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VIBO CORPORATION, INC., PLAINTIFF, v. JACK CONWAY, ET AL., DEFENDANTS.

CIVIL ACTION NO. 08-571-C

UNITED STATES DISTRICT COURT FOR THE WESTERN DISTRICT OF KENTUCKY, LOUISVILLE DIVISION

594 F. Supp. 2d 758; 2009 U.S. Dist. LEXIS 220; 2009-1 Trade Cas. (CCH) P76,462

January 5, 2009, Decided

In the mid-1990s a number of states sued the four largest tobacco manufacturers in the United  States. [**11] 3 The states' claims "centered on allegations that the manufacturers targeted youth in their advertising; knew of, controlled, and failed to disclose research into harmful effects of cigarette smoke; and knew nicotine in cigarettes was addictive and marketed their cigarettes with those addictive properties in mind." Am. Compl.P105. In 1998, the parties resolved the litigation and signed the Master settlement agreement ("MSA").

3  These companies were Philip Morris, Inc. ("Philip Morris"), R.J. Reynolds Tobacco Co. ("Reynolds"), Brown & Williamson Tobacco Corp. ("B&W"), and Lorillard Tobacco Co. ("Lorillard."). Reynolds subsequently acquired B&W. Am. Compl. P 3 n.3.

The MSA originally was negotiated by eight states' Attorneys General and then was released to other states so that they might decide whether they wished to join [*768]  it. Id. PP 109, 110. Additional states took action to enjoy the benefits of the MSA, and a total of fifty-two states and territories, through their Attorneys General, eventually signed on to the MSA. These states are collectively known as the "Settling States." 4 Kentucky, like other Settling States without a case already pending against the tobacco manufacturers, instigated [**12] litigation and then settled it by asking a state court to enter an agreed order approving the MSA and dismissing with prejudice the state's claims. Id. P 119. According to the terms of the MSA, in return for a tobacco manufacturer's agreement to the terms of the MSA, which included making substantial payments to the Settling States, a state agreed to release the company from all claims arising out of certain past and future conduct relating to its tobacco manufacturing business. See MSA § II(nn) (defining "released claims" and listing all types of conduct for which a manufacturer was released from liability). 5 Those manufacturers agreeing to the MSA are known as "Participating Manufacturers" ("PMs"). The four tobacco companies that were sued in the initial lawsuits and with which the states reached the initial settlement are known as the Original Participating Manufacturers ("OPMs"). Those that joined the MSA later are known as Subsequent Participating Manufacturers ("SPMs").

4  The Settling States include 46 states (all states except Florida, Minnesota, Mississippi, and Texas), five territories (American Samoa, Guam, Northern Mariana Islands, Puerto Rico, and the Virgin Islands), and  [**13] the District of Columbia.

5  The Master settlement agreement was attached as Exhibit A to the plaintiff's amended complaint. It is also available on the website of the National Association of Attorneys General (NAAG) at http://www.naag.org/backpages/naag/tobacco/MSA/MSA-pdf/1109185724_103246 8605_cigMSA.pdf.

The OPMs feared that by signing the MSA, and thus incurring significant costs that would require an accompanying price increase of their products, they would be creating a significant market opportunity for tobacco manufacturers that did not sign the MSA. Am. Compl. P 127. That is, the OPMs anticipated that those companies who did not sign (known as Non-Participating Manufacturers, or "NPMs") and thus had no payment obligations would be able to price their products below the OPMs' market price, thereby taking sales away from the OPMs. Id. In order to address these concerns and encourage participation in the MSA by tobacco companies other than the OPMs, the Settling States agreed to several provisions of the MSA. Id. It is these aspects of the MSA that give rise to the instant plaintiff's claims.

First, the Settling States agreed to release claims not only against the PMs but also against [**14] tobacco retailers, suppliers, and distributors to the extent of their dealings in the PMs' products. See MSA § II(oo) (defining "released parties" to include suppliers, retailers, and distributors of the PMs' products). This provision encouraged sellers of tobacco products to carry only products made by PMs. See Am. Compl. P 128.

Second, to ensure that those companies not participating in the MSA have financial obligations to the states similar to those of the companies that are participating, the MSA includes a mechanism designed to equalize the potential profits of PMs and NPMs. The MSA provides that the states may enact "Escrow Statutes" or "Qualifying Statutes." See MSA § IX(d)(2). In general terms, the Escrow Statute of a state obligates the tobacco companies that do not sign the MSA (NPMs) to make [*769]  annual deposits into an escrow account, based on their sales volume in the state. See id. The principal amounts are held in escrow for twenty-five succeeding years and, if there is no judgment against or settlement with a particular NPM on certain kinds of claims, the amounts remaining in escrow are to be returned to that NPM. See Am. Compl. P 143; see also Am. Compl., Exhibit A, MSA, [**15] Exhibit T, Model Statute. However, as originally enacted, the Escrow Statutes allowed an NPM to obtain a refund of the amount paid into escrow, to the extent that the amount paid to a state by the NPM exceeded the amount it would have paid that state under the MSA. 6 Am. Compl. P 146. This characteristic of the statutory scheme made it possible for an NPM to operate profitably by concentrating its business in only a few states. Id. States, including Kentucky, have enacted amendments to their Escrow Statutes in order to address this situation. Id. P 147; see, e.g., KRS § 131.604 et seq.

6  The defendant Attorney General of Kentucky has provided the following explanation for how the mechanism worked:

Every Participating Manufacturer makes a single annual settlement payment based on its total shipments or sales of cigarettes in the United  States during the previous year. That payment is allocated among Settling States according to percentages for each State ("Allocable Share"), which Allocable Share bears no relationship to the PM's actual sales in the State. The original Escrow Statutes, however, allowed each NPM to obtain an immediate release of any excess (a) of its annual escrow deposit [**16] for sales in a State over (b) what would have been the State's Allocable Share of the hypothetical MSA payment the NPM would have made for those sales had it been an SPM. This could effectively eliminate an NPM's escrow obligation. For example, an NPM that made 50 percent of its cigarette sales in Kentucky could obtain a release of the difference between (a) an escrow deposit based on 50 percent of its sales and (b) Kentucky's Allocable Share of 1.7611586% of the NPM's total sales, which difference would result in a release of about 96.5 percent of the NPM's escrow deposit in Kentucky.

DE 149, p. 7 n.9.

Another such provision is the "back-payment" requirement. Pursuant to the terms of the MSA, every participating manufacturer upon signing the MSA must make any payment "that it would have been obligated to make in the intervening period had it been a signatory as of the MSA Execution Date." MSA § II(jj). The PMs signing the MSA as of its execution date were obligated to make annual settlement payments based on their nationwide sales beginning in 1999, with payments coming due each year. Id. § IX(I). The back-payment provision creates a disincentive for a tobacco manufacturer to delay [**17] signing the MSA while building a market share, as it will, upon signing, become liable under the MSA for any sales made since 1999.

As a part of the goal of encouraging smaller tobacco companies not sued in the original lawsuit to join the agreement, the MSA was structured to give NPMs the opportunity to join the MSA with a reduced payment obligation. Per the terms of the MSA, any SPM that joined the MSA within ninety days of its initial execution was not obligated to make payments to the extent that its market share in a particular year is less than its 1998 market share (or 125% of its 1997 market share, if that is higher). See MSA § IX(I). If the SPM's sales exceed this "grandfathered share," then it incurs payment obligations that are the same as other PMs, calculated on a per-unit basis for all cigarettes sold above the floor amount of its grandfathered share. Id. The plaintiff terms those SPMs that joined within ninety days the "grandfathered SPMs."