Texas v. American Tobacco Co.

• Citation: 463 F.3d 399
• Decision Date: 01 September 2006
• Docket Number: No. 05-40671.,05-40671.
• Parties: State of TEXAS, Plaintiff-Appellant, v. AMERICAN TOBACCO CO., Etc.; et al., Defendants, Brown & Williamson Tobacco Co., Defendant-Appellee.
• Court: United States Courts of Appeals. United States Court of Appeals (5th Circuit)

463 F.3d 399

State of TEXAS, Plaintiff-Appellant, v. AMERICAN TOBACCO CO., Etc.; et al., Defendants, Brown & Williamson Tobacco Co., Defendant-Appellee.

No. 05-40671.

United States Court of Appeals, Fifth Circuit.

September 1, 2006.

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Edward Donald Burbach (argued), Law Enforcement Defense Div., Sean Jordan, Austin, TX, Linda Ibach Shaunessy and David Calvin Mattax, Asst. Atty. Generals, Financial Litigation Div., Austin, TX, for Plaintiff-Appellant.

Stephen R. Patton, Douglas G. Smith (argued), Kirkland & Ellis, Chicago, IL, for Defendant-Appellee.

Appeals from the United States District Court for the Eastern District of Texas.

Before SMITH and STEWART, Circuit Judges, and HANEN,^* District Judge.

HANEN, District Judge:

The issue before this Court involves the proper interpretation of the settlement agreement between the State of Texas and five large cigarette manufacturers. Specifically, this Court must determine whether Brown & Williamson Tobacco Corporation n/k/a Brown & Williamson Holding, Inc. ("B&W") breached its obligations under the settlement agreement by failing to report cigarettes that B&W manufactured for Star Tobacco & Pharmaceuticals ("Star") as its own for the purpose of calculating B&W's annual payments to Texas. As a consequence of B&W's alleged underreporting, the State claims it was deprived of approximately $16,420,252 in settlement payments between the years 1999 and 2002. For the reasons stated below, we affirm.

I. FACTUAL BACKGROUND

On March 28, 1996, the State of Texas sued several major tobacco companies seeking reimbursement for various smoking-related health care expenditures. Almost two years later, on January 16, 1998, Texas entered into a settlement agreement with B&W, Philip Morris, Inc., R.J. Reynolds Tobacco Co., Lorillard Tobacco Co., and United States Tobacco Co. (collectively referred to as the "Settling Defendants").¹ The settlement agreement, which was approved by the district court on January 22, 1998, released the tobacco companies from all past and future claims arising out of the use of, or exposure to, their tobacco products. In return, the tobacco companies agreed to make annual payments to Texas and to comply with certain restrictions, including various marketing restrictions. The parties also agreed that the United States District Court for the Eastern District of Texas, Texarkana Division, would retain jurisdiction over the parties and subject matter of the settlement for the purposes of implementing and enforcing the agreement.

Since the parties executed the original "Comprehensive Settlement Agreement and Release" ("Original Agreement"), they have amended it twice.² On July 24, 1998, the parties entered into the Stipulation of Amendment to Settlement Agreement and for Entry of Consent Decree ("1998 Amendment"), and on June 8, 2001, the parties entered into the Agreement to Amendment to Settlement Agreement ("2001 Amendment").

The 1998 Amendment reflects Texas' exercise of its rights under the Original Agreement's "Most Favored Nation" provision to adopt the more favorable terms of the settlement agreement reached between the Settling Defendants and the State of Minnesota on May 8, 1998. The Original Agreement tied the formula for calculating the annual payments to the "respective share of sales of cigarettes by unit for consumption in the United States." Apparently, some of the Settling Defendants began marketing cigarettes in "two for one" or "buy two get one free" promotions. "Free" cigarettes given as part of such promotions would likely be excluded from the annual payment calculations of the Original Agreement because they would not have been considered cigarettes "sold." Perhaps recognizing the potential decrease in the amount of the settlement payments presented by these promotions, the settlement agreement reached between the State of Minnesota and the Settling Defendants tied the Settling Defendants' annual payment obligations to shipped cigarettes. Texas and the Settling Defendants thereafter entered into the 1998 Amendment, which changed the annual payment provisions by tying the annual payment calculations to the "number of cigarettes shipped for domestic consumption." See 1998 Am., at Appx. A (emphasis added).³

In late 1999, B&W entered into a Cigarette Manufacturing Agreement with Star, an independent tobacco company that was primarily engaged in developing reduced-risk tobacco products. B&W manufactured, sold, and shipped to Star per Star's specifications and requirements over 7.5 billion cigarettes between late 1999 and December 21, 2002 ("contract-manufactured cigarettes"). B&W was paid approximately one cent for each contract-manufactured cigarette, which resulted in B&W's making approximately $4 per thousand cigarettes.⁴ Although B&W shipped the contract-manufactured cigarettes to Star, who then shipped them through its own distribution system for consumption, B&W did not include those cigarettes in its annual payment calculations to Texas.⁵ Instead, B&W based its annual payment calculations on the shipment information that it reported to Management Science Associates, Inc. ("MSA, Inc.").

MSA, Inc. is an independent third party that has been collecting information related to tobacco companies' shipments to wholesalers for over thirty years.⁶ As part of its Cigarette Research Audit ("CRA") program, MSA, Inc. collects and reports information from cigarette manufacturers concerning shipments to their wholesalers and distributors. These reports are sometimes referred to as "Shipments to Wholesale." The agreement between MSA, Inc. and B&W is such that B&W only reports the cigarettes it ships through its own distribution system. Therefore, B&W did not include the contract-manufactured cigarettes in the shipment information it reported to MSA, Inc. The MSA, Inc. reports are used by B&W and other cigarette manufacturers to analyze and monitor their respective sales and market shares. MSA, Inc. does not examine or verify the accuracy of the information that B&W provides.⁷

On May 27, 2004, over one year after B&W had stopped manufacturing cigarettes for Star, the State of Texas filed a Verified Motion to Enforce the Settlement Agreement, For an Accounting, and For a Preliminary Injunction claiming that B&W breached the agreement by failing to report as its own, and make settlement payments with respect to, the contract-manufactured cigarettes. B&W denied the allegations claiming that it was not required to include the contract-manufactured cigarettes in the annual payment calculations. On June 24, 2004, by agreement of the parties, the United States District Court for the Eastern District of Texas, Texarkana Division, heard argument and received evidence on whether B&W breached the agreement, and on whether Texas was entitled to an accounting.⁸

On March 28, 2005, the district court issued its Final Judgment in favor of B&W along with its Findings of Facts and Conclusions of Law. The court ruled that "under well-settled industry practice," the contract-manufactured cigarettes "were not B&W's cigarette shipments, they were not shipped to B&W's wholesalers, and they were properly excluded from B&W's shipments reported to MSA, Inc. or the calculation of B&W's payments under the Texas Settlement Agreement." Opinion, at 3. Furthermore, the district court ruled that the words "cigarettes shipped for domestic consumption" means those cigarettes shipped for domestic consumption as reported by MSA, Inc. Id. at 23.

Even though the court did not rule as to whether the Texas Settlement Agreement is ambiguous, the court based its ruling in part on the parties' course of performance.⁹ The district court found that since its inception, all of the annual payments due under the Texas Settlement Agreement have been based on MSA, Inc.'s "Shipments to Wholesale" reports. It also found that this practice and course of performance was explicitly recognized by the parties in 2002 when the State and the Settling Defendants entered into an engagement letter with PriceWaterhouse-Cooper ("PWC"). PWC was engaged to collect "shipment volume data" from each Settling Defendant and, based on that data, to calculate the payments due under the Texas Settlement Agreement. The engagement letter specifically stated:

By January 15 of each year, request and collect from each Settling Defendant shipment volume data for the entire preceding calendar year. Seek and obtain written confirmation of such shipment volume data from [MSA, Inc.], and notify each State and each Settling Defendant if there exists a discrepancy between the volume data collected from the Settling Defendants and the confirmation obtained from [MSA, Inc.].

Id. at 13. The court found that the letter reflected the parties' recognition that the "shipment volume data" PWC was engaged to collect would be based on the Settling Defendants' shipments as reported to MSA, Inc. Id. Thus, the court concluded that the letter reflected the parties' course of performance and their understanding that the annual payments to Texas have always been based on shipments as reported to MSA, Inc. Id. at 14.

The district court also made findings of fact that the State knew about the Cigarette Manufacturing Agreement between B&W and Star during the approximately six years prior to filing its Motion to Enforce. The court found that the evidence was "undisputed that the State of Texas, including its Attorney General, were aware of B&W's contract manufacturing agreement with Star from its inception" and never claimed that B&W was obligated to make settlement payments with respect to the contract-manufactured cigarettes. Id. at 18.

II. THE ANNUAL PAYMENT CALCULATIONS

At the heart of this appeal is the interpretation of the provisions in the Texas Settlement Agreement establishing the method for calculating the Settling Defendants' annual payments. The annual payment calculations are based on each...