Even More Lawsuits Hit Big Tobacco

Reynolds American and Altria are once again facing the prospect of lengthy court cases.

May 19, 2014 at 11:21AM

Big tobacco companies are no stranger to lawsuits. Indeed, Altria (NYSE:MO) and Reynolds American (NYSE:RAI) take the threat of lawsuits in stride, as it is just an occupational hazard of working in the tobacco industry.

However, it seemed as if tobacco companies were catching a break last year when Reynolds reported that the number of pending "smoking and health" cases against the company had fallen from 352 in 2001 to just 69 in the third quarter of 2013. The number of health-care reimbursement cases fell from 62 to two over the same period.

Unfortunately, this revelation was followed by an order from a federal court. This order obliged the major U.S. tobacco companies to publish a series of corrective statements through advertisements on television, newspapers, and the Internet which stated that the companies had deceived customers about the health risks of smoking.

Now, yet more suits face the industry.

Reviving old cases
The two newest cases facing the tobacco industry are not actually new, they are reinvestigations into previous events.

It was recently revealed that Altria is facing the reinstatement of a $10.1 billion verdict against Philip Morris USA in a lawsuit which accuses this subsidiary of misleading consumers about the risks of smoking "light" cigarettes. The lawsuit had accused Philip Morris USA of defrauding consumers into believing that "light" or "low tar" cigarettes were safer than regular cigarettes.

This case was originally brought against Philip Morris USA at the turn of the century but the courts ruled in favor of Philip Morris back during 2005.

Altria immediately appealed this ruling, which has postponed any immediate court action. That said, the appeals process is likely to to take several years and due to the size of the final settlement, it is likely that Altria will have to post a $250 million bond; this payment is likely to impact the Altria's earnings for this year.

Overseas investigation
Meanwhile, Reynolds is facing the revival of an old suit which accuses the company of money laundering. Specifically, Reynolds is facing a possible lawsuit from the European Union over claims that the tobacco company orchestrated a worldwide scheme to launder drug money.

Europe is claiming that Reynolds was part of a scheme whereby Colombian and Russian criminal organizations laundered drug profits through European money brokers. The brokers sold discounted euros obtained from drug sales to cigarette importers, who then purchased Reynolds American cigarettes.

Originally, this case was first brought against Reynolds during 2000 and the case went to the U.S. Supreme Court; Reynolds won. The case was revived during 2011 but was thrown out due to the fact that the money-laundering activities took place outside of the U.S. The judge also called the accusations:

[a] structureless morass of allegations, devoid of any sequential description of events.

However, a three-judge court panel in Manhattan recently ruled that the EU can use U.S. racketeering law to sue Reynolds.

Some benefits
While these cases could cost the two tobacco companies billions, both Altria and Reynolds are set to benefit from the expiration of the FETRA settlement in the next few weeks. FETRA was part of the American Jobs Creation Act, and it eliminated the federal tobacco quota and price support program which was put into place by the Agricultural Adjustment Act in 1938.

In essence the FETRA payments were a buyout of quotas placed on tobacco growers. Spread over ten years the total buyout cost the industry $9.5 billion. All tobacco companies were responsible for a contrbution to FETRA payments, the size of payments were determined by factors such as volume and market share, although the payments were capped at $500 million per year.

Altria's annual share of FETRA is around $500 million and Reynolds has paid an annual contribution of around $160 million. As the buyout ends this year, both Reynolds and Altria should benefit from income boosts. You can read more about how big tobacco will benefit from the expiration of FETRA here.

Foolish summary
In conclusion, big tobacco continues to attract the attention of lawyers and these two most-recent suits could cost billions if courts find the companies liable. Unfortunately, rulings against tobacco companies will hit their earnings significantly but shouldn't affect their dividends.

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Rupert Hargreaves owns shares of Altria Group. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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