$246 Billion Tobacco Settlement Faces Constitutional Challenge

Published October 1, 2005

The Competitive Enterprise Institute (CEI) has launched a legal challenge to the constitutionality of the multi-state tobacco settlement of 1998.

The suit, filed August 2, alleges the agreement between 46 states and major tobacco companies is unconstitutional because it violates the Compact Clause of the Constitution: “No State shall, without the Consent of Congress enter into any Agreement or Compact with another State.” (Article I, Section 10)

Multi-State Agreements

The Compact Clause was meant to prevent states from collectively encroaching on federal power or ganging up on other states. The tobacco Master Settlement Agreement (MSA) established a national tobacco cartel that harmed consumers and small businesses by increasing cigarette prices and restricting competition, according to the lawsuit.

The Founding Fathers crafted a check on multi-state agreements by giving the federal government–Congress–the responsibility of determining whether such agreements are in the public interest. The MSA never was approved by Congress, which had debated and rejected a similar settlement agreement proposed in 1997.

The MSA calls for major tobacco companies to make annual payments to the states in perpetuity, with an estimated cost of $246 billion over 25 years. In addition, small tobacco companies that were never part of the settlement are nonetheless required to make separate payments to the states.

‘Establishes a Destructive Cartel’

“The States became business partners in establishing one of the most effective and destructive cartels in the history of the Nation,” the complaint alleges.

The suit was filed in the U.S. District Court for the Western District of Louisiana on behalf of a distributor, two small tobacco manufacturers, a tobacco store, and an individual smoker, against the state’s attorney general, Charles C. Foti Jr.

“The tobacco settlement was a major government power grab at the expense of taxpayers and the rule of law,” said CEI President Fred L. Smith Jr.

“This lucrative backroom deal between state attorneys general and the trial bar has created a new model for targeting other politically incorrect industries and their customers,” said Sam Kazman, CEI general counsel.

Consequences Extensive

Nearly seven years after the MSA was signed, the consequences of the attorney generals’ activism extend well beyond the tobacco industry.

The tobacco lawsuits and settlement of the 1990s have become a model for attorneys general to increase the power of their office, target industries, and unilaterally craft new tax and regulatory policies, Smith said.

For decades, smokers had repeatedly sued tobacco companies over the adverse health effects of cigarette smoking. But juries consistently rejected the argument that smokers were unaware of the health risks, which were well publicized throughout the 1960s, ’70s, and ’80s. It wasn’t until state attorneys general stepped in that things changed.

States Imposed Retroactive Laws

In the early 1990s, a handful of trial lawyers and state attorneys general conceived a new strategy for suing tobacco companies.

Mississippi Attorney General Michael Moore, in partnership with prominent trial lawyers such as Richard Scruggs, filed suit against major tobacco companies, arguing the companies should be forced to reimburse the state for the Medicaid costs of treating sick smokers. Other states soon filed similar lawsuits.

The state lawsuits initially were widely regarded as a long shot, because the claim was untested and because states faced the same burden of proof as private plaintiffs, to prove that smoking had directly caused the illnesses cited by the states and that smokers were unaware of the health risks.

Florida took the lead in dispensing with that problem by retroactively changing the rules. The legislature in 1994 passed a law (the Medicaid Third-Party Liability Act) barring defendants, such as the tobacco companies, from raising those defenses in cases where the state seeks Medicaid reimbursement.

Florida Statute Provided Model

“I took a little-known statute called a Florida Medicaid recovery statute, changed a few words here and a few words there, which allowed the State of Florida to sue the tobacco companies without ever mentioning the words ‘tobacco’ or ‘cigarettes,'” boasted Florida trial lawyer Fred Levin in 1998. “It meant it was almost a slam dunk” against the tobacco industry.

Meanwhile, a Mississippi judge ruled tobacco companies could not introduce evidence the alleged Medicaid costs had been offset by cigarette taxes and shorter-than-average lifespans of sick smokers. Big Tobacco decided by 1997 to settle the state lawsuits in order to cap their losses. Four state suits–in Florida, Minnesota, Mississippi, and Texas–were settled separately.

Forty-six states signed the multi-state Master Settlement Agreement. Total settlement payments were estimated at $246 billion over the first 25 years, with an additional estimated $13 billion awarded to the trial lawyers.

Even attorneys general who had been publicly critical of the state lawsuits, such as Alabama’s William Pryor, were induced to sign the MSA. Tobacco companies would raise cigarette prices in all states to cover the settlement costs, which meant smokers in every state would be paying for it, even if a state refused to sign on.

Big Tobacco Got Protections

To safeguard the new revenue stream, states agreed to protect Big Tobacco from competitors by imposing a special set of taxes and regulations. When competitors, so-called “Nonparticipating Manufacturers” (NPMs), unexpectedly found ways to grow and gain market share, the states responded by changing the rules, forcing NPMs to make higher payments.

As Vermont Attorney General William Sorrell explained in a “privileged and confidential” missive to his colleagues in 2003, “all states have an interest in reducing sales by Nonparticipating Manufacturers in every state” in order to prevent NPMs from gaining market share and shrinking settlement payments to the states.

The tobacco model represents a radically new mode of governing, Kazman said. The American system of separation of powers reserves lawmaking power to the legislature and law enforcement powers to the executive branch, of which the attorney general is a part. When the state’s law enforcer uses prosecutorial powers to make new tax and regulatory policy, it’s often without a vote of the legislature or input from taxpayers.

Since the tobacco settlement, state attorneys general have used investigations and lawsuits to target other industries, including pharmaceutical companies, investment banks, insurers, utilities, and mutual funds.

Christine Hall-Reis ([email protected]) is director of communications at the Competitive Enterprise Institute.

For more information …

A copy of the Competitive Enterprise Institute’s constitutional challenge to the multi-state settlement with the tobacco industry is available online at http://www.cei.org/pdf/4735.pdf.