Commonwealth v. Philip Morris USA, Inc.

• Decision Date: 10 April 2015
• Docket Number: No. 804 C.D. 2014,No. 803 C.D. 2014 ,803 C.D. 2014
• Citation: 114 A.3d 37
• Parties: COMMONWEALTH of Pennsylvania by Kathleen G. KANE, in her official Capacity as Attorney General of the Commonwealth of Pennsylvania v. PHILIP MORRIS USA, INC., R.J. Reynolds Tobacco Company, Lorillard Tobacco Company, Liggett Group LLC, Commonwealth Brands, Inc., Daughters and Ryan, Inc., Farmer's Tobacco Company of Cynthiana, Inc., House of Prince A/S, Sherman 1400 Broadway N.Y.C. Inc., King Maker Marketing, Inc., Top Tobacco, L.P., Japan Tobacco International U.S.A., Inc., Kretek International, Inc., Peter Stokkebye Tobaksfabrik A/S, P.T. Djarum, Santa Fe Natural Tobacco Company, Inc., Von Eicken Group. Appeal of: R.J. Reynolds Tobacco Company, Philip Morris USA, Inc. and Lorillard Tobacco Company. Commonwealth of Pennsylvania by Kathleen G. Kane, in her official Capacity as Attorney General of the Commonwealth of Pennsylvania v. Philip Morris USA, Inc., R.J. Reynolds Tobacco Company, Lorillard Tobacco Company, Liggett Group Inc., Commonwealth Brands, Inc., Daughters and Ryan, Inc., Farmers Tobacco Company of Cynthiana, Inc., House of Prince A/S, Sherman 1400 Broadway N.Y.C. Inc., King Maker Marketing, Inc., Top Tobacco, L.P., Japan Tobacco International U.S.A., Inc., Kretek International, Inc., Peter Stokkebye Tobaksfabrik A/S, P.T. Djarum, Santa Fe Natural Tobacco Company, Inc., Von Eicken Group. Appeal of: Commonwealth Brands, Inc., Daughters and Ryan, Inc., House of Prince A/S, Liggett Group Inc., Sherman 1400 Broadway N.Y.C. Inc., King Maker Marketing, Inc., Top Tobacco, L.P., Japan Tobacco International U.S.A., Inc., Kretek International, Inc., Peter Stokkebye Tobaksfabrik A/S, P.T. Djarum, Santa Fe Natural Tobacco Company, Inc., Von Eicken Group, and Farmers Tobacco Company of Cynthiana, Inc.
• Court: Pennsylvania Commonwealth Court

114 A.3d 37

COMMONWEALTH of Pennsylvania by Kathleen G. KANE, in her official Capacity as Attorney General of the Commonwealth of Pennsylvania

v.PHILIP MORRIS USA, INC., R.J. Reynolds Tobacco Company, Lorillard Tobacco Company, Liggett Group LLC, Commonwealth Brands, Inc., Daughters and Ryan, Inc., Farmer's Tobacco Company of Cynthiana, Inc., House of Prince A/S, Sherman 1400 Broadway N.Y.C. Inc., King Maker Marketing, Inc., Top Tobacco, L.P., Japan Tobacco International U.S.A., Inc., Kretek International, Inc., Peter Stokkebye Tobaksfabrik A/S, P.T. Djarum, Santa Fe Natural Tobacco Company, Inc., Von Eicken Group.

Appeal of: R.J. Reynolds Tobacco Company, Philip Morris USA, Inc. and Lorillard Tobacco Company.

Commonwealth of Pennsylvania by Kathleen G. Kane, in her official Capacity as Attorney General of the Commonwealth of Pennsylvania

v.Philip Morris USA, Inc., R.J. Reynolds Tobacco Company, Lorillard Tobacco Company, Liggett Group Inc., Commonwealth Brands, Inc., Daughters and Ryan, Inc., Farmers Tobacco Company of Cynthiana, Inc., House of Prince A/S, Sherman 1400 Broadway N.Y.C. Inc., King Maker Marketing, Inc., Top Tobacco, L.P., Japan Tobacco International U.S.A., Inc., Kretek International, Inc., Peter Stokkebye Tobaksfabrik A/S, P.T. Djarum, Santa Fe Natural Tobacco Company, Inc., Von Eicken Group.

Appeal of: Commonwealth Brands, Inc., Daughters and Ryan, Inc., House of Prince A/S, Liggett Group Inc., Sherman 1400 Broadway N.Y.C. Inc., King Maker Marketing, Inc., Top Tobacco, L.P., Japan Tobacco International U.S.A., Inc., Kretek International, Inc., Peter Stokkebye Tobaksfabrik A/S, P.T. Djarum, Santa Fe Natural Tobacco Company, Inc., Von Eicken Group, and Farmers Tobacco Company of Cynthiana, Inc.

No. 803 C.D. 2014

No. 804 C.D. 2014

Commonwealth Court of Pennsylvania.

Argued Feb. 11, 2015.

Decided April 10, 2015.

Peter J. Biersteker, Washington, DC, Robert J. Brookhiser, Washington, DC, Elizabeth B. McCallum, Washington, DC, and J. Kurt Straub, Philadelphia, for appellants.

Jonathan P. Guy and Robert Loeb, Washington, DC, and Joel M. Ressler, Chief Deputy Attorney General, Harrisburg, for appellee.

BEFORE: DAN PELLEGRINI, President Judge, ROBERT SIMPSON, Judge, MARY HANNAH LEAVITT, Judge, P. KEVIN BROBSON, Judge, and ANNE E. COVEY, Judge.

OPINION BY Judge ROBERT SIMPSON.

In this appeal, Appellants, who are the participating tobacco manufacturers (PMs)¹ to the 1998 Master Settlement Agreement (MSA), ask whether the Court of Common Pleas of Philadelphia County²(trial court) erred by modifying an arbitration panel's award.PMs assert the trial court: applied the wrong standard of review; exceeded the strict limits on its authority under any standard of review; and, improperly interfered with the panel's rational contract interpretation.We affirm.

I.Background

A. MSA

In 1998, 52 states and territories (Settling States), including Pennsylvania, entered the MSA with PMs.The MSA settled litigation against the tobacco industry for recovery of the Settling States' tobacco-related health-care costs.The tobacco manufacturers that did not participate in the MSA are known as nonparticipating manufacturers (NPMs).

1.MSA Payment

Pursuant to the MSA, PMs agreed, among other things, to make annual payments to the Settling States in perpetuity in a base amount that totals billions of dollars every year in exchange for release from civil liability.PMs do not make the payments directly to the Settling States; rather, PMs make a single, aggregate payment (MSA Payment) to an independent auditor in an amount calculated and determined by the auditor.The auditor then allocates the MSA Payment among the Settling States by making a single, annual payment (Allocated Payment) in an amount based on the States' pre-set “allocable share” percentage.Pennsylvania's allocable share of every MSA Payment is 5.75%.The MSA Payment for 2003 is approximately $6.435 billion; Pennsylvania's Allocated Payment is approximately $370 million.

2.NPM Adjustment

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 the 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.Section IX(d)(1) of the MSA.The NPM Adjustment “shall apply to the Allocated Payments of all Settling States” unless the State meets the diligence exception.Section IX(d)(2)(A) of the MSA.A non-diligent State's potential NPM Adjustment is capped at the amount of its Allocated Payment.

3.Diligence Exception

The MSA provides an exception to the NPM Adjustment.Specifically, Settling States may avoid the NPM Adjustment if, during the year at issue, they“diligently enforced” a “qualifying statute,” which “effectively and fully neutralizes the cost disadvantages that [PMs] experience vis-à-vis [NPMs] within such Settling State as a result of the provisions of [the MSA].”Sections IX(d)(2)(B), (E) of the MSA.Settling States are not required to enact or diligently enforce a qualifying statute, but if they want the benefit of the “diligence exception,”they must do both.The exception gives states an incentive to protect the market dominance of PMs, because otherwise the states will receive fewer funds.If the Settling State satisfies the diligence exception requirement, its Allocated Payment is not subject to reduction.

The trial court and some of the parties refer to application of the diligence exception to the NPM Adjustment as the “first tier” adjustment.The final arbitration awards primarily addressed the diligence exception.

4.Reallocation Provision

Under the diligence exception, a diligent Settling State is spared an NPM Adjustment to its Allocated Payment.However, under the MSA's Reallocation Provision, the amount of the NPM Adjustment that would have otherwise applied to that diligent Settling State's Allocated Payment is “reallocated among all [non-diligent] Settling States pro rata in proportion to their respective Allocable Shares....”Section IX(d)(2)(C) of the MSA.

Generally, as the number of diligent states increase, the burden on non-diligent states increases.This is because an increase in the number of diligent states means that there is more adjustment reallocated among a smaller group.

The trial court and some of the parties refer to the application of the Reallocation Provision as the “second tier” of the NPM Adjustment.The Reallocation Provision is central to the preliminary Partial Settlement Award discussed below.It is also crucial to the current appeal.

B. 2003 NPM Adjustment Dispute and Arbitration

1.Dispute

Despite the enactment of qualifying statutes by all Settling States, PMs experienced market share loss to NPMs attributable to their compliance with the MSA.The NPM Adjustments for 1999–2002 were resolved by settlement as to all Settling States, but the NPM Adjustment for 2003(and subsequent years) was not.PMs requested that the auditor apply the total 2003 NPM Adjustment of $1,147,566,064.87 as a credit against their MSA Payment.The Settling States opposed the request and asked that the auditor presume diligent enforcement determinations for the Settling States.The auditor did not apply the NPM Adjustment because the Settling States' diligent enforcement was not yet determined.

2.Road to Arbitration

Given the impasse, PMs requested arbitration of the dispute pursuant to the MSA, which provides:

Any dispute, controversy or claim arising out of or relating to calculations performed by, or any determinations made by, the Independent Auditor (including without limitation, any dispute concerning ... application of any of the adjustments) ... shall be submitted to binding arbitration before a panel of three neutral arbitrators, each of whom shall be a former Article III federal judge.Each of the two sides to the dispute shall select one arbitrator.The two arbitrators so selected shall select the third arbitrator. ...

Section XI(c) of the MSA.The last clause provides: “The arbitration shall be governed by the United States Arbitration Act.”Id.

Pennsylvania and other Settling States refused to submit their disputes to arbitration and instead sought relief in their respective state courts.For instance, Pennsylvania filed a motion in the trial court seeking a declaration that it diligently enforced its qualifying statute in 2003 and that the auditor properly determined the 2003 NPM Adjustment should not be applied.In response, PMs filed a motion to compel arbitration, which the trial court granted.

3.Agreement Regarding Arbitration

The courts of every Settling State, but Montana, similarly ordered arbitration of the 2003 NPM Adjustment dispute.The parties then entered an Agreement Regarding Arbitration.The parties formed a panel to arbitrate the dispute, which consisted of three retired federal judges: the Honorable Abner J. Mikva(selected by the Settling States); the Honorable William G. Bassler(selected by PMs), and the Honorable Fern M. Smith(selected by the other two panel members).

The panel ruled on various threshold issues and set the ground rules for arbitration.Significantly, the panel determined each contested Settling State would bear the burden of proving it diligently enforced its qualifying statute at an evidentiary hearing.The panel rejected the Settling States' contention that they should be presumed diligent.The panel set a deadline of November 3, 2011, for PMs to contest the diligence of the States and a deadline of December 5, 2011, for the States to contest the diligence of other States.If any Settling State's diligence was not contested by any party after the conclusion of discovery and deadlines set to contest the issue, the State would be deemed to have diligently enforced its qualifying statute.

Initially, PMs challenged the diligence of every Settling State.But, after discovery, PMs contested the...