Tobacco's Month of Living Dangerously
Cigarette makers say their legal troubles are waning. But appeals in three big lawsuits being heard this month could prove otherwise.
(FORTUNE Magazine) – ALTRIA associate general counsel William Ohlemeyer sounded confident at a late-October press conference. He was belting out the many "compelling" reasons to anticipate that the Florida supreme court would choose not to reinstate the $145 billion punitive-damages award that a Florida jury had lodged against the industry in July 2000. The verdict, in the so-called Engle case, had been thrown out by an appeals court in May 2003, but the state supreme court was hearing the appeal in November. If the verdict is reinstated, Altria's Philip Morris USA unit (PMUSA) will be on the hook for $74 billion of it.
A week later, Ohlemeyer sounded just as confident at another press conference. There, he outlined reasons to expect the Illinois supreme court, after hearing arguments in what's known as the Price case, to overturn the $10.1 billion verdict that a judge entered against PMUSA in March 2003. Price is one of many statewide consumer-fraud class actions that have been filed in at least 17 states against all the major tobacco companies. These cases allege that the companies fraudulently touted their "light" (low-tar) cigarettes as being safer than regular brands when, in fact, they may have been more dangerous.
Six days after that, Ohlemeyer trotted out his unflinchingly confident persona at yet another press conference. He explained why Altria expects to win an interim appeal concerning the ongoing civil RICO trial in which the U.S. Department of Justice seeks to force the majors to disgorge $280 billion in profits. (That number represents the companies' approximate income--before taxes!--from every pack of cigarettes sold domestically since 1971 to any "youth-addicted" smoker, i.e., someone who smoked five or more cigarettes a day by age 21.) The appeal, before the U.S. Court of Appeals for the District of Columbia, is over whether the government is really empowered to seek such disgorgement under the civil RICO laws.
Finally, Ohlemeyer still sounded confident--if maybe a tad ticked off--when FORTUNE asked him about worst-case scenarios. Like, for instance, what would happen if, just supposing now, the industry does not pull off a perfect hat trick with respect to this trio of nuclear-warhead-sized legal threats. "I think it's a hypothetical exercise," Ohlemeyer protested. "We have 50 years of litigation experience. We've had some pretty significant and challenging legal issues we've confronted and overcome in the past. You could assume there's going to be a depression next year too." Then, grudgingly, as if discussing what would happen if an asteroid hit PMUSA headquarters in Richmond, he acknowledged the consequences of losing one of the cases and failing to persuade the U.S. Supreme Court to overturn it. "From legal, practical perspectives, if one of these cases is ultimately resolved unfavorably, then, yes, that would present a unique, considerable challenge to the ability of the company to conduct business uninterrupted, unimpeded by these obligations."
Truly, November has been Big Tobacco's month of living dangerously. These appellate arguments remind us that, for all its braggadocio, the industry continues to operate on the edge, bobbing and weaving around a constant barrage of monstrous hazards like a latter-day Super Mario.
Before handicapping the industry's prospects in those three cases, we should acknowledge that Ohlemeyer has grounds for short-shrifting worst-case scenarios. The conventional and largely unassailable wisdom among both industry insiders and analysts is that the litigation environment for tobacco is steadily improving. (And that was true even before the Republican Party victories in last month's elections.) The U.S. Supreme Court's 2003 ruling in State Farm Mutual Auto Insurance v. Campbell, which said that punitive damages typically should not exceed nine times compensatory damages, cushions the companies from aberrational individual verdicts, and, perhaps, in the process diminishes the incentives to lawyers to bring such cases. PMUSA statistics show that the number of both individual and class-action cases against the company is dropping; that it has blocked more than 55 cases from going forward as class actions; and that its product-liability defense costs have actually been creeping downward, from $387 million in 2001 to $307 million in 2003. After some anxious moments triggered by the Price verdict last year--when the need to post an immediate $12 billion appeal bond nearly forced PMUSA into Chapter 11--the industry swiftly persuaded the legislatures of about 25 states to cap their bond requirements, at least when the company appealing is a tobacco company. (The states now have a stake in keeping the tobacco majors from going bankrupt, lest they stanch the flow of tobacco revenue--about $246 billion over 25 years--that they stand to collect under the 1998 settlements of the Medicaid reimbursement litigation.)
Still, the rules of the game haven't fundamentally changed: The industry makes an addictive product that, according to the Centers for Disease Control and Prevention, causes more than 400,000 premature deaths a year, and the industry can still be sued by the loved ones of any of those victims. In so-called comparative fault states, the smoker's choice to start smoking and failure to quit establish only that he may share responsibility for his plight--not that the cigarette company is exonerated. The assessment of relative fault will be performed by jurors drawn from a society that increasingly bans public use of tobacco products, fears the consequences of secondhand smoke, and airs public-interest television spots portraying tobacco executives as inveterate liars whose financial success hinges on hooking children on their deadly wares. Though tobacco lawyers are proud of their many courtroom successes, the industry's air of invincibility no longer extends beyond its headquarters buildings. Since 1999, for instance, PMUSA has won 23 verdicts and lost 15--a good record in the American League, but hardly a litigation history that should comfort investors. Though most of those 15 losses (including Engle and Price) are still on appeal, PMUSA paid its first judgment on a verdict in October--close to $4 million to an individual plaintiff--and more such payouts are inevitable.
As the November arguments in Engle,Price, and the DOJ case remind us, the industry's periodic assurances that major combat operations have ended does not mean that the tobacco wars are over.
THE ENGLE CASE was filed in May 1994, at the dawn of the most recent wave of tobacco litigation. It was brought just a few months after the filing of a pioneering federal suit called Castano, which was intended as a nationwide class action focusing on addiction alone as the injury for which compensation was sought. In this atmosphere, a Florida trial judge approved--or "certified"--the Engle class, which was even more ambitious than Castano. Conceived by Stanley and Susan Rosenblatt, a husband-and-wife team of attorneys and antismoking zealots, the Engle case sought to create a nationwide personal-injury class action to seek compensation for more than a dozen smoking-related diseases. In January 1996, a Florida appeals court limited the class to Floridians but otherwise affirmed the audacious project. (The class was then thought to number 40,000 smokers but is now estimated at between 280,000 and 700,000.)
A few months after the appeals court green-lighted the Engleclass, however, a federal appeals court decertified the Castano class on the grounds that individual issues "predominated" over common ones. That influential ruling seemed to turn the judicial tide against personal-injury smoking class actions, and most courts thereafter refused to certify them.
Nevertheless, the Engle case plunged forward on its unique course, completing the first two phases of an unorthodox, tripartite trial plan. After two years of trial, at which 157 witnesses testified, the jury determined that the tobacco companies had violated numerous legal duties and should pay collective punitive damages of $145 billion (about 18 times the defendants' cumulative net worth at the time). Compensatory damages were to be determined later through individual minitrials.
The Engle verdict was appealed to a different panel of the same appellate court that had green-lighted the class in 1996. But now, seven years later, that court saw matters in a different light. With the benefit of hindsight, it agreed with the Castano line of thinking--that individual issues predominated in these cases, making them unsuitable for class treatment. In May 2003 it threw out the jury's findings and decertified the class. The Florida supreme court then decided to review the case.
Now we will do what every appellate lawyer counsels the media never to do: read tea leaves from the judges' questions at oral argument. (Think "early exit polls.") Two judges seemed to be leaning toward reinstating the verdict, two against, and two just seemed desperate to salvage something from the previous decade of litigation. (The seventh judge had recused himself.) Industry protestations notwithstanding, this court did not look ready to junk Engleentirely.
THE PRICE class action in Illinois poses the same central question as Engle--do individual issues predominate over common ones?--but in the context of consumer fraud rather than personal injury. The claim here is not that plaintiffs were physically injured by smoking Marlboro Lights and Cambridge Lights but simply that they were economically injured because they wouldn't have bought low-tar cigarettes if they'd realized they were no safer than full-flavor brands. Courts have not yet arrived at a consensus about the suitability of class-action treatment for consumer-fraud cases. (The Massachusetts Supreme Judicial Court and an Ohio appeals court have each approved class-action suits against Lights, while a Florida appeals court has rejected one.)
Based on the particulars of this case, tobacco seems to have a good shot at winning this one. Many of the judge's findings in the case were disconcertingly counterfactual. Every survey of Lights smokers discussed in the case confirmed that a large percentage--a majority by some surveys--do not think Lights are any safer than regular cigarettes, and they choose Lights because they like the taste. That should not mean, of course, that those who were deceived should have no remedy, but it suggests that, at a minimum, the class needs to be pared down to those who were really defrauded. But the trial judge in Price did not do that. Instead, he found as a fact that every one of the 1.14 million class members was deceived by the "Lights" appellation or low-tar labels into thinking that the product was safer, and bought it as a result of the deception.
If you find that puzzling, wait till you hear the damages computation. Since a consumer-fraud case seeks only economic damages--money spent on Lights that wouldn't have otherwise been spent--calculating damages presents a quandary. To begin with, Lights have always cost the same as regular cigarettes. If smokers were defrauded into buying Lights rather than quitting, then they certainly suffered economic damage--but no class member made that claim. In fact, of the 23 who testified, 17 continued smoking Lights even after learning of the alleged fraud, including two who had heard about the accusation that Lights might actually be more dangerous than regulars. So to come up with damages, the plaintiffs conducted a survey of Marlboro Lights smokers to whom they posed the following hypothetical question. First, assume current Marlboro Lights are no safer than Marlboro regulars and may actually be more dangerous. Second, assume a hypothetical Marlboro Light cigarette existed that really was safer for every smoker, and that it cost and tasted exactly like real-world Marlboro Lights. Now here's the question: How much cheaper would the dangerous cigarette have to be for you to buy it instead of the hypothetical one? The survey answer was 92.3%, and that became the measure of damages. Multiply 92.3% by the price of every pack of Marlboro Lights and Cambridge Lights ever sold in Illinois and you get $7.1 billion in compensatory damages--of which $1.78 billion was apportioned to the plaintiffs attorneys as fees. The judge then tacked on $3 billion for punitives, and voilà: a $10.1 billion verdict. (Did we mention that thiscase arose in Madison County, which has a national reputation for being aberrationally pro-plaintiff?)
THE APPEAL in the Department of Justice case involves very different issues from those in Engle or Price. While the tobacco lawyers here are making a plausible, scholarly argument, it is a bit of a long shot. They contend that Congress, when it wrote the civil RICO law--which is primarily concerned with preventing future wrongdoing--never gave the government the power to seek disgorgement of past proceeds from wrongdoing. (In a criminalRICO case, the law says explicitly that the government can seek forfeiture of ill-gotten gains.) If the industry wins on this issue, then the $280 billion disgorgement claim vanishes, and the case can be settled. (The government seeks some other injunctive relief, but that's not what's holding up a resolution.)
If Big Tobacco loses the disgorgement appeal, on the other hand, it still lives to see another day, because the government has to prove that it's entitled to the $280 billion, which is a big undertaking. That's what it's trying to do now at the trial in the federal district court. That trial is expected to last into spring.
In fact, however, no matter how the disgorgement issue is decided by the appeals court, this case will very likely be settled. Federal officials have already said that they do not seek to bankrupt the major tobacco companies, and the 50 state governments certainly don't want them to, because, again, bankruptcy would interrupt the flow of their booty from the 1998 Medicaid settlements. The tobacco companies, for their part, do not want to risk being found to be "racketeers" (RICO is the Racketeer Influenced Corrupt Organizations Act.) That would be bad public relations and might expose them to a new wave of private civil RICO actions seeking treble damages.
Surveying the horizon, there is one other discernible nuclear-weapon-sized threat to the tobacco industry that requires mention. The device is being assembled in federal court in Brooklyn by Judge Jack Weinstein--the J. Robert Oppenheimer of class-action innovators--but it will not be deployable for at least another couple of years. It's unclear so far whether it is designed to bring an end to the industry or to the litigation, which could explain why it is opposed by both the companies and the Association of Trial Lawyers of America.
At first glance the case, known as Simon II, looks like curtains for the industry: It's a nationwide class-action personal-injury punitive-damages case. In that respect it would be like Engle, but nationwide (except for Florida). The stated goal, though, is different. While punitive damages are typically assessed against mass-tort defendants over and over and over by different courts for the same course of wrongdoing, the U.S. Supreme Court has said that there is a theoretical constitutional limit to the cumulative sum that can be rung up. Judge Weinstein's goal is to quantify that theoretical limit, award it, and then help "close the book" on tobacco litigation, as he wrote when he certified this class in 2002. (Smokers would theoretically still be able to sue for compensatory damages after Simon II. But without the prospect of punitive damages, few lawyers would want to represent them, because individual cases are so expensive and risky.) Since punitive damages are not supposed to bankrupt defendants, the cumulative award eventually levied--though massive--would theoretically have to be something the industry could handle. The U.S. Court of Appeals in New York heard argumentson the propriety of the Simon IIclass action a year ago, but has not yet ruled.
Not to worry, though. Altria associate general counsel Ohlemeyer is confident that Simon II will be decertified.