We believe a recent decision by Moody’s to downgrade its ratings on all tobacco settlement bonds was premature and unwarranted. To date, neither of the other two major rating agencies, Standard & Poor’s and Fitch, has followed Moody’s lead. Moody’s action came as a result of the 2nd U.S. Circuit Court of Appeals’ denial of an “en banc” rehearing in the Freedom Holdings, Inc. v. Spitzer court case.
Freedom Holdings, a small cigarette maker that has chosen not to participate in the Tobacco Master Settlement Agreement (MSA), sued the state of New York in 2002 claiming that the “Contraband Statutes,” a state law passed to enhance enforcement of the MSA, created a cartel between the state and the cigarette industry. Freedom maintained that this cartel was designed to restrict price competition and would benefit the state financially.
The case was initially thrown out by the trial court, but was reinstated by a three-member panel of the U.S. Court of Appeals and remanded to the lower court for trial. New York then asked for a rehearing before the entire appeals court but was denied.
Unlikely assumptions
In its decision to lower ratings on tobacco settlement bonds, Moody’s expressed concern that the trial court could find the Contraband Statutes as well as other basic law underlying the MSA invalid. This, they believe, would be detrimental to cash flows to the states from the MSA and could, in turn, impact the payment of debt service.
It is highly unusual for a rating agency to downgrade a class of bonds based on the likelihood of a trial, months before the trial is scheduled to take place. More striking, Moody’s appears to have prejudged the trial’s results, all appeals, and the impact on debt service, years before the final outcome is known. Further, in the unlikely case that the 46 state attorneys general – who signed the MSA and believed in its legal standing – were wrong, Moody’s has also prejudged attempts to amend the MSA to meet any final court objections.
Agreement has strong support
While we are concerned with the potential impact of an adverse verdict in the Freedom Holdings Case, we also think that the MSA still represents a strong commitment between the cigarette industry and 46 states to mutually resolve important litigation and issues surrounding the sale and advertising of cigarettes. We have no reason to believe that the Model Statutes passed by each participating state are not legally sound, since they have been validated, in each instance, by state courts.
In sum, we believe that it is likely that the Freedom Holdings case will take several years to resolve, including appeals. Participating states are firmly committed to making the Master Settlement Agreement work. We believe that, should a legal challenge be successful, they would take necessary legal steps to ensure that the MSA remains in place. It is unfortunate that Moody’s, which only a couple of years ago was convinced that the legal basis of the MSA was solid, has decided differently now.
