An antismoking lawsuit in Illinois threatens to shut off millions of dollars that now flow to Virginia, Maryland and dozens of other states that have come to depend on money from a national settlement they reached with cigarette makers in 1998.
An Illinois judge ruled last month that Philip Morris USA must post a $12 billion bond if it wants to appeal a verdict in a class-action case involving claims that it falsely advertised its light tar cigarettes. The company has said that it wants to appeal the $10.1 billion judgment but that it cannot post the bond as well as deliver its next $2.5 billion payment under the settlement, due April 15.
State officials say a default by Richmond-based Philip Morris, which is the largest tobacco company and is responsible for paying about half of the national settlement, couldn't come at a worse time.
Faced with immense budget shortfalls because of a still-sagging economy, numerous states use money from the tobacco settlement to avoid cuts in services or increases in general tax rates. Once the leaders of antismoking lawsuits, most states now rely on proceeds from the industry's chief product, thanks to the settlement.
"The states are counting on this money. It's already in their budgets," said Lee Dixon, an analyst with the National Conference of State Legislatures. State governments face combined deficits of almost $100 billion in the next two years, according to the group.
"If Philip Morris can't make that payment, states, somehow or another, will have to make up $2.5 billion," Dixon said. "They would only be able to do that through further cuts in health services, education, et cetera."
Maryland and Virginia include tens of millions of dollars from the tobacco settlement in their budgets. Virginia would lose about $52 million from its operating budget if Philip Morris fails to make its payment. About $21 million pays for programs in the state's general fund. Without that money, Gov. Mark R. Warner (D) would need to trim spending unless the economy improves, officials said.
Maryland would lose some of the $180 million it gets each year from the tobacco settlement. About $100 million helps finance the state's Medicare responsibilities, and the rest is budgeted for a cancer screening program, crop conversion payments, drug addiction programs and tobacco-use prevention. Gov. Robert L. Ehrlich Jr. (R) is already struggling to balance his budget for next year without funds from his proposed gambling plan, which was rejected by a Senate committee last week.
Philip Morris and three other tobacco companies agreed in 1998 to pay 46 states plus the District of Columbia $246 billion over approximately 25 years to settle health-related lawsuits.
Last week, Philip Morris told federal regulators that it could not afford the court bond.
"Philip Morris USA does not have the financial resources to post a bond of that size," spokesman Brendan McCormick said. "It is the bond requirement in that case that is making it presently uncertain whether we will make our . . . settlement payment."
Eric Gally, who lobbies Maryland lawmakers for the American Cancer Society and the American Heart Association, said his organizations believe that the company, which has the capacity to produce 180 billion cigarettes a year in its Richmond factories, is overstating its plight.
"We think Philip Morris is perfectly capable of posting the bond. The parent company makes several billion dollars of net income," Gally said.
Across the country, the possible impact on state budgets has been magnified by the use of a financial arrangement called "securitization," which inflates the importance of the tobacco settlement payments.
In Virginia last week, the company's warning scuttled plans to set up a $650 million fund to help economically distressed parts of the state, including tobacco farming communities.
The Virginia Tobacco Commission had planned to take its share of the settlement upfront by selling rights to the yearly tobacco payments in the form of bonds. But just hours before the deal was to close, skittish buyers backed out after Wall Street analysts questioned whether those annual payments were in jeopardy.
"The purchasers said, 'No, thank you, we're not interested,' " said Carthan Currin III, the executive director of the commission. "Everybody is in a state of shock."
The commission may try to do the deal again later if Philip Morris continues to make payments and the financial markets rebound. Commission members said economic development work can continue even if the settlement money is received over time, rather than placed in a secure endowment.
"We were trying to put in place something that has never been done -- a foundation that would have some stability," said state Sen. Charles R. Hawkins (R-Pittsylvania), the commission's chairman. "The commission can carry out its charge with the money that we have this year."
Other states are not so lucky.
In California, the state planned to plug its massive budget shortfall in part by taking its $4.5 billion share of the tobacco settlement upfront. The state raised $2.5 billion in a bond sale in January, but May 1 plans for a $2 billion bond sale have been put on hold.
Colorado, Oregon, Illinois, Kansas, New York and Indiana all have been exploring similar arrangements to help balance their budgets, according to Dixon. Those plans are in jeopardy now, he said.
Other states, as well as the District of Columbia, have already completed plans to take their money upfront. Those states -- New Jersey, Rhode Island, Washington and Wisconsin -- are less affected by the current situation.
Virginia considered taking its money upfront two years ago. Then-governor James S. Gilmore III (R) proposed a one-time infusion of about $450 million that would have helped the state continue Gilmore's repeal of the car tax. But his plan was stopped by lawmakers, who questioned the long-term consequences of the deal.
Taking the money upfront required accepting less than what would have been provided in payments over time. Given Philip Morris's financial troubles, some Virginia lawmakers said that might have been a good tradeoff.
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"I have always felt that dealing with a known amount of money to make long-term plans . . . would give you some stability," Hawkins said.
But others said the type of plan Gilmore offered is sometimes seen as foolhardy, especially when the proceeds are used for fleeting or one-time purposes, like balancing one year's budget.
"It's questionable whether it's prudent to use the money today by stealing it from 2010," said Jody Wagner, Virginia's treasurer. "Ten years from now, we'll know for sure whether [that] was a good idea or a bad idea."
Staff writer Craig Timberg contributed to this report.