On July 28, the Iowa attorney general’s office filed suit against Philip Morris, USA, R.J. Reynolds Tobacco Co., and 16 other tobacco companies, accusing them of defrauding Iowa of over $133 million by allegedly engaging in bad faith disputes over amounts due under the Master Settlement Agreement (MSA).

Tobacco company signatories to the MSA, also known as participating manufacturers (PMs), must pay the settling states their portion of $9 billion dollars on an annual basis. These payments are subject to a handful of various upward and downward adjustments, one of which is known as the “Non-Participating Manufacturer Adjustment” or “NPM Adjustment.” The NPM Adjustment may reduce the amount of money a state is due from the PMs in a given year if the state did not enact and “diligently enforce” an “escrow statute,” requiring non-participating manufacturers (NPMs) to place money in proportion to their sales made into that state into an escrow account.

The rationale for the NPM Adjustment is that, as a result of complying with the MSA, the PMs may suffer a loss of market share due to the financial advantages gained by NPMs who are not signatories to the MSA and therefore do not bear the marketing restriction and payment obligations of the MSA. As part of the MSA bargain, each settling state had the option to pass and diligently enforce an agreed model statute that obligated NPMs to make escrow payments on their “units sold” into that state. If the state failed to pass that statute, or failed to diligently enforce it, it would risk having the NPM Adjustment applied to it (albeit capped by the PMs’ full annual payment owed to the state). In other words, a “non-diligent” state could suffer a complete loss of its annual MSA payment, creating a potentially significant budgetary hit as many states have come to depend on MSA payments to balance their annual budgets.

The settling states and the PMs spent years disputing how the NPM Adjustment dispute should be resolved, with each state seeking to have its liability decided in its state courts rather than in arbitration. Only Montana succeeded in convincing its judiciary that Montana’s liability for the NPM Adjustment should be resolved entirely in Montana state court. All the rest were required to submit the dispute to binding arbitration before a panel of three neutral arbitrators (all former Article III federal judges) under the MSA’s arbitration provision.

When a PM believes an NPM Adjustment should apply to a particular state, it can place the money in a Disputed Payments Account or not pay it until the appropriate NPM Adjustment is determined. Iowa alleges that since 2006 and in every year thereafter, the defendant tobacco companies have, at least as to Iowa, disputed the NPM Adjustment in bad faith, without evidence that Iowa has failed to diligently enforce its escrow statute, and as part of a scheme to generally withhold MSA payments. Iowa claims that defendants have both tied up money in the Disputed Payments Account and simply withheld it, resulting in a lower annual MSA payment to Iowa than it might otherwise receive. Iowa brings its claims under the MSA itself, the related state court Consent Decree, and the Iowa False Claims Act, and asks the court for damages equal to the amount allegedly wrongly withheld, treble damages, punitive damages, and maximum statutory penalties under the Iowa False Claims Act. Iowa further requests declaratory and injunctive relief.

An important matter for the court’s consideration will be whether it has jurisdiction over this dispute. The MSA requires that “any dispute, controversy or claim arising out of or relating to calculations performed by, or any determinations made by, the [independent auditor tasked with determining amounts owed to each state] be submitted to binding arbitration before a panel of neutral arbitrators.” The courts of 47 states and territories, including Iowa, have ruled that states’ claims related to diligent enforcement and application of any adjustments are subject to this binding arbitration provision. Iowa claims that the Iowa District Court for Polk County has jurisdiction based on other provisions in the MSA and the state’s related Consent Decree that give the District Court jurisdiction over “implementing and enforcing” the MSA and the Consent Decree. It remains to be seen whether the court will agree that it may hear this dispute, or if it will take the position that, despite Iowa bringing the case under the Iowa False Claims Act, the matter continues to be “arising out of or relating to calculations performed by” the independent auditor.

It also remains to be seen whether other states will bring similar suits against the defendant PMs. Montana filed an almost identical complaint in 2020 under then-Attorney General Tim Fox, which led to a settlement, requiring the tobacco company defendants to pay all the funds withheld from Montana up until 2020, plus a waiver of future similar claims through the year 2030. The total value of the settlement to Montana was over $100 million over 10 years. It bears noting that, in conformance with the troubling trend of hiring deep-pocketed plaintiffs’ law firms increasingly followed by certain state attorneys general’s offices, Iowa has hired experienced plaintiffs’ counsel from the private bar. In this case, Iowa has hired two Montana law firms and one Florida law firm to represent it in the suit at hand, with the Florida law firm employing former Montana Attorney General Tim Fox.

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Photo of Christina Sava Christina Sava

Christina is an attorney in the firm’s Regulatory Investigations, Strategy + Enforcement (RISE) Practice Group. She helps clients navigate local, state, and federal regulations affecting the tobacco, hemp, and cannabis industries – including ancillary service providers. She brings extensive experience in the cannabis…

Christina is an attorney in the firm’s Regulatory Investigations, Strategy + Enforcement (RISE) Practice Group. She helps clients navigate local, state, and federal regulations affecting the tobacco, hemp, and cannabis industries – including ancillary service providers. She brings extensive experience in the cannabis industry to her work in the tobacco, nicotine, and vapor space, giving her a deep understanding of the challenges and opportunities of launching new products and marketing campaigns in a shifting regulatory landscape.

Photo of Agustin Rodriguez Agustin Rodriguez

Agustin is sought after by clients for his strategic counsel on their most challenging competitive and regulatory compliance issues, including tobacco Master Settlement Agreement issues, federal and state enforcement investigations, licensing and excise tax issues, developing compliance programs, and evaluating advertising and marketing…

Agustin is sought after by clients for his strategic counsel on their most challenging competitive and regulatory compliance issues, including tobacco Master Settlement Agreement issues, federal and state enforcement investigations, licensing and excise tax issues, developing compliance programs, and evaluating advertising and marketing practices. A partner in the firm’s Regulatory Investigations, Strategy + Enforcement (RISE) Practice Group as well as its Tobacco and Cannabis law practices, he represents manufacturers, distributors, retailers, and suppliers in all aspects of their businesses, including regulatory compliance, FDA requirements, administrative disputes involving federal or state governmental entities, mergers and acquisitions, commercial agreements, and taxation matters.

Photo of Chris Carlson Chris Carlson

Chris Carlson represents clients in regulatory, civil and criminal investigations and litigation. In his practice, Chris regularly employs his prior regulatory experience to benefit clients who are interacting with and being investigated by state attorneys general.