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Employing broad language, the Appellate Division, First Department, handed tobacco companies a victory yesterday by ruling that disputes over reductions in their payments to the states under a $206 billion nationwide settlement must go to arbitration. The ruling has enormous fiscal implications for the states since the reduction could amount to more than $1 billion a year. Under the 1998 settlement, which compensates states for funds they spent under Medicaid for treating smoking-related illnesses, the states receive $6.2 billion annually from the 45 companies participating in the settlement. New York’s annual payments have been running around $800 million. Yesterday’s ruling, by Justice John W. Sweeny Jr., stems from a dispute over whether an adjustment in payouts should have been applied in 2004. The amount of the adjustment has been determined to be about $1.1 billion, but Philip Morris, which is entitled to about one third of the reduction, has said it will not seek its share for 2004. The reduction was provided in the agreement to protect participating companies from being disadvantaged by the advertising and marketing restrictions imposed by the pact. About 80 cigarette manufacturers operate outside the agreement. The 45 companies are entitled to the reduction if they can show that their participation in the pact was a significant factor in their market share loss. However, individual states could avoid the reduction if they can demonstrate that they “diligently enforced” model statutes designed to even the playing field between companies that participated and those that did not. In addition to Philip Morris, the two other largest U.S. cigarette makers participated: Lorillard Tobacco and R.J. Reynolds Tobacco. Under the model statute, the states are required to collect 2 cents for every cigarette sold by the non-participating companies. The companies operating under the pact contend that the states have failed to collect that fee from cigarettes sold in the burgeoning, and often illegal, Internet trade. New York contends that its obligation is only to collect the fee on sales of cigarettes that are reported to the state and taxed. Initially, three of the smaller companies, led by Commonwealth Brands Inc., had sought to compel arbitration after a determination was made in 2003 that the participating companies had suffered a 6 percent market share loss. All three had joined the pact subsequent to its signing in 1998. The market-loss determination had been made by PricewaterhouseCoopers, the firm appointed by the parties under the agreement. Since then, the two sides appointed Battle Group, a San Francisco firm, to determine the degree to which participation in the pact was a significant factor in market-share decline. The Battle Group recently derived the $1.1 billion figure for the reduction. As yet there has been no determination that any state has failed to diligently enforce its statute to collect funds from the non-participating companies. Those funds are required to be held in escrow to meet future liabilities. Supreme Court Justice Charles E. Ramos (See Profile) agreed with the state that that arbitration was improper because no significant factor determination had been made. The 2005 decision was issued before Battle Group made its determination. In State of New York v. Philip Morris Inc., 400361/97, the First Department unanimously disagreed with Justice Ramos. The decision will be published Wednesday. Justice Sweeny said the settlement agreement evinces a “clear intent” that any matter arising out of calculations concerning the adjustment are a proper subject of arbitration. He agreed with the reasoning of the Connecticut Superior Court, which also addressed the arbitration issue in State of Connecticut v. Philip Morris, 2005 Conn. Super LEXIS 2067. Justice Sweeny wrote that “chaos can result from numerous tribunals addressing identical issues.” In addition, he noted, whenever a state is found to have diligently enforced its statute, it escapes the reduction but the other states have to assume its share. As a result, he wrote, “each governmental signatory has its own self-interest at stake in the outcome of this issue, which is necessarily in conflict with every other state.” With the level of the reduction assessed in 2004 now having been set by the Battle Group, the only issue to be determined is whether the states have diligently enforced their statutes. The panel also included Justices George Marlow, Eugene Nardelli and Milton Williams. David M. Noscenti, counsel to the attorney general who represented the state, said the 1998 settlement provides that state courts, not the arbitration panel, are the forum in which questions about a state’s diligent enforcement should be resolved. “We are reviewing the First Department’s decision to decide whether to seek leave to appeal,” he added. Robert Brookheiser, the counsel for Commonwealth Brands, argued its case. Joshua K. Leader and Joseph G. Colao, of Leader & Berkon, also represented Commonwealth Brands. In addition to Mr. Noscenti, Assistant Attorneys General Caitlin J. Halligan, Daniel Smirlock and Richard Dearing represented the state. Philip Morris, as amicus curiae, was represented by Alexander Shaknes of DLA Piper Rudnick Gray Cary US. Peter A. Bellocosa of Kirkland & Ellis filed an amicus curiae brief for R.J. Reynolds Tobacco Co. Andrew J. Haile of Brooks, Pierce, Mclendon, Humphrey & Leonard filed an amicus brief for Lorillard Tobacco Company as did Robert J. Spagnoletti, attorney general for the District of Columbia, on behalf of all the settling states other than New York. Bennett Rushkoff and Edward E. Schwab worked on the states’ brief. � Daniel Wise can be reached at [email protected].

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