Tobacco industry breathes easy as US frowns upon class action

The pressure placed on tobacco bond spreads by class action litigation appears to be weakening in the wake of a spate of recent court rulings in favour of the tobacco giants. Geraldine Lambe reports.

Tobacco bondholders are increasingly able to breathe easy, maybe even sleep at night, as the US legal system becomes more sensitive to the damage done to corporates by litigation; judging from recent verdicts, the consensus seems to be that class action litigation is not the best way to deal with tobacco claims.

Under the cloud of high-profile cases, Philip Morris USA, a subsidiary of Altria Group, has had a rough ride this year. Its credit spreads suffered a major explosion in April when they widened from an average of 100bps over swaps to 500bps at the peak. Since then it has been a bumpy ride, as spreads have suffered the slings and arrows of high volatility, if on a mildly declining trend.

But things are looking up for the company, and the tobacco industry in general, following two of the most recent rulings. In September, judges in the Florida Appeals Court denied the plaintiffs appeal in the $145bn Engle case against the decertification and reversal of the class action earlier this year. Secondly, an Atlanta court upheld a decision from 2002 that the tobacco companies did not conspire to fix the prices of tobacco products.

“While neither verdict should come as much of a surprise, any legal victory provides a further boost to sentiment within the sector following recent high profile successes. The verdicts and the halving of Philip Morris’s bond requirement to $6.8bn [last month] should result in spreads tightening further still,” says Georg Grodzki, global head of credit research at Royal Bank of Canada (RBC).

Further evidence of judicial impatience with what is seen by many as the hijacking of the US legal system by trial lawyers, is recent guidance issued by the US Supreme Court following the State Farm car insurance case. The court ruled that punitive damages should not exceed 10 times the amount for compensatory damages. Such a sentiment will go some way towards reassuring the market and help to smooth the volatility in Philip Morris’s spreads.

“The guidance provided in State Farm will help to achieve a better balance between compensatory and punitive damages and could lead to companies being better protected from what are sometimes excessive demands,” says Mr Grodzki.

While litigation remains the key spread driver for all US tobacco companies, the future prognosis is more rosy now than it has been for some time. “We remain positive on Altria bonds and believe the company will achieve a successful outcome in its appeal of the Illinois lights case,” says RBC analyst Russell Jones. “The company is in a better position now to focus on competitive issues. It can get back to business rather than fight a rearguard action. This ability to refocus is important, as the company is under pressure in the US market from discount brands and counterfeit cigarettes.”