Freedom Holdings Inc. v. Cuomo

Citation624 F.3d 38
Decision Date18 October 2010
Docket NumberDocket No. 09-0547-cv.
PartiesFREEDOM HOLDINGS, INC., International Tobacco Partners, Ltd., 1010 Northern Boulevard, Suite 208, Great Neck, NY 11021, on behalf of themselves and all others similarly situated, Plaintiffs-Appellants, v. Andrew M. CUOMO, in his official capacity as Attorney General of the State of New York, Robert L. Megna, in his official capacity as Commissioner of Taxation and Finance of the State of New York, Defendants-Appellees.
CourtUnited States Courts of Appeals. United States Court of Appeals (2nd Circuit)

OPINION TEXT STARTS HERE

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David F. Dobbins (Nicolas Commandeur, Mark G. Young, on the brief), Patterson Belknap Webb & Tyler LLP, New York, New York, for Plaintiffs-Appellants.

Sasha Samberg-Champion, Assistant Solicitor General (Barbara D. Underwood, Solicitor General; Benjamin N. Gutman, Deputy Solicitor General; Monica Wagner, Steven C. Wu, Assistant Solicitors General, on the brief), for Andrew M. Cuomo, Attorney General of the State of New York, for Defendants-Appellees.

Before: JOHN M. WALKER, JR., RAGGI, Circuit Judges, and RAKOFF, District Judge. *

REENA RAGGI, Circuit Judge:

Plaintiffs Freedom Holdings, Inc., and International Tobacco Partners, Ltd., are cigarette importers. They filed this putative class action in the United States District Court for the Southern District of New York (Alvin K. Hellerstein, Judge ) to enjoin the enforcement of New York statutes enacted in furtherance of a 1998 Master Settlement Agreement (“MSA”) between a number of tobacco companies and various government entities, including New York State. Plaintiffs contend that the laws at issue, N.Y. Pub. Health Law §§ 1399-nn-1399-pp (the “Escrow Statute), and N.Y. Tax Law §§ 480-b, 481, and 1846 (collectively, the “Contraband Statute), impermissibly (1) restrain trade in violation of section 1 of the Sherman Act, 15 U.S.C. § 1; and (2) regulate out-of-state commerce in violation of the Commerce Clause, U.S. Const. art. I, § 8, cl. 3. Plaintiffs now appeal from a judgment entered in favor of defendants on January 14, 2009, after a bench trial. For the reasons stated in this opinion, we affirm.

I. Background

Numerous prior opinions of this court and the district court detail the extensive background of this case. See Freedom Holdings, Inc. v. Spitzer (“ Freedom Holdings I ”), 357 F.3d 205 (2d Cir.2004); Freedom Holdings, Inc. v. Spitzer (“ Freedom Holdings II ”), 363 F.3d 149 (2d Cir.2004); Freedom Holdings, Inc. v. Spitzer (“ Freedom Holdings III ”), 447 F.Supp.2d 230 (S.D.N.Y.2004); Freedom Holdings, Inc. v. Spitzer (“ Freedom Holdings IV ”), No. 02 Civ. 2939, 2004 WL 2251668 (S.D.N.Y. Oct. 6, 2004); Freedom Holdings, Inc. v. Spitzer (“ Freedom Holdings V ”), 408 F.3d 112, 115 (2d Cir.2005); Freedom Holdings, Inc. v. Cuomo (“ Freedom Holdings VI ”), 592 F.Supp.2d 684 (S.D.N.Y.2009). We assume familiarity with these opinions and recite only the facts relevant to the decision reached today.

A. The Master Settlement Agreement

In November 1998, the nation's four dominant cigarette manufacturers-Philip Morris, Lorillard Tobacco, Brown & Williamson, and R.J. Reynolds 1 -settled pending litigation with forty-six states, 2 the District of Columbia, and five United States territories (collectively, “the states”) by entering into the MSA. In return for releases from liability, these manufacturers agreed to make substantial annual payments to compensate the states for health care expenses incurred in the past and expected to be incurred in the future as a result of their populations' smoking-related ailments. New York's approval of the MSA is reflected in State v. Philip Morris, Inc., 179 Misc.2d 435, 686 N.Y.S.2d 564 (1998), aff'd, 263 A.D.2d 400, 693 N.Y.S.2d 36 (1st Dep't 1999).

1. The MSA's Treatment of Cigarette Manufacturers

The MSA divides cigarette manufacturers into several groups. The first group consists of the four dominant manufacturers who initially executed the MSA. They are referred to as “original participating manufacturers,” or “OPMs.” The second group consists of more than fifty smaller manufacturers who joined the MSA after its initial execution. They are referred to as “subsequent participating manufacturers,” or “SPMs.” The SPMs are divided into two sub-groups: “grandfathered SPMs,” who joined the MSA within sixty days of the initial November 1998 execution date; 3 and “non-grandfathered SPMs,” who joined the MSA thereafter. A third group consists of manufacturers who have not joined the MSA. They are referred to as “non-participating manufacturers,” or “NPMs.” An NPM may become a non-grandfathered SPM at any time by signing the MSA and making prescribed payments.

2. Payment Obligations

The MSA specifies a total base payment to be made by all OPMs to the states each year. In 2009, the required base payment was $9 billion. The MSA allocates the annual base payment obligation among OPMs according to their relative market share of the total number of individual cigarettes shipped by the OPMs to the fifty states, the District of Columbia, and Puerto Rico during the preceding calendar year. The MSA then awards the base payment to the states based on prescribed allocable shares, which for New York is 12.76%.

SPMs make annual payments approximating payments made by OPMs. The advantage conferred on grandfathered SPMs for quickly joining in the MSA is that they are exempted from payments on either their 1998 market share, or 125% of their 1997 market share, whichever is greater. Thus, grandfathered SPMs pay an amount approximating the OPM payment only for each cigarette manufactured above the grandfathered threshold.

While the average per-cigarette cost of complying with the MSA is roughly equivalent among OPMs and SPMs above grandfathered thresholds, this court and the district court have observed that the SPM payment formula may, as an arithmetical matter, disproportionately increase marginal payment obligations when SPMs gain market share from OPMs. See Freedom Holdings II, 363 F.3d at 153; see also Freedom Holdings VI, 592 F.Supp.2d at 698 n. 15; Freedom Holdings III, 447 F.Supp.2d at 258. In this case, we need not consider whether this formula raises antitrust concerns because plaintiffs are NPMs, not SPMs. See infra at [51-52 & n. 14].

3. Adjustments to Payment Obligations

The MSA also provides for various adjustments to participating manufacturers' payment obligations. First, an “inflation adjustment” increases payment obligations by a minimum of 3% annually. Second, a “volume adjustment” reduces the required base payment if there is an overall decline in the volume of cigarettes sold nationwide. Third, if participating manufacturers lose market share relative to NPMs, an “NPM adjustment” reduces the required base payment by triple the amount of market share lost. See MSA § IX(d)(1)(A). 4

B. The Challenged Statutes
1. The Escrow Statute

Under the MSA, a decline in the volume of sales by participating members necessarily decreases the payments received by the states. To the extent the decline is attributable to increased sales by NPMs, states can both make up for the lost MSA payments and avoid the NPM adjustment by enacting and diligently enforcing escrow statutes. See MSA § IX(d)(2)(B). The MSA contemplates that an escrow statute will “effectively and fully neutralize[ ] the cost disadvantages that the Participating Manufacturers experience vis-à-vis Non-Participating Manufacturers within such Settling State as a result of the provisions of [the MSA].” Id. § IX(d)(2)(E).

The settling states have, in fact, all enacted escrow statutes. The operative section of the New York Escrow Statute challenged in this case is codified at New York Public Health Law § 1399-pp. It requires each cigarette manufacturer either (1) to join the MSA as a participating manufacturer, see id. § 1399-pp(1); or (2) to make annual payments into a state escrow fund, see id. § 1399-pp(2). The statute specifies the amount of these annual escrow payments, which are adjusted for inflation.

See id. at § 1399-pp(2)(a). Escrow funds are released if needed to pay certain judgments, to the extent an NPM paid more into the escrow fund than it would have paid as an SPM, or otherwise after twenty-five years. See id. § 1399-pp(2)(b).

As originally drafted, state escrow statutes, including New York's, also contained allocable share release provisions, which allowed an NPM to recoup escrow payments to the extent the NPM paid more into the escrow fund than a state's allocable share of MSA payments. This provided an incentive for NPMs to concentrate their sales in a single state or small group of states to minimize their escrow costs. Thus, an NPM that sold 100% of its cigarettes in New York could recoup 87.24% of its escrow payments because New York's allocable share of MSA payments is 12.76%. Meanwhile an NPM that sold the same number of cigarettes nationwide could recoup none of its escrow payments. To avoid this outcome, in 2003, New York, like other settling states, amended its Escrow Statute to permit NPMs to obtain a release of escrow payments only to the extent they exceeded the per-cigarette payments the NPMs would have made as participants in the MSA. See N.Y. Pub. Health Law § 1399-pp(2)(b)(ii). 5

2. The Contraband Statute

Between 1998 and 2002, MSA participants saw their market share of cigarette sales decline while NPMs' share rose. Attributing this situation, at least in part, to the failure of certain NPMs to comply with escrow statutes, a number of states enacted “contraband statutes.” 6 See Freedom Holdings I, 357 F.3d at 213 (quoting Governor George Pataki's statement that New York's Contraband Statute would “bolster the State's ability to diligently enforce” the Escrow Statute and, thus, “help protect the State from further [NPM] adjustments” (internal quotation marks omitted) (alteration in original)). New York's Contraband Statute,...

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