Appeal from a judgment of the United States District Court for the Southern District of New York (Alvin K. Hellerstein, Judge), entered after a bench trial, which rejected plaintiffs' Sherman Act and Commerce Clause challenges to New York's Escrow and Contraband Statutes, enacted in furtherance of a 1998 Master Settlement Agreement ("MSA") between cigarette manufacturers and all but four states.
The opinion of the court was delivered by: Reena Raggi, Circuit Judge:
Freedom Holdings, Inc. v. Cuomo
Before: WALKER, RAGGI, Circuit Judges, and RAKOFF, District Judge.*fn1
Plaintiffs Freedom Holdings, Inc., and International Tobacco Partners, Ltd., are cigarette importers. They filed this putative class action in the United States District Court for the Southern District of New York (Alvin K. Hellerstein, Judge) to enjoin the enforcement of New York statutes enacted in furtherance of a 1998 Master Settlement Agreement ("MSA") between a number of tobacco companies and various government entities, including New York State. Plaintiffs contend that the laws at issue, N.Y. Pub. Health Law §§ 1399-nn-1399-pp (the "Escrow Statute"), and N.Y. Tax Law §§ 480-b, 481, and 1846 (collectively, the "Contraband Statute"), impermissibly (1) restrain trade in violation of section 1 of the Sherman Act, 15 U.S.C. § 1; and (2) regulate out-of-state commerce in violation of the Commerce Clause, U.S. Const. art. I, § 8, cl. 3. Plaintiffs now appeal from a judgment entered in favor of defendants on January 14, 2009, after a bench trial. For the reasons stated in this opinion, we affirm.
Numerous prior opinions of this court and the district court detail the extensive background of this case. See Freedom Holdings, Inc. v. Spitzer ("Freedom Holdings I"), 357 F.3d 205 (2d Cir. 2004); Freedom Holdings, Inc. v. Spitzer ("Freedom Holdings II"), 363 F.3d 149 (2d Cir. 2004); Freedom Holdings, Inc. v. Spitzer ("Freedom Holdings III"), 447 F. Supp. 2d 230 (S.D.N.Y. 2004); Freedom Holdings, Inc. v. Spitzer ("Freedom Holdings IV"), No. 02 Civ. 2939, 2004 WL 2251668 (S.D.N.Y. Oct. 6, 2004); Freedom Holdings, Inc. v. Spitzer ("Freedom Holdings V"), 408 F.3d 112, 115 (2d Cir. 2005); Freedom Holdings, Inc. v. Cuomo ("Freedom Holdings VI"), 592 F. Supp. 2d 684 (S.D.N.Y. 2009). We assume familiarity with these opinions and recite only the facts relevant to the decision reached today.
A. The Master Settlement Agreement
In November 1998, the nation's four dominant cigarette manufacturers - Philip Morris, Lorillard Tobacco, Brown & Williamson, and R.J. Reynolds*fn2 - settled pending litigation with forty-six states,*fn3 the District of Columbia, and five United States territories (collectively, "the states") by entering into the MSA. In return for releases from liability, these manufacturers agreed to make substantial annual payments to compensate the states for health care expenses incurred in the past and expected to be incurred in the future as a result of their populations' smoking-related ailments. New York's approval of the MSA is reflected in State v. Philip Morris, Inc., 179 Misc. 2d 435, 686 N.Y.S.2d 564 (Sup. Ct. N.Y. Co. 1998), aff'd, 263 A.D.2d 400, 693 N.Y.S.2d 36 (1st Dep't 1999).
1. The MSA's Treatment of Cigarette Manufacturers
The MSA divides cigarette manufacturers into several groups. The first group consists of the four dominant manufacturers who initially executed the MSA. They are referred to as "original participating manufacturers," or "OPMs." The second group consists of more than fifty smaller manufacturers who joined the MSA after its initial execution. They are referred to as "subsequent participating manufacturers," or "SPMs." The SPMs are divided into two sub-groups: "grandfathered SPMs," who joined the MSA within sixty days of the initial November 1998 execution date;*fn4 and "non-grandfathered SPMs," who joined the MSA thereafter. A third group consists of manufacturers who have not joined the MSA. They are referred to as "non-participating manufacturers," or "NPMs." An NPM may become a non-grandfathered SPM at any time by signing the MSA and making prescribed payments.
The MSA specifies a total base payment to be made by all OPMs to the states each year. In 2009, the required base payment was $9 billion. The MSA allocates the annual base payment obligation among OPMs according to their relative market share of the total number of individual cigarettes shipped by the OPMs to the fifty states, the District of Columbia, and Puerto Rico during the preceding calendar year. The MSA then awards the base payment to the states based on prescribed allocable shares, which for New York is 12.76%.
SPMs make annual payments approximating payments made by OPMs. The advantage conferred on grandfathered SPMs for quickly joining in the MSA is that they are exempted from payments on either their 1998 market share, or 125% of their 1997 market share, whichever is greater. Thus, grandfathered SPMs pay an amount approximating the OPM payment only for each cigarette manufactured above the grandfathered threshold.
While the average per-cigarette cost of complying with the MSA is roughly equivalent among OPMs and SPMs above grandfathered thresholds, this court and the district court have observed that the SPM payment formula may, as an arithmetical matter, disproportionately increase marginal payment obligations when SPMs gain market share from OPMs. See Freedom Holdings II, 363 F.3d at 153; see also Freedom Holdings VI, 592 F. Supp. 2d at 698 n.15; Freedom Holdings III, 447 F. Supp. 2d at 258. In this case, we need not consider whether this formula raises antitrust concerns because plaintiffs are NPMs, not SPMs. See infra at [22-24 & n.14].
3. Adjustments to Payment Obligations
The MSA also provides for various adjustments to participating manufacturers' payment obligations. First, an "inflation adjustment" increases payment obligations by a minimum of 3% annually. Second, a "volume adjustment" reduces the required base payment if there is an overall decline in the volume of cigarettes sold nationwide. Third, if participating manufacturers lose market share relative to NPMs, an "NPM adjustment" reduces the required base payment by triple the amount of market share lost. See MSA § IX(d)(1)(A).*fn5
B. The Challenged Statutes
Under the MSA, a decline in the volume of sales by participating members necessarily decreases the payments received by the states. To the extent the decline is attributable to increased sales by NPMs, states can both make up for the lost MSA payments and avoid the NPM adjustment by enacting and diligently enforcing escrow statutes. See MSA § IX(d)(2)(B). The MSA contemplates that an escrow statute will "effectively and fully neutralize the cost disadvantages that the Participating Manufacturers experience vis-a-vis Non-Participating Manufacturers within such Settling State as a result of the provisions of [the MSA]." Id. § IX(d)(2)(E).
The settling states have, in fact, all enacted escrow statutes. The operative section of the New York Escrow Statute challenged in this case is codified at New York Public Health Law § 1399-pp. It requires each cigarette manufacturer either (1) to join the MSA as a participating manufacturer, see id. § 1399-pp(1); or (2) to make annual payments into a state escrow fund, see id. § 1399-pp(2). The statute specifies the amount of these annual escrow payments, which are adjusted for inflation. See id. at § 1399-pp(2)(a). Escrow funds are released if needed to pay certain judgments, to the extent an NPM paid more into the escrow fund than it would have paid as an SPM, or otherwise after twenty-five years. See id. § 1399-pp(2)(b).
As originally drafted, state escrow statutes, including New York's, also contained allocable share release provisions, which allowed an NPM to recoup escrow payments to the extent the NPM paid more into the escrow fund than a state's allocable share of MSA payments. This provided an incentive for NPMs to concentrate their sales in a single state or small group of states to minimize their escrow costs. Thus, an NPM that sold 100% of its cigarettes in New York could recoup 87.24% of its escrow payments because New York's allocable share of MSA payments is 12.76%. Meanwhile an NPM that sold the same number of cigarettes nationwide could recoup none of its escrow payments. To avoid this outcome, in 2003, New York, like other settling states, amended its Escrow Statute to permit NPMs to obtain a release of escrow payments only to the extent they exceeded the per-cigarette payments the NPMs would have made as participants in the MSA. See N.Y. Pub. Health Law § 1399-pp(2)(b)(ii).*fn6
2. The Contraband Statute
Between 1998 and 2002, MSA participants saw their market share of cigarette sales decline while NPMs' share rose. Attributing this situation, at least in part, to the failure of certain NPMs to comply with escrow statutes, a number of states enacted "contraband statutes."*fn7 See Freedom Holdings I, 357 F.3d at 213 (quoting Governor George Pataki's statement that New York's Contraband Statute would "bolster the State's ability to diligently enforce" the Escrow Statute and, thus, "help protect the State from further [NPM] adjustments" (internal quotation marks omitted) (alteration in original)). New York's Contraband Statute, codified at New York Tax Law §§ 480-b, 481(1)(c), and 1846, requires a tobacco manufacturer to certify annually either (1) that it is a participating manufacturer, or (2) that it has complied with the Escrow Statute. See id. § 480-b(1). New York agents cannot affix tax stamps to cigarettes if the manufacturer has not made the required certification. See id. § 480-b(2). Cigarettes that do not bear a tax stamp are subject to seizure or forfeiture, see id. § 1846, and a civil penalty of up to $5,000 may be assessed on the non-compliant manufacturer, see id. § 481(1)(c).
On April 16, 2002, plaintiffs commenced this action in the Southern District of New York, alleging that New York's Contraband Statute violated the Sherman Act, the Commerce Clause, and the Fourteenth Amendment. The district court dismissed the complaint for failure to state a claim, and plaintiffs appealed to this court.
We affirmed dismissal of the Commerce Clause claim, concluding that the Contraband Statute did not discriminate against out-of-state economic interests, burden interstate commerce, or regulate commerce occurring outside New York, as plaintiffs alleged. See Freedom Holdings I, 357 F.3d at 217-21.*fn8 Noting deficiencies in plaintiffs' Fourteenth Amendment equal protection claim, we remanded to the district court, so that plaintiffs could have an opportunity to amend their complaint. See id. at 235.*fn9
At the same time, we reversed the dismissal of plaintiffs' antitrust claim, applying a two-step analysis that asked, (1) whether the Contraband Statute effected a per se violation of the Sherman Act and, if so, (2) whether it was nevertheless saved by the doctrine of state action immunity. Accepting plaintiffs' allegations as true, as we were required to do in reviewing a judgment of dismissal, we observed that the Contraband Statute "allegedly enforce[s] an express market-sharing agreement among private tobacco manufacturers, the MSA." Id. at 224. We determined that plaintiffs pleaded both market division and price fixing to the extent "market-share increases among manufacturers are substantially 'penalized'" by the MSA. Id. at 225. Thus, we concluded that plaintiffs adequately stated an antitrust claim by alleging that "the combination of the MSA, the Escrow Statutes, and the Contraband Statutes, allows OPMs to set supracompetitive prices that effectively cause other manufacturers either to charge similar prices or to cease selling." Id. at 226.
We next considered whether the doctrine of state action immunity shielded the Contraband Statute from application of the antitrust laws. See California Retail Liquor Dealers Ass'n v. Midcal Aluminum, Inc., 445 U.S. 97, 105 (1980). Although we were satisfied that the MSA regime was "clearly articulated and affirmatively expressed as state policy," the first prerequisite for state action immunity, Freedom Holdings I, 357 F.3d at 226- 27, we concluded that the complexity of the MSA scheme precluded determination at the dismissal stage as to whether the state was motivated by legitimate policy goals or by an impermissible desire to share in monopoly profits, see id. at 227-31. We concluded further that the state was not entitled to immunity at the pleading stage because it had yet to make the required evidentiary showing that it actively supervised pricing decisions made by cigarette manufacturers participating in the MSA. See id. at 231-32.
In response to defendants' petition for rehearing, we issued a second opinion expanding on our reasons for reversing dismissal. See Freedom Holdings II, 363 F.3d 149. First, we observed that "[a]ccording to the complaint, the function of the Escrow Statute is to coerce NPMs to join the MSA because the costs of compliance with the Escrow Statute are substantially higher than the costs of being an SPM." Id. at 152; see also id. at 154.
Second, we identified the core aspect of the alleged market division as the SPM pricing formula. Parsing that formula, we noted that it was possible that SPMs were penalized for gaining market share from OPMs because, "under the MSA, if the numerator increases because the SPM has taken market share from an OPM, the denominator decreases by the amount of the increase. Thus, the SPM's proportion of the annual payment increases by more than its proportion of overall market share." Id. at 153. We, therefore, rejected defendants' contention that, as a matter of law, an SPM's marginal payment per cigarette is always lower than an OPM's per-cigarette payment, and we concluded that plaintiffs should be afforded an opportunity to prove that "payments increase disproportionately (i.e. in more than a 1 to 1 ratio) when market share increases." Id.
Third, as to state action immunity, we reiterated that, as alleged in the complaint, the Contraband Statute was subject to the two-part analysis of California Retail Liquor Dealers Ass'n v. Midcal Aluminum, Inc., 445 U.S. at 105, because NPMs are "forced . . . to become part of the market-sharing agreement set up by the MSA," Freedom Holdings II, 363 F.3d at 154. Thus, "the Challenged Statutes have the effect, according to the allegations of the complaint, of delegating price-setting authority to the OPMs." Id. at 155. In any event, it was "too soon to say whether the state will ultimately be able to elicit evidence sufficient to meet" the second, active supervision, prong of Midcal analysis. Id. at 157.
3. Freedom Holdings III, IV, and V
On remand after our decisions in Freedom Holdings I and Freedom Holdings II, plaintiffs amended their complaint and moved for a preliminary injunction barring enforcement of New York's Escrow and Contraband Statutes. On September 14, 2004, the district court preliminarily enjoined enforcement of the Escrow Statute's allocable share release amendment, but it denied the motion in all other respects, see Freedom Holdings III, 447 F. Supp. 2d at 233, thereafter also denying rehearing, see Freedom Holdings IV, 2004 WL 2251668. Plaintiffs appealed, and we affirmed the denial of broader injunctive relief because plaintiffs failed to demonstrate the requisite likely irreparable harm. See Freedom Holdings V, 408 F.3d at 115. We did not discuss the likelihood of plaintiffs' success on the merits.
In Grand River Enterprises Six Nations, Ltd. v. Pryor, 425 F.3d 158 (2d Cir. 2005), we considered a second Commerce Clause challenge to the MSA. The Grand River plaintiffs alleged that New York's Escrow and Contraband Statutes effectively "force out-of-state merchants to seek New York regulatory approval before undertaking an out-of-state transaction, [and] that . . . interstate regulatory gridlock would occur if many or every state adopted similar legislation." Id. at 171 (quoting Freedom Holdings I, 357 F.3d at 221 (internal quotation marks omitted)). Taking "no position as to the ultimate viability" of this contention, we concluded that the pleading should not have been dismissed as a matter of law because the Grand River plaintiffs "stated a possible claim that the practical effect of the challenged statutes ...