The negotiations between the federal government and the tobacco industry-not
surprisingly-have degenerated into a shoving match. While Clinton, Gingrich and
McCain elbow each other over who will be toughest on tobacco, the industry has
spurned Congress' attempt at a compromise.
But if the tobacco industry hopes to survive, it has little choice but to
accept whatever the federal government offers it.
When the tobacco companies rejected Senator John McCain's bill in April,
claiming it would sink the industry, anti-tobacco forces declared the industry
was crying wolf. Although the deal would have raised the domestic price of
cigarettes by at least $1.10 per pack over the next five years, tobacco sales
abroad are booming where the price tag on a pack of cigarettes is two to three
times as high as in the United States. Not exactly a recipe for total industry
collapse, especially given the industry's considerable wealth of non-tobacco products.
But the threat of bankruptcy was real for the divisions of Philip Morris, RJR
Nabisco, Loews, Brooke Group and B.A.T. that sell tobacco products within the
United States. McCain's bill includes a provision protecting the assets of the
parent companies, leaving only the domestic
tobacco segments of the conglomerates vulnerable to litigation, and capping
their exposure at $6.5 billion a year. Since these domestic subsidiaries
control less than a third of the industry's total assets,
it is unlikely they would be able to support themselves against litigation on
their own for long. A few blockbuster judgements would either force the
subsidiaries into Chapter 11-in which case they could
continue selling cigarettes with the profits going to creditors rather than to
the parent companies-or the parent companies could step in and pump money into
a losing enterprise.
Wall Street analyst Gary Black of Sanford and Bernstein insisted the McCain
bill would bankrupt the industry. Beyond the vulnerability of the subsidiaries,
Black said the basic components of the deal would saddle tobacco companies with
a burden too cumbersome to bear. In addition to
the $516 billion Big Tobacco would have to pay to the federal government over
the next 25 years, Black said the deal's look-back penalties would actually
raise the price of cigarettes to $1.80 a pack. And according to Black, the $6.5
billion cap would hurt the industry more than it would
help it. He described the cap as a giant piece of flypaper that would attract
tens of thousands of new claims as lawyers line up to get their share of
"As a shareholder, I would take the $1.10 excise tax Congress will likely
impose if the industry does not accept the settlement and avoid the payments to
the feds and the liability cap. The cap is worthless to the industry," Black
said. Black's employer, Sanford & Bernstein is, in fact, one of the top ten shareholders of Phillip Morris stock with 30,830
Tobacco executives may have found these hazards daunting, but it is hard to
imagine that going to court without the protection of the settlement is any
more inviting. By rejecting the settlement's safeguards and taking its chances
in court, the tobacco industry has a much greater likelihood of crumbling.
"If this settlement doesn't go forward, the industry will be
killed,"Mississippi Attorney General Mike Moore said in January. "There's no
question in my mind. The state's lawsuits will put the industry into
With a string of billion dollar settlements in state courts, the tobacco
companies no longer look unbeatable. The industry's $5 to $6 billion deal with
Minnesota last week was the sixth out-of-court settlement it has made since
last June. In each case the industry offered double, triple or --in
Mississippi's case-- quadruple the claim to avoid a trial. But it can't stall
forever. Washington state is preparing to try its $3.5 billion damage suit this
fall, with Massachusetts and Maryland waiting in the wings.
While legal experts have argued that not every state has a strong enough case
to win a settlement or win in court, the gathering momentum for the plaintiffs
in these cases makes the possibility of a tobacco victory unlikely. Already,
some states have moved beyond just seeking Medicaid expenses to going after
anti-trust, consumer protection, RICO claims and punitive damages. If the
industry were to lose any of these cases, it would set a new standard for
future cases. Big Tobacco, we can presume, doesn't want to see this happen.
So far, the industry has avoided having to pay a large judgment by settling
its cases and allowing damages to be paid over 25 years. But the fact that the
industry keeps settling will just encourage further litigation. When asbestos
companies such as Johns-Manville decided to settle cases in the early 1980s,
the number of lawsuits brought against them rose form 16,000 to 24,000 in less
than a year and a half.
If just one state wins a large judgment against the tobacco companies, it
could be the first step toward an industry-wide collapse. Market analysts and
legal experts agree that RJR Nabisco and the smaller tobacco companies might
lack the resources to pay the "good faith" bond they would be required to front
to appeal the case. It wouldn't be the first time. In 1987, for instance, when
Texaco lost a $10 billion judgment to Pennzoil, the company filed for
bankruptcy because it could not afford the $10 billion appeal bond.
Let us not forget that tobacco companies initiated settlement talks with
Congress in the first place to avoid bankruptcy. Each case costs the industry
$150,000 a year to fight. There are now approximately 500 cases pending against
the industry including labor unions hoping to recover health and welfare benefits and individuals filing class action
lawsuits. If that number were to double to 1,000, a low estimate considering
the 400,000 people who die each year from smoke related illnesses, the industry
would have to pay $150 million a year in litigation fees alone. Add settlements
and court judgements to that figure, and the potential liability of the
industry clearly exceeds its entire $150 billion market value.
Senior Vice President of Philip Morris Steve Parrish said the industry
supported the June 1997 settlement deal because "we could find common
ground...I think that the attorneys general, for example, realized that
bankruptcy of the tobacco industry is not going to solve the youth smoking
issue. It's not going to solve the public health issues that are addressed in
this comprehensive resolution, because there will just be new
manufacturers...There could very well be a black market. And I don't think
anybody wants that." But tobacco changed its tune when the Senate voted a much
tougher deal, raising the ante to $507 billion and eliminating most of the
provision for immunity. They walked away from the bargaining table saying the
new legislation would bankrupt the industry.
But chances are, no one involved in the tobacco negotiations will allow the
industry to go down. Tobacco executives don't want to see the destiny of the
business fall into the hands of a bankruptcy judge. And too much money is at
stake for the country's healthcare system, for the attorneys trying these cases and especially for the investors and pension funds
still holding tobacco stocks.
Legal experts agree that if the industry were to file for bankruptcy, it would
almost surely file for a reorganization under Chapter 11, rather than declaring
itself insolvent under Chapter 7. As mentioned earlier, Chapter 11 would allow
tobacco companies to continue selling cigarettes to pay their debts. While the
move would temporarily halt the onslaught of lawsuits, it would also transfer
control of the companies to a bankruptcy judge. And a judge could make things
very uncomfortable for tobacco companies by choosing to disclose all of the
industry's documents to the public or demanding more direct disclaimers of
possible health hazards of their products.
Bankruptcy lawyers and creditors would have first priority in getting to the
industry's assets. Medicaid claimants would be next in line, but they could
probably expect less money and a more difficult time getting it. Private
lawyers trying the cases would rank low on the list of money
recipients because they would have no direct claim on the industry's assets.
Investors in tobacco stocks will be the last to see any money if the industry
crashes. But many within the anti-tobacco movement say that is exactly what
those who have profited from cigarettes deserve.
"They will have gambled and lost," said Stanton Glantz, Professor of Medicine
at the University of California, San Francisco. "They will have bet that the
stock was undervalued and that it would go up. I don't see why we should
sympathize with someone who bet wrong on a product that kills people."
Tobacco shareholders have weathered these waves of litigation in the past and
come out ahead. The price of tobacco stocks have dropped during previous waves
of litigation -- first between 1959 and 1964, second between 1982 and 1987. In
each case, the stocks rebounded after the industry survived the litigation.
Shareholders may not be so lucky in this third wave. Already stocks have
reacted to every concession the industry has made in court.
For instance, during the middle of March, 1996, when the
Liggett group settled with five states, Philip Morris stock
dropped six points in one week, only to gradually rise again as investors
scooped up what they saw as undervalued stock. Tobacco stocks cannot count on
such buoyancy, however, after a large judgement against the industry or after a
long series of state settlements.
Financial analysts such as Sanford & Bernstein's Gary Black have said
stocks will continue to be undervalued until the fate of the industry is
certain. That is another reason why tobacco executives, hoping to boost stock
prices, began negotiating a settlement. But the McCain bill failed to offer the
liability protections the industry had been hoping for, thus failing to provide
shareholders with any certainty about tobacco's future in the market. No
wonder the industry has rejected the deal.
But what about those who have an indirect stake in the market such as
California public employees? These pension fund holders have been exposed to
the risk of an industry bankruptcy without much say in the matter. The
California Public Employees Retirement System (CalPERS),
providing retirement and health benefits to over one million state employees,
has over $1 billion invested in foreign and domestic tobacco stocks. A court
judgement could cause the tobacco stocks to plummet and leave CalPERS holding
the bag. While it may be easy to paint tobacco investors as gamblers, it's hard
to see CalPERS members as anything but victims.
Few want to see the industry capsize. Too much can be gained in a settlement;
too much will be lost in bankruptcy. The tobacco bosses had best swallow their
pride and begin negotiating with Congress again, or be prepared to drag a lot
of people down with a sinking ship.
Matt Isaacs is a freelance writer and a student at the University of
California at Berkeley Graduate School of Journalism. He has worked with the
Center for Investigative Reporting and FRONTLINE. His articles have appeared
in the Bay Guardian, The Progressive and the Sacramento News and
Review. He also produces a public policy radio show in San Francisco
A shorter version of this article will appear in the June 1st issue of The
the criminal probe .
will there be a deal? .
a look at the depositions .
big tobacco - what's at stake .
links & readings .
tapes & transcripts .
frontline online .
web site copyright 1995-2013 WGBH educational foundation