In 1999, the tobacco industry entered into a Master Settlement Agreement (MSA) with more than 40 U.S. states and territories. This "global settlement" deals with tobacco-related illness claims and will, when all is said and done, cost the signatory companies more than $206 billion through 2024, and then $9 billion per year in perpetuity after that. As we've pointed out in the past, all of the various MSA payments, excise taxes, and other sin fees associated with tobacco products make the largest beneficiary of tobacco revenues not the companies, but the states themselves.
And as we've seen, the class action suits haven't stopped -- ongoing litigation has put Altria Group (NYSE:MO), R.J. Reynolds (NYSE:RJR), British American Tobacco (AMEX:BTI), and plenty of other companies in the crosshairs of multi-billion dollar judgments -- but they've certainly slowed.
There's a big problem here, though. This isn't actually a "global" settlement. It doesn't even cover all 50 states. What happens when suits in all of the countries in which these companies operate begin to creep up? This week an Israeli court agreed to hear a $1.7 billion claim by that country's largest health provider against tobacco companies. The suit was filed in 1998, but has languished in the court system. The suit claims (surprise, surprise) that tobacco companies distributed their products even though they knew they were unhealthy and addictive.
So the question is this -- if the payments for most of the U.S. exceeded $200 billion, what happens when the other 191 countries of the world jump on the same gravy train and demand payments? If you're an anti-smoking activist, the possibility must be exciting. If you're an investor in one of these companies -- not so much. But this suit in Israel should serve notice not just for American tobacco companies, but all companies -- the threat of outsized awards coming from outside the United States in the upcoming decades is very real.
One of the biggest mistakes an investor can make is to confuse regulatory or legal conditions with natural law. Not only do regulations and laws change, they sometimes do so in wrenching fashion. It would be folly to think that the application of American jurisprudence is perfect, and we shouldn't harbor any illusion that U.S. companies would receive better treatment overseas. What's to stop foreign governments under enormous budget constraints from mounting self-righteous, politically popular lawsuits against foreign corporations, coloring them as little better than carpetbagging profiteers? Who knows what will happen, but when the local government needs money, or when the court system feels like punishing a deep pocket, companies that are targeted can feel pretty friendless.
Corporations providing vice products are the most likely targets. But as we've seen in the U.S., product-liability lawsuits threaten companies like McDonald's (NYSE:MCD), Yum! Brands (NYSE:YUM), and other fast-food purveyors, though there is no evidence anywhere that their products are masquerading as health food. Pull a "We must protect the children," though, and the plaintiff's bar and politicians start to get that familiar gleam in their eyes -- the "I think that gazelle is wounded" sort of look. For many industries, including health services and pharmaceuticals, these lawsuits are simply a cost of doing business.
But all of the costs for excise taxes and lawsuits are passed on to consumers and to investors. The runaway asbestos litigation expenses have already sent hundreds of companies into bankruptcy, including Owens Corning and USG (NYSE:USG). Some, such as Halliburton (NYSE:HAL), have massive asbestos liabilities even though they've never made a nickel in the asbestos business.
In many cases, the lawsuits are little more than ways for people to use the court system to enrich themselves. For all of our pride over the American system of jurisprudence, there is no country in the world as litigious. What happens if this changes? What happens if some court in Poland, Pakistan, or Peru decides that the best way to punish America for its sins is to use lawsuits to go after the assets of American companies operating there? Because it ought to be clear in this country that the court system in some instances has been used as a weapon, and that there's nothing quite so attractive for lawsuits as really, really deep pockets. As such, there is not much at all keeping the same thing from happening elsewhere. In fact, I'm somewhat surprised we haven't seen more of it.
I wish that I could offer some sage advice on how to discount against lawsuits when you're in the process of valuing a company. The bad news is that I cannot. The worse news is that very, very few people are any good at figuring out what juries are going to do, or the chances of individual suits being won or lost, or what the value of damages would be. The fatalistic answer would be to avoid companies that have current or potential future litigation overhangs -- that it's simply impossible to determine what's going to happen and thus to value them. This is completely sound advice in general, but is likely to be both impractical and disingenuous on the margins.
A more realistic piece of advice is to watch for big lawsuits and simply recognize the risk they entail to your investment capital. A company with big lawsuits, or a company that has exposure in an area where big equity-destroying damages are being rewarded may be one that you should think twice about. It may be that the company is convinced that the suits lack merit, but you never know. Surprises in lawsuits are very rarely good, as the shareholders in Sealed Air (NYSE:SEE) discovered last year. If you're unsure of what might happen if a big suit goes against the company, it's perhaps best just to walk away.
Fool on!
Bill Mann, TMFOtter on the Fool Discussion Boards
How in the world did they get "soot" from S-U-I-T? Bill Mann owns shares of R.J. Reynolds and McDonald's. Motley Fool Income Investor seeks out companies offering dividend income that's safe from pesky things like massive lawsuits. Come on, see what Mathew Emmert's offering up this month with a free trial.
