2008 VT 11


State
v. Philip Morris USA Inc. (2006-360)
 
2008
VT 11
 
[Filed
01-Feb-2008]
 
NOTICE: 
This opinion is subject to motions for reargument under V.R.A.P. 40 as well as
formal revision before publication in the Vermont Reports.  Readers are
requested to notify the Reporter of Decisions, Vermont Supreme Court, 109 State Street, Montpelier, Vermont 05609-0801 of any errors in order that corrections may
be made before this opinion goes to press.
 
 
                                                                     2008
VT 11
 
                                                                   No.
2006-360
 
 
State
of Vermont                                                                             Supreme
Court
 
On Appeal from
    
v.                                                                                                 Chittenden
Superior Court
 
 
Philip
Morris USA Inc., R.J. Reynolds Tobacco Co.,                     May Term, 2007
Lorillard
Tobacco Co., Anderson Tobacco Co.,  
The
Chancellor Tobacco Co., et al.
 
Ben
W. Joseph, J.
 
William
H. Sorrell, Attorney General, and Christy Taylor Mihaly and Julie S. Brill,
Assistant
  
Attorneys General, Montpelier, for Plaintiff-Appellant.
 
Karen
McAndrew of Dinse, Knapp & McAndrew, P.C., Burlington, Thomas J. Frederick
and
 
Kevin J. Narko of Winston & Strawn LLP, Chicago, Illinois, and Alexander
Shaknes, James
 
Mathias and Brett Ingerman of DLA Piper US LLP, New York, New York, for
Defendant-
 
Appellee Philip Morris USA Inc.
 
Robert
B. Hemley, Norman Williams and Matthew B. Byrne of Gravel and Shea, Burlington,
 
Stephen R. Patton of Kirkland & Ellis LLP, Chicago, Illinois, and Marjorie
Press Lindblom and
 
Peter A. Bellacosa of Kirkland & Ellis LLP, New York, NewYork, for Defendant-Appellee
R.J.
 
Reynolds Tobacco Company.
 
Michael
W. Wool of Langrock Sperry & Wool, LLP, Burlington, and Penny Packard Reid
of
 
Weil, Gotshal & Manges LLP, New York, New York, for Defendant-Appellee
Lorillard
 
Tobacco Company.
 
Gregory
S. Mertz of Mertz, Talbott & Simonds, Burlington, and Robert J. Brookhiser
and
 
Elizabeth B. McCallum of Howrey LLP, Washington, DC, for
Defendants-Appellees    
 
Subsequent Participating Manufacturers.
 
 
PRESENT: 
Reiber, C.J., Dooley, Johnson, Skoglund and Burgess, JJ.
 



¶  1.          
BURGESS, J.   Plaintiff, the State of Vermont, appeals a judgment of the Chittenden Superior Court compelling arbitration and
dismissing this declaratory judgment suit.  The State sought a ruling
concerning the amount of money to be paid to the State in accordance with the
1998 Master Settlement Agreement (MSA) entered into by the State, fifty-one
other states and territories (settling states), and the major domestic
cigarette manufacturers.  The superior court ruled that the dispute was subject
to an arbitration clause in the MSA, and dismissed the case.  We affirm. 
¶ 
2.          
In
reviewing an order of dismissal, “we assume that all factual allegations
pleaded by plaintiff, and reasonable inferences therefrom, are true, and that
all contrary allegations are false.”  Town of Brattleboro v. Garfield,
2006 VT 56, ¶ 15, 180 Vt. 90, 904 A.2d 1157.  Conclusions of law are reviewed
de novo.  Bessette v. Dep’t of Corrs., 2007 VT 42, ¶ 6, __ Vt. __, 928 A.2d 514.



¶ 
3.          
The
MSA was a settlement of state claims against tobacco manufacturers for recovery
of health-care costs attributed to smoking-related illnesses.  In exchange for
the release of those claims, participating cigarette manufacturers (PMs)[1]
agreed to, among other things, restrict their advertising and make annual
payments to the settling states in perpetuity.  Payments are disbursed from an
escrow account to each settling state based on a set of formulas, calculations,
and adjustments in § IX of the MSA.  Master Settlement Agreement, http://naag.org/upload/1032468605_cigmsa.pdf. 
One such adjustment accounts for loss of PM market share to nonparticipating
manufacturers (NPMs) as a result of the marketing limitations imposed on PMs by
the MSA.  Section IX(d) provides that when a market share loss has occurred,
each state’s allocated payment is reduced based on the percentage of the lost
market share (NPM adjustment).  However, a state is not subject to a reduced
payment if the state “diligently enforced” a qualifying tobacco statute that
requires NPMs to make escrow payments in lieu of settlement.[2] 
The reduction that would have otherwise been applied to a diligent-enforcement
state is instead applied to further reduce payments, on a pro-rata basis, to
the states that did not diligently enforce their qualifying statutes.  Thus, a
state that did not diligently enforce would benefit from a determination that
other states also did not diligently enforce so that the market share loss
reduction would be spread among multiple states.  On the other hand, if all
states have diligently enforced their qualifying statutes, all states receive
their full allocation and the PMs get no reduction to their annual payment. 
¶ 
4.          
The
calculations for payment allocations are performed by an independent auditor.
Section XI provides that the auditor:
shall calculate and determine the amount
of all payments owed pursuant to [the MSA], the adjustments, reductions and
offsets thereto (and all resulting carryforwards, if any), the allocation of
such payments, adjustments, reductions, offsets and carry-forwards among the
Participating Manufacturers and among the Settling States, and shall perform
all other calculations in connection with the foregoing . . . . The Independent
Auditor shall promptly collect all information necessary to make such
calculations and determinations.  
 
¶ 
5.          
Section
VII(a) acknowledges that state courts have general jurisdiction to implement
and enforce the parties’ agreement:  “Each [PM] and each Settling State
acknowledge that the Court . . . shall retain exclusive
jurisdiction for the purposes of implementing and enforcing this Agreement and
the Consent Decree as to such Settling State.”  Section XI(c), however, states
that



Any dispute, controversy or claim arising
out of or relating to calculations performed by, or any determinations made by,
the Independent Auditor . . . shall be submitted to binding arbitration before
a panel of three neutral arbitrators . . . . The arbitration shall be governed
by the United States Federal Arbitration Act. 
 
Section XI(c) thus
carves out of § VII(a)’s general jurisdiction all disputes “arising out of or
relating to calculations performed by” the auditor, specifically stating that
these disputes “shall be submitted to binding arbitration before a panel of
three neutral arbitrators.”  State v. Philip Morris, Inc., 905 A.2d 42,
49 (Conn. 2006); see People v. Lorillard Tobacco Co., 865 N.E.2d. 546, 552
(Ill. App. Ct. 2007).  The disputes subject to arbitration include “any dispute
concerning the operation or application of any of the adjustments, reductions,
offsets, carry-forwards and allocations.”  MSA § XI(c).  
¶ 
6.          
In
2006, the auditor determined that the PMs experienced a market share loss for
the year 2003.  Pursuant to § IX, a separate consulting firm concluded that the
market share loss was a result of the MSA.  Accordingly, the PMs requested that
their payments be reduced.  The settling states responded by asking that the
auditor continue its past practice of presuming diligent enforcement for states
that had enacted qualifying statutes.  The auditor granted the states’ request
and continued to presume diligent enforcement for 2003.  Several of the PMs,
believing the auditor’s presumption to be in error, made their 2006 payments
into the MSA’s escrow account for disputed payments.  The State of Vermont and thirty-six other states then filed suits in courts in their own jurisdictions
for declaratory judgments that they had diligently enforced their qualifying
NPM escrow-payment laws in 2003. 



¶ 
7.          
The
trial court found the language of the MSA to be “very clear” with regard to
arbitration of payment disputes.  The auditor is required to calculate all
payments owed to the settling states.  Any NPM adjustment is included in those
calculations.  Therefore, the court reasoned, any dispute about application of
an NPM adjustment is covered by § XI(c)’s arbitration clause.  The court noted
that, at the time of its decision, courts in six other states had addressed the
same issue and all had ruled in favor of arbitration.  Having concluded that
the issue must go to arbitration, the court dismissed the case.  The State
appealed.
I.  Jurisdiction
¶  8.          
Before
reaching the merits of the trial court’s decision, we must consider the PMs’
motion to dismiss this appeal.  The PMs argue that
the Vermont Arbitration Act (VAA), 12 V.S.A. §§ 5651-5681, does not permit
appeal of an order compelling arbitration. 
¶ 
9.          
The
question before the trial court, and now this Court on appeal, is one of
contract interpretation: whether the parties contractually assigned disputes
over determinations of diligent enforcement to arbitration via § XI(c) of the MSA.  State
courts have general jurisdiction to consider questions of contract; this
jurisdiction is limited only when the Legislature has specifically divested the
courts of jurisdiction over particular claims through statute.   Ordinarily,
this Court is empowered to review, and litigants are entitled to appeal from,
any final order of the superior court.  4 V.S.A. § 2. 
¶ 
10.      
The
PMs argue that the VAA precludes jurisdiction in this Court to entertain an
appeal by the State from the trial court’s order granting the PMs’ motion to
compel arbitration in accordance with the MSA.  See 12 V.S.A. § 5681(a)(1)
(allowing an appeal from an order denying, rather than granting, a
motion to compel arbitration).  The VAA, however, is inapplicable in this
case.  The
MSA expressly provides, in § XI(c), that arbitration between the parties shall
be governed by the Federal Arbitration Act (FAA), 9 U.S.C. §§ 1-14.  



¶  11.      
Whether
and how a particular issue between the parties is subject to arbitration is a
matter of contract.   Parties “are generally free to structure their arbitration agreements
as they see fit . . . .[T]hey may limit by contract the issues which they will
arbitrate, . . . [as well as the] rules under which
that arbitration will be conducted.”  Volt Info. Scis., Inc. v. Bd. of Trs.,
489 U.S. 468, 479 (1989) (citation omitted).  Courts must
give effect to these arbitration provisions.  See 9 U.S.C. § 2 (“A written
provision in . . . a contract evidencing a transaction involving commerce to
settle by arbitration a controversy thereafter arising out of such contract . .
. shall be valid, irrevocable, and enforceable . . .”); 12 V.S.A. § 5652(a) (“[A]
provision in a written contract to submit to arbitration any controversy
thereafter arising between the parties creates a duty to arbitrate, and is
valid, enforceable, and irrevocable.”); see also Volt, 489 U.S. at 478
(explaining that the FAA “requires courts to enforce privately negotiated
agreements to arbitrate, like other contracts, in accordance with their terms”). 
Here, the PMs and the State specifically contracted to arbitrate
disputes “arising out of or relating to calculations performed by . . . the
Independent Auditor . . . [under] the United States Federal Arbitration Act.” 
MSA § XI(c).  
¶ 
12.      
This
provision makes clear the parties’ intention to arbitrate under the FAA rather
than the VAA, and we must
give effect to this choice.  See Mayo v. Dean Witter Reynolds, Inc., 258
F. Supp. 2d 1097, 1114 (N.D. Cal. 2003) (“Under the FAA, [the parties] ha[ve] a
right to enforce the arbitration agreement according to its terms.”).  Given
our broad implementation and enforcement jurisdiction under § VII(a) of the MSA, we
find no authority in the FAA to divest this Court from hearing an appeal from
the trial court’s order interpreting the contract provision.  See Philip
Morris, 905 A.2d at 49.  Accordingly, this Court has jurisdiction to hear
the State’s appeal.
II.  Arbitration



¶ 
13.      
In
deciding whether parties agreed to arbitrate a matter, we apply the ordinary
rules of contract interpretation.  Bellows Falls Union High Sch.
Dist. No. 27 v. Rodia, 139 Vt. 262, 264, 428 A.2d 1094, 1095 (1981).  “[W]e
interpret contracts to give effect to the parties’ intent, which we presume is
reflected in the contract’s language when that language is clear.”  In re
Adelphia Bus. Solutions of Vt., Inc., 2004 VT 82, ¶ 7, 177 Vt. 136, 861 A.2d 1078.  We also strive to “give effect to every part of the instrument and
form a harmonious whole from the parts.”  In re Verderber, 173 Vt. 612, 615, 795 A.2d 1157, 1161 (2002) (mem.).
¶ 
14.      
We
begin our analysis with MSA § VII’s jurisdiction provision.  That section
provides that a designated court in each settling state—Chittenden Superior
Court in Vermont—retains “exclusive jurisdiction for the purposes of
implementing and enforcing this Agreement and the Consent Decree as to such
Settling State” and “shall be the only court to which disputes under this
Agreement or the Consent Decree are presented as to such Settling State.”  The
State acknowledges that there are several exceptions to § VII’s general rule of
jurisdiction, including special arbitration for disputes over attorney’s fees
for the settled lawsuits, MSA § XVII(d), and, as described above, § XI(c)
arbitration for disputes over determinations by the auditor.  The State
contends, however, that no exception, including § XI(c), applies because the
determination regarding diligent enforcement is not expressly assigned to the
auditor.
¶ 
15.      
Applying
an NPM adjustment is a three-step process.  First, the auditor determines that
a market share loss has occurred.  Second, the consulting firm determines that
the MSA was a significant factor in the market share loss.  Finally, when both
those determinations have been made, someone must determine whether each of the
settling states should nevertheless retain a full allocation of payment based
on diligent enforcement of a qualifying statute.  The State argues that because
the MSA does not designate any particular decisionmaker to evaluate the state’s
diligence in enforcing its qualifying statute, § VII’s general jurisdiction
provision should control.  



¶ 
16.      
The
PMs contend, and the trial court agreed, that the task of determining diligent
enforcement falls to the auditor, at least by default.  The auditor must
calculate all payments owed to the settling states.  MSA § XI(a).  The MSA
provides specific steps that the auditor must follow in making its
calculations, including the order in which adjustments are made.  MSA § IX(j). 
Applying the NPM adjustment is the sixth step in the thirteen-step process of
calculating payments due.  Id.  Thus, the auditor cannot calculate
payments due in conformity with the MSA without deciding whether the NPM
adjustment applies, and it can make that decision only after first deciding
whether each state performed diligent enforcement.  As the events leading up to
this case demonstrate, the auditor must somehow decide whether to apply the NPM
adjustment, even if that means simply making a presumption of diligent enforcement
in certain circumstances, as was done for 2003.  The State’s argument—that the
auditor is an unlikely or even ill-equipped party to be making an initial
determination of diligent enforcement—does not change the fact that diligent
enforcement is a condition precedent to payment.  See State v. Philip
Morris USA, Inc., 927 A.2d 503, 510 (N.H.  2007) (rejecting state’s
argument that auditor lacked authority to make determination of diligent
enforcement when MSA § XI(a) requires auditor to determine amount PMs owe,
including adjustments).



¶ 
17.      
Furthermore,
the arbitration clause applies not just to determinations by the auditor but
also to disputes “arising out of or relating to” those determinations.  MSA §
XI(c).  This language broadens the arbitration clause’s application to “any
matter arising out of, or relating to, the subject matter” of the auditor’s
calculations and determinations.  State v. Philip Morris, Inc., 813
N.Y.S.2d 71, 75 (App. Div. 2006).  The phrase “related to” is broad, ordinarily
encompassing matters “connected to,” “associated with” and “brought with
reference to” that which is subject to arbitration.  Vt. Pure
Holdings, Ltd. v. Descartes Sys. Group, Inc., 140 F. Supp. 2d 331, 335 (D.
Vt. 2005) (quotations omitted).  The question of diligent enforcement is, at
the least, “related to” the auditor’s calculations and determinations.  As
described above, the MSA makes no provision for someone other than the auditor
to determine diligent enforcement, and the task therefore falls to the auditor
by virtue of its responsibility to apply adjustments in calculating payments. 
Because diligent enforcement is a required component of the auditor’s payment
calculations, it arises out of or relates to the auditor’s calculations and determinations,
and is therefore subject to arbitration.[3]




¶ 
18.      
According
to the State, interpreting the MSA as providing for the auditor—an accounting
firm—to determine diligent enforcement would be “inappropriate,” if not “nonsensical,” 
and therefore contrary to what the parties must have intended.[4] 
See FutureSource LLC v. Reuters Ltd., 312 F.3d 281, 284-85 (7th Cir.
2002) (“Nonsensical interpretations of contracts . . . are disfavored. . . .
[n]ot because of a judicial aversion to nonsense as such, but because people
are unlikely to make contracts . . . that they believe will have absurd
consequences.”).  In FutureSource, the court rejected a contract
interpretation that would have entitled the plaintiff to “a lifetime of free
data service” worth millions of dollars.  Id. at 285.  The result
alleged by the State in this case is significantly less absurd, if at all.  The
qualifying statute for which the auditor must make a determination of diligent
enforcement is purely financial, requiring NPMs to make payments into an escrow
account for each unit of tobacco sold.  33 V.S.A. § 1914.  Presumably, the
auditor could determine diligent enforcement by comparing the units of tobacco
sold and the amount of money deposited into the account.[5] 
That the auditor would be asked to perform this function is not so unreasonable
that the parties could not have intended it.
¶ 
19.      
Finally,
the State maintains that submitting each settling state’s dispute over diligent
enforcement to one “nationwide arbitration” is unworkable in addressing the
individual facts of each state’s case.  Other courts addressing this issue,
however, have found “compelling logic” in having disputes over diligent
enforcement handled by one arbitration panel rather than separate courts in
each settling state.  Philip Morris Inc., 813 N.Y.S.2d at 76.  The New York court reasoned:
Since
the granting of an exemption by one settling state will automatically lead to
the reallocation of its allocated portion of the NPM adjustment to all other
non-exempt settling states, each governmental signatory has its own
self-interest at stake in the outcome of this issue, which is necessarily in
conflict with every other state. Such a result defeats the whole purpose of
having a Master Settlement Agreement. The mechanism of submitting disputes
involving the decisions of the Independent Auditor to a neutral panel of
competent arbitrators, who are guided by one clearly articulated set of rules
that apply universally in a process where all parties can fully and effectively
participate, obviates this problem and ensures fairness for all parties to the
MSA. To hold otherwise is contrary to both the spirit and the plain language of
the Master Settlement Agreement.



Id.  We agree.  Even if the
State’s fear that a single arbitration panel will be unable to adequately
address the specifics of each state’s case proves to be true, that fear is not
a basis for denying arbitration here.  How the arbitrators pursue their
determination of diligent enforcement is a separate issue from whether
arbitration is required by the MSA.  Such problems, if they do materialize, may
be raised in a post-arbitration motion to vacate or modify the award pursuant
to § 16(a)(3) of the FAA.  
The order compelling arbitration and dismissing the suit is
affirmed.            
 
 
 
FOR THE COURT:
 
 
_______________________________________
Associate Justice
 


[1]  The PMs comprise two groups: those who
were initial parties to the MSA, known as the “Original Participating
Manufacturers” and those who joined the MSA later, known as the “Subsequent
Participating Manufacturers.”  Differences between the two groups are
irrelevant to this discussion.


[2]  “A ‘Qualifying Statute’ means a
Settling State’s statute, regulation, law and/or rule . . . that effectively and
fully neutralizes the cost disadvantages that the [PMs] experience vis-à-vis
[NPMs] within such Settling State as a result of the provisions of [the MSA].” 
MSA § IX(d)(2)(E).  Vermont’s qualifying statute essentially mandates
equalizing payments by NPMs to an escrow account for every unit of tobacco
product sold.  33 V.S.A. § 1914(a)(2); see also §1914(b) (discussing when these
funds will be released from escrow).  


[3]  Section XI(c) goes on to
parenthetically state that disputes subject to arbitration include, “without
limitation, any dispute concerning the operation or application of any of the
adjustments, reductions, offsets, carry-forwards and allocations described in
subsection IX(j).”  The State argues that this parenthetical phrase should not
supersede the main clause’s provision that it applies to any dispute “arising
out of or relating to calculations performed by, or any determinations made by,
the Independent Auditor.”  The State’s point is that the auditor did not make a
calculation or determination of diligent enforcement, only a presumption.  On
this point we agree with the thorough opinion of the Connecticut Superior Court
addressing this issue: the broader main clause “delimits the substantive scope
of the right to arbitrate under MSA § XI(c), while the narrower, parenthetical
phrase that immediately follows it . . . describes a subset of disputes that
clearly fall within that scope and usefully illustrate the full range of
disputes, controversies or claims that are made arbitable thereunder.”  State
v. Philip Morris, Inc., No. X02CV9601484145, 2005 WL 2081763, at *35 (Conn. Super. Ct. Aug. 3, 2005).  Even accepting the State’s position and not considering
the parenthetical, the main clause is sufficiently broad to include the present
issue.


[4]  Curiously, while the State now believes
that having the auditor determine diligent enforcement would be “inappropriate”
and “nonsensical,” the State previously asked the auditor to presume diligent
enforcement.  See supra, ¶ 6.


[5]  The State tobacco stamp tax is assessed
through the sale of stamps to licensed wholesale and retail dealers, who must
affix a stamp to each package of cigarettes sold to evidence payment.  32
V.S.A. § 7772.  It appears the auditor could determine the number of units of
tobacco sold by tallying the stamps sold by the State in a given year.  Id.  (“The commissioner shall keep accurate records of all stamps sold to each
wholesale dealer and retail dealer.”).  


