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June 17, 2002


The opinion of the court was delivered by: Sylvia H. Rambo, United States District Judge


Before the court is Defendants' motion to dismiss Plaintiffs' complaint pursuant to Federal Rule of Civil Procedure 12(b)(6), or, in the alternative, pursuant to Rule 12(b)(7). The parties have briefed the issues, and the motion is ripe for disposition.

I. Background

Plaintiffs' complaint, filed on January 10, 2002, alleges the following:

A. Introduction and Parties

Plaintiffs challenge certain provisions of the Master Settlement Agreement (hereinafter the "MSA") that the four largest United States tobacco companies (the "Majors") entered into with forty six states on November 23, 1998. Plaintiffs allege that the MSA violates Section 1 of the Sherman Act, 15 U.S.C. § 1, as well as the Commerce and Compact Clauses of the United States Constitution.

Plaintiffs are all Pennsylvania residents and cigarette consumers. Defendant Michael Fisher is the Attorney General of Pennsylvania, and Defendant Larry Williams is the Secretary of the Pennsylvania Department of Revenue. Defendant Fisher was one of eight state Attorneys General that negotiated the MSA, and his office receives the payments from the settlement. Defendant Williams collects the revenues from the settlement. The Masters — Philip Morris, Inc., R.J. Reynolds Tobacco Company, Brown & Williamson Tobacco Corp., and Lorillard Tobacco Company — are not named as Defendants in the instant suit because the Third Circuit has held that the Noerr-Pennington immunity doctrine shields them from liability from suit. (Compl. at ¶ 10 (citing A.D. Bedell Wholesale Co. v. Philip Morris, Inc., 263 F.3d 239 (3d Cir. 2001).)

B. The Relevant Market

The relevant market for Plaintiffs' antitrust action is the sale of tobacco products by cigarette manufacturers and importers of cigarettes in the United States. This market is highly concentrated. "For decades, the market consisted of six major manufacturers" which included the Masters, American Tobacco Company, and Vector Group. (Compl. at ¶ 12.) When the MSA was negotiated in 1998, the Majors collectively accounted for more than 98% of sales in the domestic market. In the first six months of 2001, the Majors had in creased prices for cigarettes by 60%, and had a combined market share of 93.6%. The rest of the market is comprised of small manufacturers and importers.

Domestic cigarette consumption has not declined since the MSA was entered into. In 1999, there was a 10% decline in the shipments of cigarettes, but in 2000, shipments increased. At the manufacturers' level, industry revenues have increased from $21 billion in 1997 to $45 billion in 2000.

C. The MSA

The MSA was negotiated as a result of a series of lawsuits brought or threatened by the states against the Majors and other companies and organizations in the tobacco industry. The states sought to recover Medicaid funds expended in treating tobacco related diseases. Pennsylvania filed suit against the Majors in April 1997. Pennsylvania v. Philip Morris, Inc., No. 9704-2443 (Ct. Com. Pleas, Phila. County, April 1997). The suit was settled as part of the MSA.

Pursuant to the MSA, the Majors agreed to pay the settling states initial and annual payments totaling $206 billion over the first twenty-five years and $9 billion annually after that. The MSA also includes marketing restrictions, regulations of lobbying, and "restrictions on association." (Compl. at ¶ 18.) These restrictions have further entrenched the Majors' market share.

The Majors required that the MSA include structures so that the Majors could fund transfers of billions of dollars to the states by having wholesalers and consumers pay artificially high prices for cigarettes. The prices charged by the Majors since the MSA was entered into have generated revenue far in excess of what is needed to fund the MSA end have enabled the Majors to spend record amounts on advertising.

D. The Output Cartel Created by the MSA

Certain provisions of the MSA restrict the output of the Majors' competitors and prevent the competitors from gaining market share. The MSA was designed to destroy the free market for cigarettes so that consumers would not be able to choose lower priced products of companies that did not raise prices to fund the MSA. The state Attorneys General crafted the MSA to save the Majors and "ensure a perpetual shared and unregulated monopoly for [the Majors]." (Compl. at ¶ 20.)

The MSA prevents Subsequent Participating Manufacturers ("SPMs") and Non-Participating Manufacturers ("NPMs") of cigarettes from expanding their market share and prevents new competitors from entering the market. The MSA coerces smaller companies to join the MSA, and furthers a tradition of anti-competitive conduct. The MSA displaces competition in the cigarette industry in the following ways: (1) it contains discount sales by small competitors; (2) it prevents the entry of new competitors at the discount end of the market; (3) it prevents significant price competition among the Majors; and (4) it permits significant price increases through tacit agreements to raise prices.

The MSA has two provisions that stifle price competition. First, it requires each state to enact a "Qualifying Statute" that "effectively and fully neutralizes the cost disadvantages that the Participating Manufacturers experience vis-a-vis Non-Participating Manufacturers within such settling State. . . ." (Id. at ¶ 24 (citing MSA § IX(d)(2)(E).). The Qualifying Statutes require NPMs to pay "massive amounts" into an Escrow Fund for the payment of potential damages in future health care liability suits. A $50 million "enforcement" fund was established to finance enforcement of the Qualifying Statutes and the MSA.

Pennsylvania's Qualifying Statute is called the "Tobacco Settlement Agreement Act," ("TSAA"), 35 Pa. Cons. Stat. Ann. §§ 5672-5674. The TSAA requires that NPMs either become an SPM of the MSA or make payments into escrow. In 2000, payments were $2.09 per carton of cigarettes, increasing to $3.77 per carton in 2007. If the NPMs' payments under the Qualifying Statute are higher than they would be as an SPM of the MSA, the excess is returned to the NPM.

The option to remain an NPM is prohibitively expensive, and "the only option that permitted an NPM to remain in business without violating the Qualifying Statutes was to join the MSA and become an SPM." (Compl. at ¶ 26.) Thus, small manufacturers became SPMs, but are restricted from gaining market share by the "Renegade Clause" in the MSA. This provision states: "A[n] [SPM] shall have payment obligations under this Agreement only in the event that its Market Share in any calendar year exceeds the greater of (1) its 1998 Market Share or (2) 125 percent of its 1997 Market Share." (Compl. at ¶ 27 (citing MSA § IX(i).) This provision creates disincentives for SPMs to increase production and market share.

The MSA also imposes barriers against new entrants in the market. Specifically, it provides that the 1997 market share for new entrants will be 0% for determining the market share cap. (Id. at ¶ 29 (citing MSA § IX(i)(4).) New entrants must contribute settlement payments or pay penalties under the Qualifying Statutes.

The MSA also establishes penalties for the encroachment of market shares among the Majors. (Id. at ΒΆ 33 ...

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