Kraft spinoff was made possible by Altria’s litigators

February 2, 2007, 3:33 PM UTC

Altria’s spinoff of Kraft, announced two days ago, could not have occurred even two-and-a-half years ago. At that point, Altria’s Philip Morris USA unit was still mired in three multi-billion-dollar appellate court battles, and a loss in any one of them could have left the company strapped, if not insolvent.

If you remember, in the Fall of 2004 Altria was asking the Florida Supreme Court not to reinstate a $145 billion judgment against the industry ($74 billion of it against PMUSA) in the Engle class-action in Florida; urging the Illinois Supreme Court to overturn a $10.1 billion judgment in the Price class-action in Illinois (over Lights cigarettes); and requesting a federal court of appeals in Washington, D.C., to nullify the government’s attempt to impose $280 billion in disgorgement penalties in its civil RICO case against the major tobacco companies.

Altria’s law department, led by associate general counsel Bill Ohlemeyer, pulled off the hat trick–essentially, it won all three appeals–and more. It also won a federal appeals court ruling in New York decertifying another potential game-ender: a nationwide punitive damages class action (the Simon case) that had been certified in federal court in Brooklyn. I poked fun at Ohlemeyer in a November 2004 Fortune article called “The Month of Living Dangerously,” because I thought it unlikely he could achieve this clean sweep, but the joke was on me. (That now-embarrassing article is available here.)

To be sure, PMUSA still faces the challenge of several Lights cigarettes class actions around the country, and Altria faces the possibility that the plaintiffs in the Schwab class-action (a nationwide Lights cigarette class-action brought under the RICO statute) may yet even try to enjoin the Kraft spinoff before its targeted close on March 31. “We have contingency plans depending on what they announce,” Schwab lead plaintiffs counsel Michael Hausfeld told me in December. “It would concern us if it may alter the responsibility of Philip Morris or make it more difficult, if not render impossible, its ability to pay any judgment.”

But Altria chairman and CEO Louis Camilleri appears to have solid grounds for expressing confidence–as he did repeatedly to anxious analysts on January 31–that such an attempt, if made, would fail. To win such a challenge Hausman would have to argue that Altria is, in effect, already legally “insolvent” because of the liability it will eventually face due to the Schwab suit, and that the spinoff of Kraft therefore amounts to a fraudulent conveyance under the bankruptcy laws–i.e., an attempt to sneak assets out of the estate before they can be divvied up properly among creditors. That will be a tough sell given that Altria’s balance sheet, even without Kraft, currently shows total assets of $48 billion, cash of $4.8 billion, and shareholder equity of $12.7 billion, according to Camilleri’s presentation. (It’s 2006 net income ex-Kraft was $9.3 billion.)

Does the spinoff say anything broader, however, about an improved litigation climate for business generally? Both The American Lawyer, in a story called “It’s Over,” and Business Week, in a story called “How Busines Trounced the Trial Lawyers,” each had recent cover stories discussing the improved litigation environment for business in the mass torts arena. (AmLaw story available here; BW story here.) But attributing the Kraft spinoff to such a phenomenon would probably be pushing it.

Like every piece of journalism, including mine, the AmLaw and BW stories were more nuanced than their headlines. They focused mainly on important victories the Chamber of Commerce has won with respect to state tort reform legislation and the election of sympathetic justices to state supreme courts, primarily in Texas, Mississippi, and Alabama. These victories don’t happen to have been the crucial ones for tobacco.

Tobacco’s big landmark victories have been the Cipollone case in the U.S. Supreme Court in 1992, which limited failure-to-warn challenges after 1969, when Congress began requiring beefed up mandatory warnings on cigarette packs; the Rhone-Poulenc and Castano federal appellate rulings of 1995 and 1996, in which the federal courts signalled hostility to personal injury class-actions; and the U.S. Supreme Court ruling in State Farm v. Campbell in 2003, which said that, in all but extraordinary cases, punitive damages could not be greater than about nine times compensatory damages.

When combined with the industry’s no-settlement litigation policy (excepting, of course, the massive $246 billion Medicaid reimbursement settlement worked out with the state attorneys generals in 1998), increased sophistication of the media and Wall Street (e.g., recognition that a $100 million jury award is very likely to be slashed on appeal), and, possibly, general judicial fatigue over tobacco litigation, the industry does seem to be operating now in a more predictable, business-as-usual environment than a decade ago.

Still, tobacco industry lawyers may yet understate the threat they face from the ongoing Lights class actions. Industry lawyers usually argue that courts have rejected class actions in tobacco cases, but in fact they have unambiguously rejected only class actions in personal injury cases. The Lights cases are typically brought as consumer class actions, which are fundamentally different, and the class certification rulings have gone both ways so far. The plaintiffs in these suits are not claiming that they were injured by cigarette smoking (inherently requiring an individualized inquiry), but merely that the advertising was misleading. Some state consumer protection laws are so broad that they adopt objective standards of misleadingness–i.e., they ask only whether a reasonable person would have been misled, not whether any individual plaintiff really was misled. Whether or not such laws are wise, they present questions that are unquestionably more plausible candidates for class treatment.

Schwab will be cutting edge in the economic tort arena,” says Hausfeld, noting that its implications will extend far beyond the tobacco industry. In fact, the degree to which class actions will be allowed in the realm of consumer class actions is clearly one of the most critical questions now confronting courts nationwide in the mass torts arena.