Billions of dollars in taxes could go up in smoke as $13.5B judgment weighs on tobacco industry

Industry’s demise would hit nation’s finances, the revenue stream cigarette sales provide to Aboriginal people, and lead to a potential boom in illicit tobacco trade

May 13, 2019 12:50 PM EDT

A $13.5 billion judgment against Canada’s Big Three tobacco companies has forced them into the largest and most complicated restructuring proceedings this country has ever seen — with implications that could dig deep into the nation’s pockets.

At stake is the survival of Canada’s tobacco industry, the impact its demise would have on the nation’s finances, the fate of the revenue stream cigarette sales provide to Aboriginal people, and a potential boom in the illicit tobacco trade.

Tobacco companies paid about $8 billion in taxes in 2017-18. Some $3 billion went to the federal government, with 10 provinces splitting the remaining $5 billion.

“Imperial Tobacco’s contribution alone is approximately $4 billion,” said Eric Gagnon, head of corporate and regulatory affairs at Imperial Tobacco Canada Ltd., which boasts a 48 per cent market share.

The upshot is that tobacco taxes represent almost 1 per cent of federal tax revenues, absent which the federal deficit would increase by some 17 per cent from its current level of $18.1 billion. Tobacco taxes also represent roughly 1 per cent of the provinces’ tax haul.

All three companies were granted creditor protection in the wake of a March 1 judgment of the Quebec Court of Appeal. The decision substantially upheld the award made in 2015 by Justice Brian Riordan of the Quebec Superior Court to smokers seeking damages for addiction and smoking-related diseases in two class actions commenced in 1998. Riordan had ruled that the smokers should have been warned of the risks of smoking, but never were.

Riordan ordered Imperial, a subsidiary of British American Tobacco plc, to pay about $10.5 billion. Rothman, Benson & Hedges Inc., the Canadian unit of Philip Morris International Inc., was tagged with about $3.1 billion and JTI-MacDonald Corp., a subsidiary of Japan Tobacco Inc., faced a $2-billion liability.

While the Court of Appeal reduced the total damages by about $2 billion, the actual amount payable by each company is likely a moot point as the law imposes what lawyers call “joint and several” liability, meaning that if any of the three companies is unable to pay its portion of the judgment, the others must come up with the balance — if they can.

And that’s the looming question, because the Quebec judgment is just a sliver of the total picture. Quite apart from outstanding class actions by smokers, every Canadian province has enacted legislation authorizing health care costs recovery litigation — ironic, because it’s precisely that litigation that could impair the massive contribution the tobacco companies make to government revenues.

“We’ve identified about $600 to $700 million in claims but we don’t know the total amount yet,” says Deborah Glendinning of Osler, Hoskin & Harcourt LLP in Toronto, who represents Imperial.

What is clear is that the Canadian companies certainly can’t pay up in full.

“I don’t believe that the value of the cigarette-producing assets of the Big Three come close even to the value of the Quebec judgment alone,” says Ian Irvine, an economics professor at Concordia University in Montreal. “Based on a price-to-earnings ratio, their value has been estimated at about $10 billion.”

Enter the international parent companies. The general rules of corporate law suggest that they are under no obligation to pitch in. But practical realities, including the international scope of tobacco litigation, suggest that they have no choice.

I don’t believe that the value of the cigarette-producing assets of the Big Three come close even to the value of the Quebec judgment alone,”Ian Irvine, economics professor at Concordia University in Montreal

“Our objective is to facilitate a negotiated global resolution to all Canadian tobacco litigation under court supervision,” Gagnon says.

What’s clear, however, is that a “global resolution” won’t happen without the parents’ involvement.

Asked whether Imperial’s parent, BAT, is willing to contribute to any settlement, Gagnon points out that he can’t speak for BAT.

“However,” he added in an email, “they are participating in this process and seek the same objectives, a global resolution to the litigation.”

In 1998, the four major cigarette manufacturers in the US — three of whom were controlled by the same companies that control Canada’s Big 3 — effected just such a resolution by negotiating a Master Settlement Agreement that transferred U.S.$246 billion over 25 years to 46 states. To some extent, the agreement was tied to the sales performance of the various companies.

But whether or not a similar approach will work here is open to question.

“We will not be partners to the tobacco industry in any agreement that depends on their future sales,” said Philippe Trudel of Trudel Johnston & Lespérance in Montreal, and a lawyer for the successful plaintiffs in the Quebec case. “We’re very skeptical that the tobacco industry will be acting in good faith, as they certainly haven’t done so to date. My view is that they want to have their cake and eat it too.”

Even Gagnon’s not sure the U.S. approach is appropriate here.

“The Master Settlement Agreement is one example of an approach,” Gagnon said. “However, the Canadian market and environment are very different. For example, our levels of taxation and illegal trade of tobacco products are dramatically higher than in the U.S.”

Still, Trudel says he’ll consider any offer that’s fair and reasonable — with a caveat.

“We don’t want to be put in the same basket as all the other claimants, because we’re the only ones who actually have a judgement and they can’t do anything without settling with us,” he said.

Glendenning disagrees.

“The Quebec plaintiffs are trying to position themselves differently from everyone else, but we don’t see them that way,” she said.

Meanwhile, the Ontario Superior Court of Justice, which is overseeing the restructurings, has appointed former Ontario Chief Justice Warren Winkler and his counsel, Jonathan Lisus of Lax O’Sullivan Scott Lisus LLP in Toronto, to mediate a settlement.

That could prove to be a very difficult task.

“With government involved, public policy and national implications will have to be taken into account in any settlement, but I don’t know that the Quebec plaintiffs are willing to look beyond their own economic interest,” Glendinning said.

“What’s clear is that everyone will have to negotiate. The court-ordered terms of the restructuring mean that neither the Quebec plaintiffs nor the governments-in-waiting can do a darn thing until the restructuring has been resolved.”

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