State v. Philip Morris Usa Inc., 2PA05.

• Decision Date: 19 August 2005
• Docket Number: No. 2PA05.,2PA05.
• Citation: 618 S.E.2d 219
• Court: North Carolina Supreme Court
• Parties: STATE of North Carolina v. PHILIP MORRIS USA INC., f/k/a Philip Morris Incorporated; R.J. Reynolds Tobacco Company, individually and as successor to R.J. Reynolds Tobacco Company and Brown & Williamson Tobacco Corporation; and Lorillard Tobacco Company.

618 S.E.2d 219

STATE of North Carolina v. PHILIP MORRIS USA INC., f/k/a Philip Morris Incorporated; R.J. Reynolds Tobacco Company, individually and as successor to R.J. Reynolds Tobacco Company and Brown & Williamson Tobacco Corporation; and Lorillard Tobacco Company.

No. 2PA05.

Supreme Court of North Carolina.

August 19, 2005.

On discretionary review pursuant to N.C.G.S. § 7A-31, prior to a determination by the Court of Appeals, of an order and opinion entered on 23 December 2004 by Judge Ben F. Tennille in Superior Court, Wake County. Heard in the Supreme Court 16 May 2005.

Ellis & Winters LLP, by Richard W. Ellis and Thomas D. Blue, Jr., for petitioner-appellants JPMorgan Chase Bank, N.A., as Trustee, and the North Carolina Phase II Tobacco Certification Entity, Inc.

Brooks, Pierce, McLendon, Humphrey & Leonard, LLP, by Jim W. Phillips, Jr., for respondent-appellees Philip Morris USA Inc., R.J. Reynolds Tobacco Company, and Lorillard Tobacco Company; and Smith Moore LLP, by Larry B. Sitton, Gregory G. Holland, and Angela L. Little, for respondent-appellee Philip Morris USA Inc.

Shanahan Law Group, by Kieran J. Shanahan and Reef C. Ivey, II, for North Carolina Phase II Beneficiaries, amici curiae.¹

H. Julian Philpott, Jr., General Counsel, and Stephen A. Woodson, Associate General Counsel, North Carolina Farm Bureau Federation, Inc., for North Carolina Farm Bureau Federation, Inc., American Farm Bureau Federation, Florida Farm Bureau Federation, Georgia Farm Bureau Federation, Kentucky Farm Bureau Federation, Maryland Farm Bureau, Inc., Missouri Farm Bureau Federation, Ohio Farm Bureau Federation, South Carolina Farm Bureau Federation, Virginia Farm Bureau Federation, Tennessee Farm Bureau Federation, and Indiana Farm Bureau Federation, amici curiae.

NEWBY, Justice.

In this case we construe the language of the National Tobacco Grower Settlement Trust to determine whether enactment of the Fair and Equitable Tobacco Reform Act of 2004 relieved defendant tobacco companies of their obligations to the Trust for 2004. We hold it did not and reverse the trial court.

I. BACKGROUND

In 1938 the federal government began implementing price supports and marketing quotas for U.S. tobacco in an effort to stabilize the domestic tobacco market. Quotas limited production and confined the cultivation of tobacco to specific tracts of land. While the federal government adjusted quota levels annually based on tobacco companies' demand, federal price supports kept tobacco prices elevated. In recent years, tobacco quotas and price supports often worked at cross-purposes. Artificially high prices dampened demand for domestic tobacco and led to reduced quotas. Along with many other factors, this contributed to a worsening financial situation among the members of the tobacco farming community.

During the 1990s, all fifty states and six other American jurisdictions filed suit against defendant tobacco companies ("Settlors") to recover healthcare costs associated with smoking-related illnesses. On 16 November 1998, forty-six states, the District of Columbia, the Commonwealth of Puerto Rico, and four other American territories agreed to settle their claims. The resultant Master Settlement Agreement ("MSA") was the object of consent decrees and final judgments in each complaining jurisdiction.² Settlors immediately raised prices to cover the future costs of payments due under the MSA.

The parties anticipated this rise in prices would curtail tobacco consumption; indeed, reduced consumption was one of the aims of the MSA.³ They also understood decreased demand for tobacco products could cause tobacco growers and quota holders ("tobacco farmers") significant economic hardship.⁴ The MSA therefore required that Settlors meet with the political leadership of the fourteen tobacco growing states ("Grower States") to devise a plan for mitigating the MSA's potentially negative economic consequences.⁵ These meetings produced the National Tobacco Grower Settlement Trust ("the Phase II Trust" or "the Trust"). By agreeing to the Phase II Trust, Settlors pledged to spend approximately $5.15 billion on economic assistance to tobacco farmers in Grower States.

Despite its cost, the Trust appealed to Settlors for financial reasons. Funding the Trust satisfied the requirement of the MSA "to address the economic concerns of the Grower States." In other words, Settlors agreed to the Trust because doing so was a condition of the settlement that had relieved them of potentially bankrupting liability for smoking-related healthcare costs.⁶ Additionally, the Trust shields Settlors from claims the Grower States might otherwise bring for economic damages suffered as a result of the MSA. National Tobacco Grower Settlement Trust at ¶ 4.05 (July 19, 1999) [hereinafter Trust Agreement] ("The Grower States confirm that the releases they have given to the Settlors cover, and thus bar, any claims for damages allegedly incurred by the Grower States as a result of adverse economic consequences suffered by the tobacco grower communities in the respective Grower States.").⁷

The preamble announces the purpose of the Trust: "[T]o provide aid to Tobacco Growers and Tobacco Quota Owners and thereby to ameliorate potential adverse economic consequences to the Grower States." The Trust accomplishes this objective through annual distributions to the beneficiaries. Id. at ¶ 1.02. These distributions supplement the declining incomes of tobacco farmers as they adapt to an economy in which the MSA has dulled the appetite for tobacco.

The Phase II Trust operates on a calendar year basis. Settlors fund the Trust through "Annual Payment[s]" divided into four equal installments due on March 31, June 30, September 30 and December 15, respectively.⁸ Id. at A-1 to A-2. An Independent Accountant chosen by the Settlors sets the amount of each Annual Payment by March 1 of each year. Id. at A-14 to A-15. Certification entities in each of the Grower States communicate annually to the Trustee the names and addresses of tobacco farmers who qualify to participate in the Trust. Id. at ¶ 1.02. Distributions to eligible tobacco farmers take place once each year by December 31. Id. The Trustee ordinarily disburses all funds it has received during the calendar year, and, once disbursed, funds may not be recovered. Id.

Schedule A of the Trust Agreement establishes the formulae used to calculate Settlors' Annual Payments. Simply put, the assessment for a given calendar year is determined by taking the specified base payment for that year and applying certain adjustments.⁹ Trust Agreement at A-1 to A-16. These include an "Inflation Adjustment," which increases the base payment in response to changes in the Consumer Price Index during the previous calendar year, and a "Volume Adjustment," which either increases or decreases the base payment depending on the number of cigarettes shipped during the preceding calendar year. Id. at A-4 to A-5.

Another adjustment to Annual Payments is the Tax Offset Adjustment. The parties drafted the Trust Agreement knowing federal and state governments might take additional measures to aid tobacco farmers. They realized such measures would probably entail additional assessments against Settlors. The Tax Offset Adjustment entitles Settlors to reduce their Annual Payment in response to the imposition of a "Governmental Obligation," which is a new or increased cigarette tax used in whole or in part for the benefit of tobacco farmers.¹⁰ Trust Agreement at A-5 to A-8. Schedule A defines Governmental Obligation broadly enough to encompass everything from an individual state's excise taxes on cigarettes to the massive assessments necessary to fund a federal tobacco buyout. Id. Likewise, a Governmental Obligation includes the cost to Settlors of complying with laws or regulations that require them to purchase minimum quantities or percentages of domestic tobacco. Trust Agreement at A-8 to A-9. Whereas the Inflation and Volume Adjustments are allocated evenly across quarterly installments, the Tax Offset Adjustment may be "allocated in full to the first payment due after the Adjustment is applied (and to subsequent payments as necessary to ensure full credit)." Id. at A-1.

From 1999 to 2003, the Phase II Trust functioned without significant controversy. Settlors paid their quarterly installments, and the Trustee made annual distributions to tobacco farmers. In 2003, however, the parties disagreed over whether a tobacco buyout bill pending in the United States Senate (the Tobacco Market Transition Act of 2003) constituted a Governmental Obligation. Some Settlors withheld their payments to the Phase II Trust arguing the proposed legislation would earn them a Tax Offset Adjustment for 2003. The Trustee moved for specific performance. During the ensuing mediation, the Trustee and Settlors negotiated Amendment One to the Trust Agreement. National Tobacco Grower Settlement Trust Agreement Amendment Number One (effective Mar. 30, 2004) [hereinafter Amendment One].

Amendment One prohibits Settlors from claiming a Tax Offset Adjustment "based upon proposed changes in laws." Amendment One at 2. It also refines the rules regarding refunds of Trust assets to Settlors. Arguably, prior to Amendment One such refunds were not permitted. Trust Agreement at 4.15. Settlors could apply Tax Offset Adjustments to future payments only. Under Amendment One, Settlors may receive refunds of quarterly payments during the calendar year in which a Tax Offset Adjustment "first became effective," but only to the extent the adjustment exceeds their remaining obligations to the Trust.¹¹ Significantly, the amendment stipulates it cannot be considered when determining when a Tax Offset Adjustment occurs:

No Resolution of Tax Offset Adjustment Effective Date Dispute: The Settlors and the Trustee have different interpretations of the language in the original Agreement concerning the date on or from...