State v. Philip Morris USA, Inc.

State v. Philip Morris USA, Inc., 2007 NCBC 27

STATE OF NORTH CAROLINA IN THE GENERAL COURT OF JUSTICE
SUPERIOR COURT DIVISION
COUNTY OF WAKE 98 CVS 14377

STATE OF NORTH CAROLINA,

Plaintiff,

v.

PHILIP MORRIS USA, INC.;
R.J REYNOLDS TOBACCO ORDER AND OPINION
COMPANY; BROWN &
WILLIAMSON TOBACCO
CORPORATION, individually and
as successor by merger to The
American Tobacco Company; and
LORILLARD TOBACCO
COMPANY,

Defendants.

{1} The Court is called upon once again to construe certain provisions of the
National Tobacco Grower Settlement Trust (“the Phase II Trust” or “the Trust” or
“the Trust Agreement” or “the Agreement”).1 The currently pending cross motions
for summary judgment require the Court to determine if enactment of the Fair and
Equitable Tobacco Reform Act of 2004 (“FETRA”), Pub. L. No. 108-357, 118 Stat.
1521 (codified as amended in scattered sections of 7 U.S.C.), relieved the defendant
tobacco companies of their obligation to fund the Phase II Trust through 2010 solely

1See State v. Philip Morris USA, Inc., 2004 NCBC 9 (N.C. Super. Ct. Dec. 23, 2004),
http://www.ncbusinesscourt.net/120945/2004%20NCBC%209.htm, rev’d, 359 N.C. 763, 618 S.E.2d
219 (2005). The courts of this state have jurisdiction to hear the claims of Maryland and
Pennsylvania as Grower States under the Phase II Trust because North Carolina is the original situs
of the Trust and North Carolina law governs administration of the Trust and interpretation of the
Trust Agreement. (See National Tobacco Grower Settlement Trust § 4.15.) On August 19, 1999, this
Court entered an order approving the Trust, and retains jurisdiction to consider disputes such as
this regarding implementation of the Trust.
for the benefit of tobacco farmers in Maryland and Pennsylvania who did not
receive any benefits under FETRA. For the reasons set forth below and following
the reasoning of the North Carolina Supreme Court in the first FETRA case, State
v. Philip Morris USA, Inc., 359 N.C. 763, 618 S.E.2d 219 (2005), the Court holds
that the defendant tobacco companies are not relieved of their obligations to the
tobacco growers in Maryland and Pennsylvania and grants summary judgment in
favor of Maryland and Pennsylvania.

Ellis & Winters by Richard W. Ellis and Thomas D. Blue Jr., for JPMorgan
Chase Bank, as Trustee for National Tobacco Settlement Fund and North
Carolina Phase II Tobacco Certification Entity, Inc.; Kelley, Drye & Warren
LLP, by Sarah L. Reid for JPMorgan Chase Bank, as Trustee.

Attorney General J. Joseph Curran Jr. by Marlene Trestman, David S. Lapp,
William F. Brockman and Craig A. Nielsen for Plaintiff State of Maryland
Certification Entity.

Attorney General Thomas W. Corbett by Joel M. Ressler, Troy L. Beaverson
and Tracey D. Tubbs for Plaintiff Commonwealth of Pennsylvania
Certification Entity.

Brooks, Pierce, McLendon, Humphrey & Leonard, LLP, by Jim W. Phillips
Jr. and Charles F. Marshall III for Defendants R.J. Reynolds Tobacco
Company, Brown and Williamson Tobacco Company and Lorillard Tobacco
Company.

Smith Moore LLP by Larry B. Sitton, Gregory G. Holland and Jonathan P.
Heyl for Defendant Philip Morris USA Inc.

Tennille, Judge.

I.
BACKGROUND
{2} In the previous segment of this litigation the North Carolina Supreme
Court was called upon to decide if FETRA relieved the defendant tobacco companies
(“Settlors” of the Trust) of their obligations to fund the Phase II Trust for the 2004
calendar year. In making that decision the Supreme Court had to interpret the
language in certain provisions of the Phase II Trust containing a Tax Offset
Adjustment (“the TOA”). Those same provisions are involved here; however, the
claims are different. The prior case dealt with the payments due to the Phase II
Trust only for 2004 for all states that were beneficiaries of the Trust (“the Grower
States”). Maryland and Pennsylvania were included in that segment of the case
because they had claims to the 2004 payments which were founded on the same
claims as the other Grower States. Here, the Maryland and Pennsylvania claims
are different.2 These two states seek to require the Settlors to continue to make
payments under the terms of the Phase II Trust for the benefit of their tobacco
farmers until the Trust terminates in 2010. The Settlors have been relieved of all
other obligations to other Grower States under the terms of the Phase II Trust after
2004 because the amounts paid to tobacco farmers and quota holders in those states
under FETRA exceeded the amounts due under the Phase II Trust. In fact, the
amounts due from the defendant tobacco companies under FETRA exceed the total
of all their remaining obligations under the Phase II Trust. Maryland and
Pennsylvania farmers grow Maryland Type 32 tobacco and did not participate in
the federal tobacco quota programs. Thus, they were not the beneficiaries of any
distributions under FETRA. They received benefits under the Phase II Trust up
until 2005 when the Settlors contended that they were no longer required to fund
the Trust for the benefit of the Maryland and Pennsylvania tobacco growers. Up
until 2005 tobacco farmers in other states had received both the benefits of the
Phase II Trust and the federal quota system.
{3} The question presented is whether, under the language of the TOA, the
Settlors are excused from making payments to the Phase II Trust for tobacco
growers who were not beneficiaries of a federal Governmental Obligation3 when the
federal Governmental Obligation created by FETRA exceeded the total obligation of

2 The amounts at issue in the previous phase exceeded four hundred million dollars. By contrast, the

total amount at issue here, including payments through 2010 are approximately twenty-five million
dollars, or about five million dollars a year. Overall FETRA payments to farmers and quota holders
in other states will total billions of dollars. Maryland and Pennsylvania farmers will not participate
in those payments.
3 See infra ¶ 10.
the Settlors under the Trust Agreement. The Court finds they are not. In doing so
the Court has relied heavily on the North Carolina Supreme Court’s prior
interpretation and application of language in the TOA provision of the Trust
Agreement and the very clear purposes for which the Trust was originally created.

II.
THE PURPOSE OF THE TRUST
{4} The rationale for creation of the Trust for tobacco growers is best stated in
a letter from Steve Parrish of Philip Morris to the Honorable J. Phil Carlton4 dated
January 14, 1999. The letter stated in pertinent part:
Dear Judge Carlton:

As I stated in our December 18, meeting in Raleigh, Philip Morris is
proud of its tradition of support of American tobacco growers and we
have no intention of breaking with that tradition. We have always met
our purchase intentions and, in fact, we have often purchased more
than our submitted intentions. Excluding a small amount of Oriental
tobacco, our domestic brands contain 90% or more of American grown
tobacco. As I also said in Raleigh, we intend to continue to maximize
our use of domestic tobacco.
As you know, for years there has been a steady decline in cigarette
consumption in this country. This trend will be accelerated as a result
of the recent settlement agreement between the industry and the
states. In addition, our export business suffered in 1998 because of
significant economic problems in Russia, Asia, and other overseas
markets.
These are difficult times for all of us in the tobacco family,
particularly for tobacco growers and quota holders, and something
obviously needs to be done to address their plight. In crafting the right
solution for this very real problem, it is imperative that we be honest
and realistic about the situation. The fact is, as a result of the recent
settlement, there will be a significant reduction in the demand for
tobacco in this country. Whatever is done to address the financial
problem of growers and quota holders must take this into account. It
is in no one’s best long term interest to devise a system which merely
makes a bad situation worse by encouraging growers to produce

4 At the time the letter was written, Judge Carlton was the lead spokesperson for the four largest

tobacco companies in their negotiations with the states over the Master Settlement Agreement
(“MSA”).
tobacco for which there is no demand. We believe growers should be
encouraged to grow as much tobacco as can be sold, and that both
growers and quota holders should be compensated for the economic
harm they suffer as a result of the state settlement.
Philip Morris believes the best way to solve this very real problem
is for the four major U.S. cigarette manufacturers to create a trust
fund to be administered by the tobacco growing states to compensate
tobacco growers and quota holders for this economic harm.
We believe this is the best approach for a number of reasons. First,
it gives each state flexibility in determining what is best for its growers
and quota holders. Second, it is legally binding on the companies and,
therefore, enforceable by the states. As a result, it protects the states
against changes in management or future financial problems at the
companies. Third, it is a verifiable way of guaranteeing that the
money is equitably collected and distributed. Fourth, it is legally
within our power to do so. Finally, it provides states, growers and
quota holders with an economic safety net for the future.

Letter from Steve Parrish, Chief Executive Officer, Philip Morris Companies, Inc.,
to the Honorable J. Phil Carlton, Carlton Law Firm (Jan. 14, 1999) (Brief of the
Maryland and Pennsylvania Certification Entities Opp. Settlors’ Mot. Summ. J. Ex.
E) (emphasis added). It is the last sentence which this Court finds compelling. The
Trust was created to provide a safety net for tobacco growers. Settlors now seek to
remove that safety net for tobacco growers in Maryland and Pennsylvania.
{5} There were two other purposes for the creation of the Trust highlighted by
the Supreme Court in its decision. The court said:
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. Additionally, the Trust shields
Settlors from claims the Grower States might otherwise bring for
economic damages suffered as a result of the MSA.

Philip Morris, 359 N.C. at 766, 618 S.E.2d at 221. Settlors received releases from
Maryland and Pennsylvania as a result of the creation of the Trust and the
inclusion of Maryland and Pennsylvania in the agreement even though they were
not states in which tobacco growers participated in the federal tobacco program.
{6} The Supreme Court used even stronger language with respect to the
purpose of the Trust:
Certainly the most compelling reason for rejecting the trial court’s
holding is that, taken to its logical extreme, it could defeat the express
purpose of the Phase II Trust. As previously explained, the Trust was
crafted to protect tobacco farmers from economic harm caused by the
MSA. The Trust achieved this goal through annual distributions to the
beneficiaries. These distributions were scheduled to furnish tobacco
farmers a steady stream of supplemental income until at least 2010.

Id. at 779, 618 S.E.2d at 229.
The court went on to hold:
Of course, Settlors entered into the Trust Agreement knowing a
tobacco buyout program might not materialize until long after their
obligation to the Trust had been discharged. . . . Settlors apparently
decided the legal protections of the MSA and the Trust Agreement
outweighed the risk of having to fund both the Trust and a buyout
program in succession. On the other hand, the Grower States entered
into the Trust Agreement to obtain a regular source of supplemental
income for tobacco farmers hurt by the economic repercussions of the
MSA. Interpreting the Trust Agreement in a manner that could leave
those individuals without this extra income for years runs squarely
counter to the express purpose of the Trust.

Id. at 780, 618 S.E.2d at 229 (emphasis added).
{7} Maryland and Pennsylvania entered into the Trust Agreement and
provided releases to obtain a regular source of supplemental income through 2010
for tobacco farmers hurt by the economic repercussions of the MSA at a time when
everyone understood that those farmers were not participants in the federal tobacco
program. To interpret the Trust Agreement in a manner that could leave those
individuals without this extra income for years would run squarely counter to the
express purpose of the Trust.
III.
INTERPRETATIVE GUIDANCE FROM THE SUPREME COURT
{8} This Court also has the benefit of express and specific guidance from the
Supreme Court with respect to the principles of contract interpretation to be applied
to this contract.
Interpreting a contract requires the court to examine the language
of the contract itself for indications of the parties' intent at the moment
of execution. Lane v. Scarborough, 284 N.C. 407, 409-10, 200 S.E.2d
622, 624 (1973). “If the plain language of a contract is clear, the
intention of the parties is inferred from the words of the contract.”
Walton v. City of Raleigh, 342 N.C. 879, 881, 467 S.E.2d 410, 411
(1996) (“A consent judgment is a court-approved contract subject to the
rules of contract interpretation.”). Intent is derived not from a
particular contractual term but from the contract as a whole. Jones v.
Casstevens, 222 N.C. 411, 413-14, 23 S.E.2d 303, 305 (1942) (“'Since
the object of construction is to ascertain the intent of the parties, the
contract must be considered as an entirety. The problem is not what
the separate parts mean, but what the contract means when
considered as a whole.'”) (citation omitted). Consistent with the
aforesaid principles, we must carefully inspect the provisions of the
Phase II Trust to ascertain the parties' intention at the time it was
executed.

Id. at 773, 618 S.E.2d at 225 (footnote omitted).

{9} As previously noted, the Supreme Court was concise and unequivocal in its
holding that the purpose of the Trust viewed as a whole was to provide a safety net
for farmers impacted by the MSA.

IV.
THE CURRENT CONTROVERSY

{10} In this Court’s earlier decision it did not find that Congress intended to
trigger the provisions of the TOA. Rather, it found that Congress had avoided
dealing with the issue, but that the practical effect of the passage of FETRA was to
trigger the TOA provision for 2004. The Supreme Court reversed, finding that
FETRA did not trigger the TOA provisions until 2005. Here, this Court concludes
again that Congress took no action with a discernable specific intent with respect to
the Phase II Trust. Based upon the guidance from the Supreme Court and its own
determination of the purposes of the Phase II Trust, the Court concludes that
FETRA did not trigger the TOA provisions as to Maryland and Pennsylvania. At
issue is the meaning of the Tax Offset Provision found at pages A-5 to A-7 of
Schedule A of the Trust which read:
(A-
(A-5) Tax Offset Adjustment. Except as expressly provided below, the
amounts to be paid by the Settlors in each of the years 1999 through and
including 2010 shall also be reduced upon the occurrence of any change in
a law or regulation or other governmental provision that leads to a new,
or an increase in an existing, federal or state excise tax on Cigarettes, or
any other tax, fee, assessment, or financial obligation of any kind. . . .
(A-
(A-6) imposed on the purchase of tobacco or any tobacco products or
on production of Cigarettes or use of tobacco in the manufacture of
Cigarettes at any stage of production or distribution or that is imposed on
the Settlors, to the extent that all or any portion of such Governmental
Obligation is used to provide: (i) direct payments to [tobacco farmers]; (ii)
direct or indirect payments, grants or loans under any program designed
in whole or in part for the benefit of [tobacco farmers]; (iii) payments,
grants or loans to Grower States to administer programs designed in
whole or in part to benefit [tobacco farmers]; or (iv) payments, grants or
loans to any individual, organization, or Grower State for use in activities
which are designed in whole or in part to obtain commitments from, or
provide compensation to [tobacco farmers] to eliminate tobacco
production.
The amount of the Governmental Obligation used for any of the
purposes set forth above shall be the “Grower Governmental Obligation.”
(A-
(A-7) In the event of such a Governmental Obligation, the amount
otherwise required to be paid by each Settlor each year (after taking
account of all adjustments or reductions hereunder) shall be reduced by
an amount equal to the product of the amount of such Governmental
Obligation paid in connection with Cigarettes manufactured by the Settlor
(or tobacco or tobacco products used by the Settlor to manufacture
Cigarettes) for the same year multiplied by the ratio of the Grower
Governmental Obligation divided by the amount of the Governmental
Obligation, which reduction amount may be carried forward to
subsequent years as necessary to ensure full credit to the Settlor. If the
Governmental Obligation results from a law or regulation or other
governmental provision adopted by a Grower State, or by a political
subdivision within such Grower State, the amount that a Settlor may
reduce its payment to the Trust in any one year shall not exceed the
product of the amount the Settlor otherwise would have paid to the Trust
in that year in the absence of the Tax Offset Adjustment multiplied by the
allocation percentage for the pertinent Grower State set forth in Section
1.03. The Settlor may reduce its annual payment by a reasonable estimate
of any such reduction and adjust its payment after the actual amount is
finally determined.

Id. at 774–75, 618 S.E.2d at 226.

{11} As they did in the prior phase of this litigation, the parties each read the
same language, claiming it to be unambiguous, to support their interpretation of the
Trust Agreement. In this circumstance the Supreme Court has directed this Court
to look at the whole of the contract and be guided by its purposes. The Supreme
Court interpreted the contract to provide payments to tobacco farmers as long as
those farmers were not receiving double payments from the tobacco companies. It
said:
The trial court was assuredly correct when it concluded the Tax
Offset Adjustment provision was written to keep Settlors from having
to fund two payment streams to the same tobacco farmers at the same
time. Our decision does nothing to thwart this intent. Rather, we hold
that Settlors must actually assume the burden of FETRA before being
relieved of their obligations to the Phase II Trust. In so doing we
adhere to the plain language of the Tax Offset Adjustment provision
and the express purpose of the Trust.

Id. at 781, 618 S.E.2d at 230 (emphasis added).
{12} Under the present circumstances, the Maryland and Pennsylvania tobacco
farmers do not receive any benefit from the buyout generated by FETRA. They are
not double dipping and receiving two streams of income from the tobacco companies
at the same time. If they receive no benefits from the Phase II Trust, the purpose of
the Trust will be defeated, as they will be deprived of any supplemental benefits to
offset the damages generated by the MSA. It makes little sense that Maryland and
Pennsylvania would execute releases of substantial claims in return for an
agreement that payments to their farmers could be eliminated by payments to
farmers in other states who were already receiving the benefits from the federal
tobacco quota program.
The TOA may be graphically represented as follows:

Company’s Grower Governmental Obligation
Governmental x ÷ = Reduction in Trust
Obligation Governmental Obligation Payments

(Mem. Supp. Mot. of Maryland and Pennsylvania Certification Entities for Summ.
J. 9.)
{13} Simply stated, Maryland and Pennsylvania contend that their farmers
received no Governmental Obligation; thus the Company’s Governmental
Obligation is zero, and consequently the Reduction in Trust Payments is zero. The
tobacco companies contend that under the Agreement they are obligated to pay up
to a fixed amount and that if any Grower Governmental Obligation exceeds the
balance then due under the Trust Agreement the companies have no further
obligation under the Trust, even if some beneficiaries do not receive benefits under
the Grower Governmental Obligation. FETRA assessments are likely to total $5.1
billion compared to the $2.4 billion remaining due under the Trust Agreement when
FETRA was passed. The TOA can be logically read to support the position of the
tobacco companies. They argue that the Agreement provides a cap on their total
liability. However, such a reading defeats the purpose of the Trust as far as the
individual states that signed releases are concerned. If the tobacco companies are
correct that the impact on an individual state may not be considered, they prevail
and this decision should be reversed. This Court believes it is following the
guidance of the North Carolina Supreme Court in making its decision based on the
clear purpose of the Trust.
V.
PROCEDURAL ISSUES
{14} Several procedural matters require clarification before concluding. The
Court has not considered the deposition testimony from Judge Carlton offered
under seal with respect to whether or not the parties considered what would happen
if a federal buyout did not include Maryland and Pennsylvania. The parties’
agreement specifically prohibits use of the negotiations in litigation. Defendants’
Motion to Exclude Evidence of Negotiations or Discussions Underlying the Trust in
Proceedings Before the Court is granted. Nor has the Court considered any
argument of counsel made in the first phase of this dispute. The Court directed and
the parties understood that the Court had separated the claims to the 2004
distribution from the claims of Maryland and Pennsylvania. Any comments made
in the prior oral arguments were directed to the 2004 distribution and
interpretation of the TOA in that context. The Court does not find any argument of
counsel in the first FETRA case to be dispositive of any issue under consideration
here.
{15} The Court also declines to base its ruling on the argument of Maryland
and Pennsylvania that the tobacco companies somehow have “unclean hands” by
lobbying Congress to exclude their farmers from the buyout. The tobacco companies
had the right to lobby Congress with respect to legislation that would affect their
interests and there is no evidence in the record that lobbying by the tobacco
companies was the cause of Maryland and Pennsylvania farmers being excluded
from buyouts under a federal program in which they had declined to participate.
The Court will not speculate on why Congress provided no relief to Maryland and
Pennsylvania farmers.
{16} Settlors have expressed concern that a decision in favor of Maryland and
Pennsylvania might somehow encourage other beneficiaries of the various state
programs funded by the payments from the Phase II Trust to assert claims for
additional payments. This opinion would not open the door to such claims. It is
limited solely to the claims of the states of Maryland and Pennsylvania whose
tobacco farmers have not received any benefit from the federal buyout. It is based
upon the execution of the releases by those two states which were a quid pro quo for
the execution of the Trust Agreement. This order should not be broadly interpreted
to create any rights other than the specific rights of Maryland and Pennsylvania to
continue to receive payments from the Phase II Trust. No other participating states
have such rights and the Court is not creating any “equitable” right to payments not
specifically provided in the Trust Agreement.

VI.
CONCLUSION

{17} The execution of the Phase II Trust and exchange of releases in return for
that execution served two purposes. First, it provided tobacco farmers with relief
from the adverse consequences of the MSA’s lowering of demand for tobacco
products. Second, it provided the tobacco companies with finality to their litigation
with the grower states that executed releases. To interpret the language of the
Trust provisions to relieve the tobacco companies of their obligation to tobacco
farmers in states that executed releases but in which farmers have received no
benefit from a Grower Governmental Obligation would defeat the purpose of the
Trust as determined by the North Carolina Supreme Court. This Court interprets
the language of the Trust to fulfill that purpose, not defeat it.
{18} Maryland and Pennsylvania do not seek to create a new obligation, only to
enforce an old one for which they gave consideration in the form of releases from
future litigation. Compared to the billions involved in the federal buyout, the
payments to Maryland and Pennsylvania tobacco farmers are miniscule. The
tobacco companies, tobacco growers and tobacco quota holders in other states all
received benefits from FETRA. Maryland and Pennsylvania tobacco farmers
received no benefits from FETRA and should not be denied their benefits under the
Phase II Trust Agreement.
{19} Finally, the Court notes once again that the decision to grant a writ of
petition for discretionary review lies exclusively with the Supreme Court. See State
v. Philip Morris USA Inc., 2004 NCBC 9 ¶ 113 n.31 (N.C. Super. Ct. Dec. 23, 2004),
http://www.ncbusinesscourt.net/120945/2004%20NCBC% 209.htm, rev’d, 359 N.C.
763, 618 S.E.2d 219 (2005). This Court can only express its views that the issues
decided here are of “significant public interest” warranting certification for review
by the Supreme Court without delay. See N.C. Gen. Stat. § 7A-31(a)–(b).

{20} Based upon the foregoing, it is, therefore, ORDERED:
1. The Motion of Maryland and Pennsylvania Certification Entities for
Summary Judgment is GRANTED.
2. The Settlors’ Motion for Summary Judgment is DENIED.

This the 17th day of August, 2007.