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From Products Liability Law Daily, April 10, 2015

Tobacco MSA panel wrongfully deducted over $127M from Pennsylvania’s settlement funds

By Pamela C. Maloney, J.D.

The arbitration panel administering the 1998 Master Settlement Agreement between 52 settling states and the participating tobacco manufacturers (PMs) exceeded its authority in fashioning settlement awards that reduced the funds authorized for the Commonwealth of Pennsylvania by more than $125 million dollars, the Commonwealth Court of Pennsylvania ruled, affirming the trial court’s modification of that panel’s award based on its interpretation of the MSA”s express terms (Commonwealth of Pennsylvania v. Philip Morris USA, Inc., April 10, 2015, Simpson, R.).

Background. Pursuant to the terms of the 1998 MSA, PMs agreed to make annual payments—through an independent auditor—to the Settling States in perpetuity in a base amount that totals billions of dollars every year in exchange for release from civil liability. The annual MSA payment is subject to a downward adjustment, known as the NPM Adjustment, if it is determined that PMs lost market share to nonparticipating manufacturers (NPMs) as a result of PMs’ compliance with the MSA. The NPM Adjustment is divided among all of the Settling States, according to each State’s allocable share, in each year where the NPM Adjustment applies, unless a state meets the diligence exception. Under the diligence exception, a Settling State could avoid the NPM Adjustment if, during the year at issue, they “diligently enforced” a “qualifying statute.” The MSA stipulates that the amount of the NPM Adjustment that would have applied to that diligent Settling State’s Allocated Payment was to be “reallocated among all [non-diligent] Settling States pro rata in proportion to their respective Allocable Shares.”

When an impasse arose over the NPM Adjustment for 2003 and subsequent years, PMs requested arbitration of the dispute. The arbitration panel initially determined that each Settling State that contested the NPM Adjustment had the burden of proving that it diligently enforced its qualifying state at an evidentiary hearing, rejecting the Settling State’s contention that diligence should be presumed. During arbitration, PMs and 22 of the Settling States entered into a term sheet agreement; of those 22 states, PMs contested the diligence of 20 states. The panel ultimately resolved the dispute by determining that the Term Sheet States were not subject to the 2003 NPM Adjustment, removing them from the reallocation pool, which consequently reduced the size of that pool. The panel also applied a pro rata reduction under which the dollar amount of the 2003 NPM adjustment was to be reduced by a percentage equal to the aggregate allocable share of the Term Sheet States (i.e., 46%). The arbitration panel then determined the diligence of the remaining 15 contested Non-Term Sheet States, finding that Pennsylvania and 5 other settling states were not diligent.

The Commonwealth filed a motion with the trial court to modify or vacate the Final Award and the Partial Award Settlement, arguing that the panel applied the wrong standard of review and contesting the panel’s determination that it had not been diligent in enforcing its qualifying statute. The trial court agreed and ordered that the Allocated Payment awarded by the arbitration panel to Pennsylvania for 2003 be modified to increase it from $127,498,097.35 (which reflected an NPR reduction of $242,309,663.54) to $253,350,570.16 (reflecting an NPM reduction of only $116,457,190.73). The modification to the award made by the trial court left a total amount payable to the commonwealth of $127,498,097.35. The PMs appealed this ruling.

Modification upheld. On appeal, the commonwealth court held that under any standard of review, the trial court properly modified the Partial Award Settlement. According to the court, the MSA expressly created two categories for Settling States with regard to the NPM Adjustment: states that were diligent and those that were not. If a state was not diligent, they bore both the allocable share of the NPM adjustment and their proportional share of the aggregate NPM adjustment reallocated from those states found to be diligent. Because the MSA did not address the effect of a partial settlement on the reallocation, the panel construed it as ambiguous, deciding that the Term Sheet States were diligent without requiring proof thereof and applying a pro rata reduction methodology adapted from outside the confines of the MSA to the reallocation of the NPR adjustment. In so doing, the panel far exceeded the scope of its authority as provided by the MSA, the court ruled.

First, in determining that the Term Sheet States were diligent, the panel created a new term as to when a Settling State would not be responsible for its NPM adjustment, i.e., when it settles its diligence contest without having to prove that it had met the diligence requirements established by the clear terms of the MSA. Relief from the NPM adjustment depended on a determination of diligence and, in the absence of such a determination, no relief was available to any state under the MSA. Because PMs had challenged the diligence of 20 of the Term Sheet States, the panel’s decision to treat all the Term Sheet States as diligent exceeded the powers granted to it under the MSA.

Secondly, by applying the pro rata reduction of the reallocation amount, the panel supplied its own formula for reallocation borrowed from an external source. The pro rata methodology was premised on the doctrine of joint and several liability allowing a joint tortfeasor to sue nonpaying tortfeasors for contribution if it paid more than its proportionate share of a verdict. According to the court, the MSA used the term “pro rata” to distribute reallocated portions of the NPM adjustment in accordance with a set rate among all states that were not found diligent. The language used in the MSA did not excuse any state from the reallocation pool; it applied to all states unless those states were diligent. By applying its own methodology borrowed from judgment reduction methodologies outside the MSA, the panel fashioned its own formula, again exceeding the scope of its authority.

The panel’s Partial Award was also irrational in that it removed the Term Sheet States from the pool of states available to bear the reallocated NPR adjustment amounts, which, in turn, caused the Non-Term Sheet States found to be non-diligent, including Pennsylvania, to pay more than they agreed to pay under the MSA. This determination again contradicted the express terms of the MSA that all states must bear the NPM adjustment unless they provided that they were diligent. The court admonished that even though the panel had jurisdiction over the dispute, it was not authorized to disregard MSA language or to fashion a new remedy based on its own notions of economic justice.

Reiterating that the trial court’s modification took into consideration the express terms of the MSA and was rationally derived from the MSA, it was affirmed.

The case is No. 803 C.D. 2014.

Attorneys: Kathleen G. Kane, Attorney General of the Commonwealth of Pennsylvania for Commonwealth of Pennsylvania. Peter John Biersteker (Jones Day), Tara Beth Dickerman (Obermayer Rebmann Maxwell & Hippel, LLP), and Elizabeth B. McCallum (Baker & Hostetler LLP) for R.J. Reynolds Tobacco Co., Philip Morris USA, Inc., Liggett Group LLC, and Lorillard Tobacco Co.

Companies: R.J. Reynolds Tobacco Co.; Philip Morris USA, Inc.; Liggett Group LLC; Lorillard Tobacco Co.

MainStory: TopStory DamagesNews TobaccoProductsNews PennsylvaniaNews

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