DALLAS — A dispute over whether states have appropriately enforced terms of 1998 Master Settlement Agreement with tobacco manufacturers could reduce by as much as $1.1 billion to $4.9 billion an April 15 payment to states. The payment initially was to be $6 billion.
The Boston-based Brattle Group, which was retained under an agreement between the 46 attorneys general and major tobacco companies, is expected to deliver a determination in the dispute arising from market share losses that large tobacco manufacturers claim stem from limitations imposed by the MSA.
Some tobacco bond analysts say that if a final determination is reached that favors the major tobacco companies — and they choose to withhold part of their payments or put that amount into escrow funds pending a final determination — the impact on tobacco bonds could be severe.
MSA payments made by the major companies account for 94% of all MSA payments, which back more than $25 billion of outstanding tobacco settlement revenue bonds sold by issuers in 20 states. A hit of $1 billion could impair states’ abilities to repay turbo bonds, and some states might even be forced to delve into reserve funds to meet debt service obligations, said analysts.
Philip Morris USA, Lorillard Tobacco Co., and R. J. Reynolds Tobacco Co. are disputing payments made to states for cigarette shipments made in 2003. Under the terms of the MSA, if companies that signed the agreement lose more than 2% per year of market share to companies that did not participate in the MSA — known as non-participating manufacturers, or NPMs — the major companies can reduce their payment by three times the amount of the market share loss. Because the market share loss for 2003 is 6.2%, MSA payments could be reduced by as much as 18.6%.
Eleven of the 43 small tobacco companies that have signed on to the MSA invoked the NPM clause for payments made in 2003 and 2004. In doing so, they deducted money from their overall payments made last year or placed money in a disputed holdings account. The amount withheld, however, was only $84.2 million, not enough to affect tobacco bonds.
A three-part test to determine whether a payment dispute is successful requires the companies to prove that market share lost to NPMs is more than 2%, that the share was lost specifically because of the company’s participation in the MSA, and that states have failed to diligently enforce statutes that require NPMs to pay into state-overseen escrow funds for 25 years. Those escrow funds would be tapped to pay settlements if any NPM is sued during that timeframe.
The Brattle Group recently released to attorneys general a preliminary finding that the tobacco companies did in fact lose market share because of their participation in the MSA.
However, a source close to the process said that attorneys general have written a memo to tobacco companies promising to work with them to find a resolution to their issues about their market share loss.
Sources have said the states are willing to discuss matters with the participating manufacturers in an effort to resolve the issue.
Attorneys general from several states have confirmed that such a finding exists. However, they say that the finding is not a final determination and that all parties are working toward a resolution that is favorable to states.
“This is the first stage of a long process,” said Michael Pumley, an assistant attorney general in Kentucky, adding that states will have the opportunity to prove that they are in fact adequately enforcing their escrow statutes.
North Dakota solicitor general Doug Bahr reiterated that the dispute process in not complete.
“Both parties have the opportunity to respond,” he said. “The finding in question was a preliminary decision. If there is a final decision in favor of the tobacco manufacturers, only they know what they will do. Reducing their payments is not their only option.”
Ron Fielding, a senior vice president with OppenheimerFunds Inc. who oversees its municipal bond fund group and an early investor in tobacco bonds, says that the test that would determine whether a payment dispute is successful is complicated because all of the determining factors have to be met.
“The participating manufacturers have to prove that they have collectively lost market share of more than 2% — they’ve done that, there’s no dispute there,” he said. “They have to prove that the MSA has been a contributing factor in their market share loss — allegedly, that’s what the Brattle Group has said.”
Fielding said that the final question appears to be whether states have diligently enforced their escrow statutes.
“That’s the tough one — there is no definition for diligent enforcement,” he said.
However, he added that states would want to diligently enforce escrow statutes, because the more market share loss is experienced by the companies that signed on to the MSA, the less money states will receive.
“There could be some ineptitude involving states’ ability to enforce the statutes, but certainly they want to enforce the statutes as diligently as the companies want them to,” Fielding said.
Dick Larkin, a municipal analyst with J.B. Hanauer & Co., said that if in fact a final determination is favorable to tobacco companies, those companies could decide to either withhold the total amount of $1.1 billion from the April 15 payment or place it in a dispute fund. States would receive the balance of the payment.
“I strongly believe that it will not just be a one time adjustment for 2003,” he said, adding that companies that signed on to the MSA have also had market share losses in 2004 and 2005.
