No. 72 - State of New York v Philip Morris Incorporated

This case arises from the 1998 settlement of a lawsuit brought against major American tobacco companies by New York and 45 other states, as well as the District of Columbia and five territories, to recover health care costs associated with smoking. In the Master Settlement Agreement (MSA), participating manufacturers agreed to make annual payments to the settling states and to accept significant restrictions on their advertising and marketing of tobacco products in exchange for the states' release of current and future claims against them. An independent auditor determines the amounts of the manufacturers' annual payments, whether any adjustments apply, and how the payments are allocated among the states.

This dispute stems from the auditor's refusal to apply the Nonparticipating Manufacturers (NPM)
Adjustment to reduce the $6.2 billion payment due from participating manufacturers for 2004. The NPM Adjustment is designed to compensate participating manufacturers for loss of market share to nonparticipating companies resulting from the MSA's restrictions, which place the participating manufacturers at a competitive disadvantage. For it to apply, the auditor must find that there was a loss of market share and that the MSA was a significant factor. However, the NPM Adjustment does not apply to any state that has enacted a "qualifying statute" and "diligently enforced the provisions of such statute during the entire [prior] calendar year." A qualifying statute requires all tobacco companies selling cigarettes in the state to either join the MSA or deposit into escrow an amount equivalent to what they would have owed under the MSA. In calculating the 2004 payment, the auditor found there had been loss of market share and that the MSA was a significant factor, but refused to apply the NPM Adjustment based on representations by the National Association of Attorneys General that all of the settling states had enacted qualifying escrow statutes and diligently enforced them.

Participating manufacturers objected to the auditor's determination and sought arbitration. When the states refused, three companies -- Commonwealth Brands, King Maker Marketing, and Sherman 1400 Broadway N.Y.C. -- filed this motion to compel arbitration. The MSA generally reserves to state courts jurisdiction to enforce the settlement agreement, but it carves out several exceptions. The manufacturers cited one that provides any dispute "arising out of or relating to calculations performed by, or any determinations made by, the Independent Auditor (including, without limitation, any dispute concerning the operation or application of any of the adjustments
[including the NPM Adjustment] ... shall be submitted to binding arbitration before a panel of three neutral arbitrators" who are former federal judges. Supreme Court ruled the dispute was not subject to arbitration under the MSA, concluding that a court should decide whether New York diligently enforced its escrow statute.

The Appellate Division, First Department reversed and granted the motion to compel arbitration. It said, "The Independent Auditor's decision not to apply the NPM Adjustment, and the dispute over whether that adjustment should have been applied, clearly 'aris[es] out of' that decision and is certainly 'relat[ed] to' it, thus making it a proper subject for arbitration pursuant to the plain terms of the MSA." The court also said "... there is a compelling logic to having these disputes handled by a single arbitration panel of three federal judges, rather than numerous state and territorial courts."

The State argues, in part, that the MSA charges courts, not arbitrators, with determining whether a state has diligently enforced its escrow statute, a determination that "would be well outside the ordinary competence and purview of an accounting firm." The State argues that a determination of diligent enforcement is a precondition for the auditor's application of the NPM Adjustment, but is not a determination made by the arbitrator, and only determinations actually made by the auditor are arbitrable under the MSA.