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States to Commence First Tobacco Arbitration

Peter Levin, Project Director and Chief Counsel, Tobacco Project

Early next year the signatory states to the tobacco Master Settlement Agreement (MSA) will commence the first MSA arbitration. Signatory states include all but Florida, Minnesota, Mississippi, and Texas, which settled separately with the tobacco companies. The arbitration will resolve with finality disputes over whether state MSA revenues will be lowered by a “Non-Participating Manufacturer Adjustment.” A Participating Manufacturer (PM) is a tobacco product manufacturer that has settled state claims over smoking-related costs by signing the MSA. A Non-Participating Manufacturer (NPM) is a tobacco product manufacturer that has not settled with the states. The NPM Adjustment can potentially reduce state MSA revenues (and corresponding PM settlement payments) for years in which PMs lose market share to NPMs because of the MSA.

The disputes to be arbitrated pertain to the NPM Adjustment for 2003, which potentially totals approximately $1.1 billion and which would, if applied, reduce MSA revenues that were due the states in 2004. However, the arbitration could resolve underlying legal issues and create precedents for disputes over potential NPM Adjustments for 2004-2008. These potential 2004-2008 NPM Adjustments total an additional $4.1 billion.

The arbitration will focus primarily, but not exclusively, on disputes over whether a particular prerequisite to the NPM Adjustment for 2003 has been satisfied. Specifically, if during a relevant year (2003 for purposes of this initial arbitration) a state had in full force and effect a “Qualifying Statute” and “diligently enforced” that Statute, its share of MSA revenues for that year would not be subject to an NPM Adjustment. A “Qualifying Statute” requires an NPM to escrow each year a specified sum for each of its cigarettes sold in a state during the preceding year. The escrowed sum is slightly less per cigarette than the sum the NPM would have paid per cigarette had it been an MSA signatory. For the first 25 years after the escrow deposit is made, the deposit can be released only to pay a judgment or settlement obtained by the state against the escrowing NPM. If there is no such judgment or settlement within 25 years, the deposit is released back to the NPM.

If a state had in full force and effect a “Qualifying Statute” and “diligently enforced” that Statute in a given year, the state’s share of the NPM Adjustment for that year would be reallocated to those states, if any, that did not meet one of these two requirements. Under this reallocation provision, a state that did not meet one of the two requirements could potentially lose its entire year’s MSA revenue. On the other hand, if all states were to meet both requirements for a given year, the PMs would receive no NPM Adjustment for that year.

Where a dispute is subject to MSA arbitration, the states and the PMs each select a neutral arbitrator, and the two arbitrators then select a third neutral arbitrator. All arbitrators must be former Article III federal judges. The states and the PMs have selected the Honorable Abner J. Mikva and the Honorable William G. Bassler, respectively, as arbitrators. Unless the selection of either Judge Mikva or Judge Bassler is successfully objected to, they will soon begin the process of selecting the third arbitrator. In the meantime, the states and the PMs are negotiating the procedures that will govern the arbitration. Where the arbitration will take place or how long it will last is not currently known.

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