and six territories for the cost of caring for sick smokers. The agreement mandates that the companies — led by original participating manufacturers, or OPMs, Philip Morris USA, R.J. Reynolds Tobacco Co., and Lorillard Tobacco Co. — will make perpetual payments to the states, with the tally over the first 25 years pegged at approximately $205 billion.
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. However, states and tobacco companies acknowledge that the escrow accounts are actually in place to ensure that NPMs have at least the same cost of doing business as participating manufacturers.
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, 2006. Most of that money was placed into a dispute account pending a resolution about whether the states have adequately enforced the escrow statutes, though several small tobacco companies opted to withhold their payments altogether.
Philip Morris, while asking for an NPM reduction this year, made its payment, which helped several muni issuers avoid tapping debt service reserves to meet interest and principal payments this year, tobacco bond analysts said. Had Philip Morris also placed its payment into a dispute account, the MSA payment would have been reduced by a total of $1.2 billion.
Analysts predicted that such a reduction of revenue to states expecting those payments would have spurred several tobacco bond issuers to dip into reserves to meet debt service obligations this year. Among the issuers that analysts predicted might have difficulty meeting interest and principal payments should the entire NPM adjustment have been taken were Rhode Island’s Tobacco Settlement Financing Corp., the California County Tobacco Securitization Agency for its issue on behalf of the Sonoma County Securitization Corp., and the Puerto Rico Children’s Trust Fund.
The MSA allows participating cigarette makers to reduce annual payments if they lose market share to non-participating manufacturers by more than 2% per year, and if that loss was caused by the companies’ participation in the MSA.
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 the model statutes. Attorneys general hope to resolve that issue through litigation, while tobacco companies contend the MSA mandates binding arbitration.
If all states were found to have diligently enforced the model statutes, the $800 million of disputed payments would be distributed to among them. 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.
In addition, a number of tobacco companies — including all three OPMs — have stated that they plan to take NPM reductions when they make their 2007 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 that they have traded at 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.
Meanwhile, a Sept. 14 report from Merrill Lynch & Co. states that possible upgrades to the corporate ratings for tobacco companies are unlikely to result in similar upgrades for tobacco bond issuers.
“Tobacco industry upgrades would have no impact on MSA bonds because most were structured at BBB stress levels,” the report stated. “This leverage, in addition to NPM market share disputes and challenges to the MSA, constrain muni bond ratings.”
The report also warned that states that use tobacco bond proceeds to bolster pension funds could find their tobacco bond issues stripped of their tax-exempt status.
