Appellate Court in Pennsylvania Affirms Commonwealth's $126 Million Victory Over Big Tobacco


When an arbitration panel of three former federal judges ruled in favor of the big Tobacco companies, allowing those companies to reduce by $126 million the annual payment owed to the Commonwealth of Pennsylvania under the 1998 Tobacco Master Settlement Agreement (“MSA”), the Commonwealth brought in the appellate team from Orrick, Herrington & Sutcliffe to turn that ruling around.  The Orrick team, led by partner Bob Loeb, convinced the Court of Common Pleas that the arbitration panel had exceeded its powers, and now after briefing and an en banc oral argument, the Commonwealth Court has affirmed.  The Pennsylvania appellate ruling is the first on this important MSA issue, which is also pending is several other states.  The ruling increased the payment to Pennsylvania by $126 million (funds used in part for cancer research, health care and smoking cessation programs), and it should help prevent future similar reductions of the payments owed to Pennsylvania and to other states as well. 

The MSA requires the tobacco companies to make annual payments to compensate the states for tobacco-related health care costs they anticipated incurring due to the harmful effects of cigarette smoking.  The annual payment owed to Pennsylvania was over $370 million.  There can be a reduction in the annual payment, called the NPM Adjustment, for loss of market share to tobacco companies that did not sign the MSA, if it is shown that a state was not diligent in enforcing certain laws against the nonparticipating companies. But if a state manages to avoid incurring a NPM Adjustment to its annual payment by showing it “diligently” enforced the relevant laws, its share of the overall NPM Adjustment is shifted the remaining states and can reduce their annual payments.

During an arbitration to decide the states’ diligence, some 20 states facing such reductions of their annual payments entered into a side deal with the tobacco companies where they gave up a significant percentage of their annual payments.  The tobacco companies then argued to the arbitration panel that part of the NPM Adjustment responsibilities borne by the settling states should be shifted onto the remaining states that did not prove their diligence for that fiscal year.  The arbitration panel agreed, allowing an additional $126 million reduction to the Pennsylvania payment, as well as multimillion dollar reductions to the payments owed to New Mexico, Indiana, Maryland, Kentucky and Missouri. 

The en banc Commonwealth Court affirmed the trial court’s decision and held that panel had overstepped.  The Court recognized that review of an arbitration panel’s contract interpretation is highly deferential under both state and federal law.  What is not allowed, the Court explained, is adopting a reading the contract that is not rationally derived from the agreement.  The Court held that the panel’s ruling “did not draw its essence from the MSA because the panel departed from the MSA’s clear and unambiguous language regarding reallocation.”  “By fashioning its own award that deviated from the contract terms, the panel did not enforce the terms of the MSA.  Rather, the panel fashioned a new contract for the parties under the guise of contract interpretation.”  The Court thus concluded that, under any standard of review, “the arbitration panel exceeded its powers.”

The appeal was handled by Bob Loeb and Alec Orenstein from Orrick, together with Tad Berger, Paul Jarabeck, Joel Ressler and Sharon Rogers from the Pennsylvania Office of the Attorney General.  The Orrick team representing Pennsylvania also includes Jonathan Guy, Kathleen Orr and Aaron Rubin.