In the next chapter of the ongoing tobacco litigation saga, the Department of Justice will seek to reclaim $280 billion in ill-gotten profits from tobacco companies under the Racketeer Influenced and Corrupt Organizations (RICO) Act, a statute originally intended to prosecute the Mafia. The outcome could hurt ABS transactions backed by litigation fees.
None of the litigation-fee backed transactions are currently on credit watch, however, they are vulnerable to an unfavorable ruling, said Moody's Investors Service analyst Myrna Fajardo. "It would depend on which companies were downgraded, and how many notches," Fajardo said.
The trial begins on Sept. 21, and is expected to run six months or more, according to Moody's analysts. Of critical importance to the tobacco industry is a ruling that will be handed down by the District of Columbia Court of Appeal on the applicability of a disgorgement remedy. This ruling will decide how much, if any, of the $280 billion the DOJ can go after.
In a pretrial ruling to the DOJ RICO case, the judge refused to place limits on the possible level of disgorgement.
"If the court of appeals in the pending DOJ case applies strong restrictions on the amount of allowable monetary awards, [corporate bond] ratings may well be affirmed, but if the court allows for even moderate penalties, ratings may well be placed under review for downgrade," Moody's analyst Christopher Razaire wrote in a report.
Even an award in the single-digit billions of dollars could be enough to cripple the financial flexibility of tobacco companies, the Moody's report found, and could lead to liens on assets and the court-ordered buildup of escrow accounts that would limit cash flow available to service debt.
Neither the industry nor the DOJ has indicated a willingness to settle at this stage. In fact, the tobacco industry rebuffed an attempt by the DOJ to open settlement talks in 2001. Moody's analysts have not ruled out the possibility, but maintain that a settlement is unlikely before the ruling on disgorgement from the D.C. court of appeals.
Notably, this is first tobacco lawsuit that names Phillip Morris USA parent company Altria as a defendant, Fajardo said. Also named as defendants are RJR Reynolds Tobacco, Lorillard Tobacco, Liggett and Myers, and Brown & Williamson Tobacco, among others.
In addition to the potential damage a sizable monetary award would cause to cash flows, the rating agency is mindful of the possibility of a strategic bankruptcy by tobacco operating subsidiaries, which could interrupt payments being made to states under the Master Settlement Agreement.
Meanwhile, many of the state tobacco bonds are already on negative credit watch, due largely to the implications of the Freedom Holdings case currently being tried in the New York appellate court, Fajardo said. The case calls into question the enforceability of The Master Settlement Agreement.
"There are concentric circles of risk around the tobacco deals," Fajardo said. "The most important aspect at this point [for the states' bonds] is the Freedom Holdings case."
The litigation fee-backed deals would only be impacted by the Freedom Holdings decision to the extent that it impacted the creditworthiness of tobacco companies, analysts said.
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