State v. Philip Morris, Inc. , 225 Md. App. 214 ( 2015 )

REPORTED
IN THE COURT OF SPECIAL APPEALS
OF MARYLAND
No. 1256
September Term, 2014
STATE OF MARYLAND
v.
PHILIP MORRIS, INC., ET AL.
Wright,
Reed,
Kenney, James A., III
(Retired, Specially Assigned),
JJ. 1
Opinion by Wright, J.
Filed: October 2, 2015
1
Judge Andrea M. Leahy and Judge Dan
Friedman did not participate in the Court’s
decision to designate this opinion for
publication in the Maryland Appellate Reports
pursuant to Maryland Rule 8-605.1.
I. INTRODUCTION
This appeal arises from a Master Settlement Agreement (“MSA”) between
appellees, who are numerous cigarette manufacturers (the “Participating Manufacturers”
or “PMs”),1 and appellant, the State of Maryland (“Maryland”), along with 51 other states
and territories (collectively, the “Settling States”). Specifically, it involves the multi-state
arbitration of an MSA dispute over the “Non-Participating Manufacturer Adjustment”
(“NPM Adjustment”) – a potential reduction to the annual payment that the PMs make to
the Settling States under the MSA, which is allocated among those states who failed to
diligently enforce certain obligations under the MSA.
During the arbitration of the 2003 NPM Adjustment dispute, the PMs reached a
settlement (“Term Sheet” agreement) with 22 states (the “Term Sheet States”) before it
was determined whether those states were diligent or non-diligent. Maryland and the
other “Non-Term Sheet States” were also offered the settlement, but declined to join. In
light of this partial settlement, the arbitrators (a “Panel” of three former federal judges)
were tasked with resolving how the 2003 NPM Adjustment should be allocated to any
Non-Term Sheet States who were found non-diligent. On March 12, 2013, the Panel
1
The original PMs, Philip Morris USA, Inc., R.J. Reynolds Tobacco Co., and
Lorillard Tobacco Co., filed one brief, and another brief was filed by certain subsequent
PMs – including Commonwealth Brands, Inc., Compania Industrial de Tabacos Monte
Paz, S.A., Daughters & Ryan, Inc., House of Prime A/S, Liggett Group LLC, Sherman
1400 Broadway N.Y.C Inc., King Maker Marketing, Inc., Top Tobacco, LP, Japan
Tobacco International U.S.A., Inc., Kretek International, Inc., Peter Stokkebye
Tobaksfabrik A/S, P.T. Djarum, Santa Fe Natural Tobacco Company, Inc., Von Eicken
Group – and also on behalf of Farmers Tobacco Co. of Cynthiana, Inc.
interpreted the MSA’s language and concluded that the NPM Adjustment should be
allocated post-settlement pursuant to the “pro rata” method of judgment reduction.
After holding individual evidentiary hearings for the Non-Term Sheet States,
whose diligence for 2003 was still contested, the Panel concluded that Maryland and five
other Non-Term Sheet States were non-diligent and thus subject to the 2003 NPM
Adjustment. On September 11, 2013, after assessing Maryland’s enforcement record for
2003, the Panel found that Maryland lacked “a culture of compliance” and that its efforts
“fell short of its efforts in earlier years.”
Maryland filed motions in the Circuit Court for Baltimore City to vacate the
Panel’s awards for the 2003 NPM Adjustment that adopted the pro rata judgment-
reduction method and that found Maryland to be non-diligent. On November 12, 2013,
Maryland also filed a motion to compel the PMs to arbitrate Maryland’s diligence for
2004 in a state-specific arbitration, rather than as part of a multi-state arbitration of the
entire 2004 Adjustment dispute. On July 28, 2014, the circuit court denied all three
motions, and on August 20, 2014, Maryland noted this appeal.
II. QUESTIONS PRESENTED
We have rephrased Maryland’s questions as follows:2
2
In its brief, Maryland asked:
1) Did the Arbitration Panel exceed its authority when it approved a
side agreement between the Participating Manufacturers and the Term
Sheet States that altered the MSA’s reallocation provision, where the MSA
prohibits amendments absent specific agreement by all affected parties,
Maryland and other parties to the MSA expressly objected to the Panel’s
2
1) Did the circuit court err in refusing to vacate the Panel’s award
which adopted the pro rata judgment-reduction method in
reallocating the 2003 NPM Adjustment only among the non-diligent,
Non-Term Sheet States?
2) Did the circuit court err in refusing to vacate the Panel’s finding that
Maryland was not diligent in 2003?
3) Did the circuit court err in failing to order the PMs to arbitrate
Maryland’s diligence for 2004 in a state-specific arbitration?
For the reasons that follow, we answer only the first question in the affirmative, and
reverse the circuit court’s judgment regarding that issue. Accordingly, we remand the
case for further proceedings not inconsistent with this opinion.
III. FACTS
A. MSA
In 1998, Maryland and the 51 other Settling States entered the MSA, thus settling
their claims for “wrongful marketing and advertising of cigarettes, as well as damages
based upon the costs of treating smoking-related illnesses,” against three major cigarette
manufacturers – Philip Morris USA, Inc., R.J. Reynolds Tobacco Co., and Lorillard
approval of the side agreement, and the Panel’s approval of the side
agreement operated to the substantial detriment of Maryland?
2) Did the Arbitration Panel refuse to consider material evidence
related to the enforcement efforts of the contested Term Sheet States, given
that all of the states had entered an agreement for a national arbitration to
determine, in one proceeding, the diligence of each of the states?
3) Did the circuit court err in failing to order the Participating
Manufacturers to arbitrate in a Maryland-specific proceeding their claim
that Maryland did not diligently enforce the provisions of its Qualifying
Statute during 2004, in light of the terms of the MSA and the prejudice
Maryland experienced in the multi-state arbitration for 2003?
3
Tobacco Co. (collectively, “Original Participating Manufacturers” or “OPMs”). State v.
Philip Morris Inc., 179 Md. App. 140, 142-43 (2008). Since then, more than forty
subsequent participating manufacturers (“SPMs”) have joined the MSA. Id. at 145 n.2.
In exchange for the dismissal of “any pending action and [a] release [of] all past and
future claims” against them, the PMs agreed “to restrict the manner in which they market
and advertise tobacco products and . . . to make a substantial annual payment to be
allocated among the settling states.” Id. at 145.
Pursuant to the MSA, the PMs do not make the annual payment (“MSA Payment”)
directly to the Settling States. Id. Rather, each PM is “required to make a single,
nationwide annual payment into an escrow account on or before April 15” of each year,
the exact amount of which is calculated annually by an “Independent Auditor . . .
pursuant to a comprehensive formula contained within the MSA.” Id. at 145-46. “The
calculation begins with each original participating manufacturer paying into an escrow
account its relative market share of the base amount for the calendar year.” Id. at 146
(citing MSA § IX(c)(1)). That amount is then subject to several reductions and
adjustments, including the NPM Adjustment. Id. (citing MSA §§ IX(c)(j), XI(a)(1)).
Thereafter, the funds are “allocated among the settling states according to formulae set
forth in the MSA.” Id. at 146 n.3. Pursuant to the “allocable shares,” Maryland is
entitled to 2.2604570 percent of the PMs’ annual payment. Id. (citing MSA § II(f)).
The NPM Adjustment, governed by Section IX(d) of the MSA, is a payment
reduction designed to address the PMs’ concern that “they would incur a competitive
disadvantage to the non-participating manufacturers [(“NPMs”)], who were not subject to
4
the MSA’s strict marketing restrictions and payment obligations.” Id. at 146-47. Each
year, PMs “may be eligible to take a NPM Adjustment if (1) the independent auditor
determines that, during the year in question, the participating manufacturers collectively
lose more than two percent of their pre-MSA market share to non-participating
manufacturers and (2) an economic consulting firm determines that the MSA was a
‘significant factor’ contributing to that loss.” Id. at 147 (citing MSA § IX(d)(1)). If these
conditions are satisfied, then the PMs are entitled to the NPM Adjustment on their annual
payment as to all Settling States, subject to one exception – the “diligence exception.”
See MSA § IX(d)(2).
Pursuant to the diligence exception, “[a] Settling State’s Allocated Payment shall
not be subject to an NPM Adjustment . . . if such Settling State continuously had a
Qualifying Statute . . . in full force and effect during the calendar year immediately
preceding the year in which the payment in question is due, and diligently enforced the
provisions of such statute during such entire calendar year.” MSA § IX(d)(2)(B). The
MSA defines a “Qualifying Statute” as a “statute, regulation, law and/or rule . . . that
effectively and fully neutralizes the cost disadvantages that the [PMs] experience vis-à-
vis [NPMs] within such Settling State as a result of [the MSA].” MSA § IX(d)(2)(E).
“Maryland enacted the model ‘qualifying statute’ contained in Exhibit T to the MSA,
which is codified as Maryland’s Escrow Act [Md. Code (1992, 2010 Repl. Vol.), § 16-
401 et seq. of the Business Regulation Article].” Philip Morris Inc., 179 Md. App. at
147. It requires all NPMs to:
5
deposit into escrow a fixed sum per cigarette sold that is slightly less than
the per-cigarette cost imposed by the MSA on participating manufacturers.
These escrowed funds may ultimately be used to satisfy a judgment that the
State may obtain against a non-participating manufacturer. If the funds are
not so used within twenty-five years, they are returned to the non-
participating manufacturer.
Id. at 148 (internal citations omitted). “[I]f a state has a ‘qualifying statute’ in full force
and effect and diligently enforces that statute, the auditor must reallocate that state’s
share of the NPM Adjustment among the other states that do not qualify, ‘pro rata in
proportion to their respective Allocable Shares.’” Id. at 147 (quoting MSA § IX(d)(2)(C)
(“Reallocation Provision”)).
In other words, to incentivize the Settling States to be diligent, the MSA provides
that the non-diligent States are collectively responsible for the total available NPM
Adjustment, including what would have been the shares of the diligent states.
Accordingly, the greater the number of diligent states, the larger the amount of NPM
Adjustment that is reallocated to non-diligent states. See id. at 163 (“[T]he granting of an
exemption to one Settling State will inexorably lead to the reallocation of its allocated
portion of the NPM Adjustment to all other non-exempt Settling States. Each Settling
State thus has a vital interest in the granting or denial of each other Settling State’s
individual claim for exemption.”) (Citation omitted); Com. ex rel. Kane v. Philip Morris
USA, Inc., 114 A.3d 37, 44 (Pa. Commw. Ct. 2015) (“Generally, as the number of
diligent states increase, the burden on non-diligent states increases. This is because an
increase in the number of diligent states means that there is more adjustment reallocated
among a smaller group.”).
6
Barb. 2003 NPM Adjustment
In the present appeal, the primary dispute concerns the NPM Adjustment for 2003.
Although the PMs were entitled to take an NPM Adjustment that year, the Independent
Auditor decided not to apply it because the Settling States’ diligence in enforcing their
respective Qualifying Statutes had not yet been determined. See Philip Morris Inc., 179
Md. App. at 148-49 (“[T]he participating manufacturers requested that the auditor apply
the 2003 NPM Adjustment to their April 2006 payments. Maryland and the other settling
states, however, urged the auditor to deny the NPM Adjustment on the ground that the
settling states ‘diligently enforced’ their qualifying statutes.”). Therefore, the PMs
requested arbitration pursuant to MSA § XI(c), id. at 143, which states:
Any dispute, controversy or claim arising out of or relating to calculations
performed by, or any determinations made by, the Independent Auditor
(including, without limitation, any dispute concerning the operation or
application of any of the adjustments, reductions, offsets, carry-forwards
and allocations described in subsection IX(j) or subsection XI(i)) shall be
submitted to binding arbitration before a panel of three neutral arbitrators,
each of whom shall be a former Article III federal judge. Each of the two
sides to the dispute shall select one arbitrator. The two arbitrators so
selected shall select the third arbitrator. The arbitration shall be governed
by the United States Federal Arbitration Act [9 U.S.C. § 1 et seq.].
On May 18, 2006, Maryland asked the Circuit Court for Baltimore City “for
declaratory relief, declaring that the auditor properly determined not to reduce the
participating manufacturers’ MSA payments to reflect a NPM Adjustment.” Philip
Morris Inc., 179 Md. App. at 149 (footnote omitted). After hearing arguments on
October 5, 2006, the circuit court issued an order on January 19, 2007, compelling
arbitration, and we affirmed that decision on March 27, 2008. Id. at 150, 167.
7
In December, 2008, the PMs entered into an Agreement Regarding Arbitration
(“ARA”) with almost every Settling State, including Maryland. According to the ARA,
“[t]he 2003 NPM Adjustment shall be resolved through [a nationwide arbitration]
pursuant to Section XI(c) of the MSA” in order to determine:
1. Whether the Independent Auditor was correct in not applying the
2003 NPM Adjustment to the [PMs’] 2006 or prior annual payments
....
2. Whether the June 2003 settlement agreements release in whole or in
part, or provide a basis for excluding evidence relating to, the 2003
NPM Adjustment.
3. Whether individual Settling States diligently enforced a Qualifying
Statute in 2003 . . . .
4. (a) Whether under Section XI(i)(2)(A) of the MSA, a transfer from
the Disputed Payments Account to a [PM] should be accomplished
through a transfer from the Disputed Payments Account to such
[PM] or through an offset in favor of such [PM] accompanied by a
transfer to the Settling States; and (b) under Section XI(i)(1)(B) of
the MSA, under what circumstances, if any, should a transfer be
made from the Disputed Payments Account to a Settling State that is
determined to have diligently enforced a Qualifying Statute or whose
diligent enforcement the [PMs] no longer contest.
5. To the extent a Settling State may assert that the 2003 NPM
Adjustment should be applied to another Settling State pursuant to
Section IX(d)(2) of the MSA, a determination as to the validity of
any such assertion.
The Panel3 began proceedings on July 2, 2010, and entered various preliminary
orders governing the conduct of the hearings. For example, on January 19, 2011, it
3
The Panel consisted of Judge William G. Bassler, selected by the PMs; Judge
Abner J. Mikva, selected by the Settling States; and Judge Fern M. Smith, selected by
Judges Bassler and Mikva. All three arbitrators were former Article III federal judges.
8
concluded that the Settling States “must bear the burden of proving that they diligently
enforced their respective Qualifying Statutes for purposes of the 2003 NPM Adjustment.”
In particular, the Panel determined that “no language in the MSA supports a finding that
the States can by-pass an inquiry regarding whether they satisfied their contractual
obligation for avoiding a payment adjustment through the NPM Adjustment.” (Citation
omitted).
By order dated May 23, 2011, the Panel added that “although the conditions to
application of the NPM Adjustment under section IX(d)(1) had been met, without the
diligent enforcement determination, there was no ‘Available NPM Adjustment for the
Auditor to apply and there would be no Available NPM Adjustment unless and until the
diligent enforcement determination was made.’” Thus, according to the Panel, the
Independent Auditor could not apply the 2003 NPM Adjustment and properly declined to
do so.
Then, in an order dated July 1, 2011, the Panel concluded, in pertinent part:
(3) Any Settling State whose diligent enforcement for the year 2003 is
not contested by any PM or State[4] will be deemed [] by the
Independent Auditor for purposes of Section IX(d)(2)(B)-(C) of the
MSA as a Settling State that diligently enforced its Qualifying
Statute for that year only and is therefore [] not subject [to] the 2003
NPM Adjustment.
(4) The share of the 2003 NPM Adjustment (if any) of a Settling State
whose diligent enforcement is not contested by any PM or State, will
be governed by the reallocation provisions of Sections IX(d)(2) and
IX (d)(4) of the MSA, and will thus be reallocated among all Settling
The Panel set deadlines for PMs to contest the diligence of Settling States, and
4
for Settling States to contest the diligence of other Settling States. However, neither
Maryland nor any other Settling State contested the diligence of any other Settling State.
9
States that did not diligently enforce a Qualifying Statute during
2003 as provided in those provisions.
In that order, the Panel noted that “[b]ecause a state bears the burden of proof when its
claim of diligent enforcement [] is not challenged does not mean that there must be a
hearing when the claim is unchallenged.” Rather, “the burden to prove diligent []
enforcement comes into play only when a state’s contested claim is required to [be]
resolved.”
On or about November 3, 2011, the PMs filed a notice of their intent to contest the
diligence of 35 Settling States, including Maryland. Thereafter, the Panel scheduled
individual evidentiary hearings for each of those 35 Settling States. A hearing devoted to
Maryland’s enforcement evidence took place from 8:30 a.m. to 5:00 p.m. on October 22-
23, 2012, and from 8:30 a.m. to 3:30 p.m. on October 24, 2012. During that time,
Maryland presented the testimony of two lay witnesses, one document summary witness,
and three expert witnesses. Meanwhile, the PMs had three expert witnesses testify on
their behalf.
On or about December 17, 2012, before the Panel had finished all of the state-
specific hearings, the PMs and 19 of the Settling States “agreed to a Term Sheet for
settlement” that purported to “resolve[] the 2003-12 NPM Adjustments as to the
signatory States and revise[] the NPM Adjustment provision as to those States for the
years following 2012.” All of the remaining Settling States were invited to join the
settlement, and three more did. Maryland declined the invitation.
10
The 22 total Term Sheet States had an aggregate allocable share of approximately
46% of the NPM Adjustment. Of those 22 states, the PMs had contested the diligence of
20. The Term Sheet, which was to become binding “upon the Panel’s approval,” did not
address the MSA’s Reallocation Provision – in particular, its effect on the reallocation of
the 2003 NPM Adjustment among the Non-Term Sheet States.
In January 2013, the PMs and Term Sheet States filed a Proposed Stipulated
Partial Award with the Panel, presenting alternatives for “how the 2003 NPM Adjustment
will be allocated among the [Non-Term Sheet] States in light of the settlement.” On
February 22, 2013, many of the Non-Term Sheet States, including Maryland, filed a brief
in opposition to the Proposed Stipulated Partial Award. In pertinent part, they argued that
“the reallocation provisions of the proposed award are contrary to the MSA, adversely
affect the majority states, and are not remedied by the proposed set-offs.” Particularly,
they urged:
If the Panel chooses to enter an award regarding the settlement, the
order should instruct the Independent Auditor to treat any contested [Term
Sheet] State as non-diligent for purposes of calculating the allocation of the
NPM Adjustment. That result is mandated by the plain language of the
MSA unless and until the contested [Term Sheet] States prove their
diligence. The MSA’s reallocation structure requires a determination as to
the diligence of each State because each State’s potential exposure to an
NPM Adjustment depends on every other State’s diligence. The MSA’s
reallocation procedure requires that each State be determined diligent or not
diligent and contains no exception for a partial settlement.
(Footnote omitted).
After hearing argument on the issues surrounding the Proposed Stipulated Partial
Award, the Panel issued a Stipulated Partial Settlement and Award (“Partial Settlement
11
Award”) on March 12, 2013.5 At the outset, the Panel noted that “the MSA does not
directly speak as to the process to be used when some States settle diligent enforcement
and some do not.” The Panel then ruled that it “ha[d] jurisdiction to rule on the issues
raised concerning the MSA reallocation provisions and to determine how the 2003 NPM
Adjustment will be allocated among the [Non-Term Sheet] States in light of the
settlement.” According to the Panel, its “jurisdiction to interpret and determine the
operation of the reallocation provisions is no less where a State is no longer contested
because of a settlement.”
Turning to the merits, the Panel concluded, in pertinent part:
1. In light of the settlement, the 2003 NPM Adjustment will be
allocated among the [Non-Term Sheet] States as follows. The dollar
amount of the 2003 NPM Adjustment will be reduced by a percentage
equal to the aggregate Allocable Shares of the [Term Sheet] States as of the
date of the Panel’s Final Award . . . . The Independent Auditor will treat
the [Term Sheet] States as not subject to the 2003 NPM Adjustment, as that
Adjustment amount is reduced as provided above, will be governed by the
reallocation provisions of Sections IX(d)(2) and IX(d)(4) of the MSA, and
will thus be reallocated among all [Non-Term Sheet] States that did not
diligently enforce a Qualifying Statute during 2003 as provided in those
provisions. The maximum portion of the 2003 NPM Adjustment that can
be applied to a [Non-Term Sheet] State remains as provided by Section
IX(d)(2)(D) of the MSA.
2. This judgment reduction is appropriate and adequate under
the MSA and governing law. Where multiple parties have a potential
shared contractual obligation and some of them settle and some do not, the
non-settling parties cannot necessarily block the settlement, but may be
5
The Partial Settlement Award largely tracked the Proposed Stipulated Partial
Award, with one significant addition – namely that the “relief, if any,” for objecting
states that believe they are negatively affected by the Partial Settlement Award, would be
an “appeal to their individual MSA court.” Maryland’s MSA court is the Circuit Court
for Baltimore City.
12
entitled to a judgment reduction. The “three standard methods for reducing
judgment against non-settling defendants after a partial settlement” are “pro
rata (court divides the amount of the total judgment by the number of
settling and non-settling defendants, regardless of each defendant’s
culpability), proportionate fault (after a partial settlement and trial of the
non[-]settling defendants, the jury determines the relative culpability of all
the defendants and the non-settling defendant pays a commensurate
percentage of the total judgment), and pro tanto (the court reduces the non-
settling defendant’s liability for the judgment against him by the amount
previously paid by the settling defendants, without regard to proportionate
fault).”
3. Where non-settling defendants are given the protection of the
applicable judgment-reduction method required under the contract and law,
they are not prejudiced by the partial settlement.
4. Under Paragraph 1, the [Non-Term Sheet] States receive the
pro rata reduction, under which the dollar amount of the 2003 NPM
Adjustment will be reduced by a percentage equal to the aggregate
Allocable Shares of the [Term Sheet] States. Construing the parties’
contract, the Panel concludes that the MSA reallocation provisions indicate
that the pro rata method is appropriate. These provisions use the specific
term “pro rata,” stating that the shares of diligent States are to be
“reallocated among all other Settling States pro rata in proportion to their
respective Allocable Shares.” MSA § IX(d)(2)(C) (emphasis added); see
also MSA § IX(d)(2)(D) (“pro rata in proportion to their respective
Allocable Shares”). More fundamentally, the MSA also provides that the
reallocation is not done on a relative fault basis. The amount of a diligent
State’s share that is reallocated is its pro rata share of the whole, not an
amount derived from its particular fault level. Likewise, the amount of
reallocated share that a non-diligent State receives is derived from its pro
rata share of the liable States, not its fault level. If the reallocation of
diligent States’ shares is done on a pro rata basis in this way, the Panel
reads the MSA as likewise meaning that a judgment reduction arising from
some States’ settlement of the diligent enforcement issue should be pro
rata as well.
(Internal citations omitted).
13
Addressing the Non-Term Sheet States’ objections, the Panel stated that the Partial
Settlement Award and the Term Sheet “do not legally prejudice or adversely affect the
[Non-Term Sheet] States.” It continued:
The Panel does not agree with the Objecting States’ contention that
all [Term Sheet] States must be treated as non-diligent for the purposes of
the 2003 NPM Adjustment. There is no basis in the facts to assume that
every [Term Sheet] State was non-diligent in 2003. Moreover, the
Objecting States’ position does not reflect any of the three standard
methods of judgment reduction. Such an assumption would produce a
considerably larger reduction in the [Non-Term Sheet] States’ potential
obligations than any of the standard methods. It is also contrary to the
underlying principle of judgment reduction that, because a settlement is not
tantamount to an admission of liability, settling defendants are not regarded
as necessarily culpable or liable.
The Objecting States argue that the MSA reallocation provisions
must be wholly inapplicable to a State’s share unless there is an actual
determination that the State was diligent. They claim that any approach by
which any State’s share is otherwise subject to reallocation is an
“amendment” to the MSA requiring their consent. But the MSA does not
directly speak as to the process to be used when some States settle diligent
enforcement and some do not. It is thus within the Panel’s jurisdiction to
interpret the contract in light of governing law to determine what the
appropriate process and judgment reduction is where there is a partial
settlement of diligent enforcement involving fewer than all of the States.
There is thus no “amendment” to the MSA in the Panel doing so. Should
any Objecting State, found by the Panel to be non-diligent, have a good
faith belief that the pro rata deduction does not adequately compensate
them for a [Term Sheet] State’s removal from the re-allocation pool, their
relief, if any, is by appeal to their individual MSA court. The cut-off date
for interstate suits set forth in the Panel’s “no contest” order, is not
applicable to such procedure.
(Internal citation omitted).
On September 11, 2013, the Panel issued diligence rulings for the remaining 15
Non-Term Sheet States whose diligence had been contested by the PMs (“Final
14
Awards”). The Panel determined that six of those states, including Maryland, failed to
diligently enforce their Qualifying Statutes.
In its Final Award for Maryland, the Panel began its analysis with “common”
findings and conclusions for all States, including the general standard and specific factors
that it had used to objectively assess the diligence of each contested State. The Panel
explained that it had interpreted “diligent enforcement” to mean “an ongoing and
intentional consideration of the requirements of a Settling State’s Qualifying Statute, and
a significant attempt by the Settling State to meet those requirements, taking into account
a Settling State’s competing laws and policies that may conflict with its MSA contractual
obligations.” “In order to objectively assess a Settling State’s diligent enforcement in
light of that definition,” the Panel also considered a list of eight factors:
a. Collection Rate
b. Lawsuits Filed
c. Gathering Reliable Data
d. Resources Allocated to Enforcement
e. Preventing Non-Compliant NPMs from Future Sales
f. Legislation Enacted
g. Actions Short of Legislation
h. Efforts to be Aware of NAAG [National Association of Attorneys
General] and Other States’ Enforcement Efforts
Applying these factors “objectively” to assess Maryland’s diligent enforcement,
the Panel concluded that “Maryland failed to meet its burden of proof.” According to the
Panel, “Maryland did not exhibit a culture of compliance” for most of 2003, and its
“efforts in 2003 actually fell short of its efforts in earlier years.” As such, it ruled that
Maryland was “subject to an NPM Adjustment pursuant to Section IX(d)(2)(B) of the
[MSA].”
15
C. Circuit Court
On March 26, 2013, following the Panel’s issuance of the Partial Settlement
Award but prior to its issuance of the Final Awards, Maryland filed a “Petition to Vacate
Arbitration Award” in its MSA court, the Circuit Court for Baltimore City. In its
petition, Maryland argued that the Partial Settlement Award “vastly exceed[ed] the scope
of the Panel’s power under the MSA, purport[ed] to alter the terms of the MSA without
the concurrence of Maryland and other states, and fail[ed] to adhere to clear and
undisputed contractual language.” Acknowledging that “the full implications of the
Partial [Settlement] Award [would] not be known until the arbitration is fully concluded,”
Maryland requested that the circuit court “enter an order setting the briefing and hearing
schedule [as proposed by Maryland], or, in the alternative vacating the Partial
[Settlement] Award without further argument.”
On November 12, 2013, Maryland filed a “Motion to Compel a Maryland-Specific
Arbitration on the Issue of Whether Maryland Diligently Enforced during 2004.” In that
request, Maryland averred that “[t]he MSA entitles the State to its own arbitration of the
dispute over whether it diligently enforced” its Qualifying Statute in 2004. Furthermore,
Maryland argued that “[a] State-specific arbitration would advance the fairness,
efficiency, and other purposes of arbitration, while the only alternative to an individual
arbitration, a multi-state arbitration, would defeat those same purposes.”
Soon thereafter, on November 18, 2013, Maryland filed a “Petition to Vacate
Arbitration Award Finding that [Maryland] Did Not Diligently Enforce its Qualifying
Statute During 2003.” In that petition, Maryland contended that “[t]he Panel’s Final
16
Award must be vacated because the Panel refused to hear evidence material to the
controversy.”
Following a hearing on the motions on February 19, 2014, the circuit court entered
a memorandum opinion and order on July 28, 2014, denying all three of Maryland’s
petitions. In reviewing the Panel’s decisions, the court applied the vacatur standards of
the FAA, which provide that “a reviewing court shall vacate an arbitration award, if the
arbitrators exceeded their powers due to an error in their construction of the agreement;
or the arbitrators were guilty of misconduct or misbehavior by which the rights of any
party have been prejudiced.”
With regard to the Panel’s issuance of the Partial Settlement Award, the circuit
court found:
[T]he Partial Settlement Award and the NPM reallocation adjustment
disputes do arise from the MSA; and are all clearly subject to the arbitration
agreement and within the Panel’s authority. Accordingly, this Court finds
that the Panel did not lack jurisdiction, nor did it exceed its powers in
interpreting the MSA and determining the appropriate method for
reallocating the 2003 NPM Adjustment post-settlement.
Further, this Court finds the Panel’s conclusion of the pro-rata
method to be based on a reasonable analysis of the MSA and review of
applicable judgment-reduction principles of contract law . . . .
While Maryland argues that the Panel disregarded the plain language
of the MSA, this Court finds this argument to be without merit as the Panel
did not and could not disregard the language of the MSA, as § IX(d)(2)(C)-
(D) of the MSA is silent on the issue of the reallocation of the NPM
Adjustment among non-settling states where diligence is no longer
contested due to settlement . . . . This Court does not find any indication in
the Panel’s Award that the Panel was substituting its own notions of
fairness and/or economic justice. Rather, the Panel was engaged in a good
faith interpretation of the MSA and applicable law. Therefore, this Court
finds that Maryland has failed to meet the requisite burden to establish that
17
the Panel, in issuing the Partial Settlement Award, engaged in misconduct
by failing to construe the MSA or by substituting its own notion of fairness
and/or economic justice . . . .
(Internal citations and footnotes omitted) (emphasis in original).
With regard to its denial of Maryland’s request for a state-specific arbitration, the
circuit court concluded that “the only reasonable interpretation of the MSA is that
nationwide arbitration is required.” The court explained that, under the text of the MSA’s
arbitration provision, the “two sides to the dispute” are “the MSA States in opposition to
the downward adjustment, and the PMs.” The circuit court also stated that “[t]he only
way for the payment structure to remain ‘nationwide and unitary,’ as intended, is for the
arbitration itself to be nationwide and unitary, since the diligence determinations made at
the arbitration are directly tied to the reallocation provision.” (Citing Philip Morris, Inc.,
179 Md. App. at 162) (footnote omitted).
Finally, with regard to the Panel’s Final Award, the circuit court found that the
Panel did not “refuse[] to hear pertinent and material evidence,” as Maryland alleged,
because “Maryland never requested the Panel to consider the comparative non-diligence
of the contested ‘term sheet states,’” nor did Maryland make “any substantive argument
to the Panel that the Panel needed to consider the enforcement record of the ‘term sheet
states’ when making diligence determinations for the non-settling states.” The court also
noted that Maryland’s argument failed on the merits because “it [was] clear that the
Panel’s diligence determination focused on the objective standard and assessing diligence
that was common to all states, and then applying that standard to each State’s individual
enforcement for 2003,” instead of comparing Maryland with any other contested state.
18
(Emphasis and citation omitted). The court then concluded by noting that “[e]ven if
some, most or all of the ‘term sheet states’ were less diligent than Maryland, from the
facts there is no guarantee that the Panel would have found Maryland to be diligent.”
Additional facts will be included as they become relevant to our discussion, below.
IV. STANDARD OF REVIEW
At the outset, we must determine the applicable standard of review in a case such
as this, where the Panel issued an award in an arbitration governed by the United States
Federal Arbitration Act (“FAA”) – as mandated by the MSA – but directed aggrieved
parties to appeal to their respective state courts.
Maryland contends that “the standard of review is governed by Maryland law and
is de novo.” Although Maryland acknowledges that this Court may rely on decisions
interpreting the FAA because the Maryland Uniform Arbitration Act (“MUAA”) is the
FAA’s state analogue, Maryland maintains that we are not bound by the federal
procedural provisions of the FAA. Instead, Maryland avers that this Court must look to
the pertinent state law relating to arbitration agreements to determine whether the circuit
court erred in denying the relief sought.
In response, the PMs argue that the circuit court correctly applied “the FAA’s
extremely narrow judicial-review standards,” and that Maryland’s claim that a de novo
standard applies is “both waived and wrong.” First, the PMs contend that “Maryland
waived [its] argument by not raising it below.” Specifically, the PMs note that Maryland
“repeatedly acknowledged that the MSA requires application of the FAA” through its
opening and subsequent briefs, and its post-hearing submission. Second, relying on the
19
MSA, the PMs aver that “the FAA will ‘govern’ MSA arbitrations” and, thus, the circuit
court acted properly in applying the vacatur standards of the FAA. Third, the PMs argue
that “to the extent . . . that Maryland law would authorize broader judicial review in this
case, it would be preempted by the FAA.” (Emphasis in original). Lastly, the PMs
contend that “the Maryland standard of review is equally or nearly as narrow as the FAA
standard,” and its application would not, therefore, lead to a different result.
We agree with Maryland that judicial review of the arbitrator’s decision in this
case is governed by Maryland law. We explain and address each of the PMs’
contentions.
The PMs first argue that Maryland waived its present claim by not raising it in the
circuit court, but they cite no authority to support their position that the applicable
standard of review can be waived. Indeed, although no Maryland court has ruled on this
matter, several federal courts have stated that “a party cannot ‘waive’ the proper standard
of review by failing to argue it.” Brown v. Smith, 551 F.3d 424, 428 n.2 (6th Cir. 2008)
(citations omitted); see also Ward v. Stephens, 777 F.3d 250, 257 n.3 (5th Cir. 2015) (“A
party cannot waive, concede, or abandon the applicable standard of review.”) (Citations
omitted), petition for cert. filed, U.S. No. 14-10033 (June 2, 2015); Gardner v. Galetka,
568 F.3d 862, 879 (10th Cir. 2009) (holding that “the standard of review under AEDPA
cannot be waived by the parties”) (citations omitted); Vizcaino v. Microsoft Corp., 120
F.3d 1006, 1022 n.4 (9th Cir. 1997) (en banc) (O’Scannlain, J., concurring in part and
dissenting in part) (“[A] party cannot, by waiver or estoppel, change the applicable
standard of review.”); Ingle v. Metro. Life Ins. Co., 947 F. Supp. 2d 1163, 1167 (N.D.
20
Okla. 2013) (citing Izzarelli v. Rexene Products Co., 24 F.3d 1506, 1519 (5th Cir. 1994),
and stating that “at least one circuit court has explicitly held that a party cannot waive the
standard of review in an ERISA case”). This is because it is “the court, not the parties,
[who] must determine the standard of review[.]” Worth v. Tyer, 276 F.3d 249, 262 n.4
(7th Cir. 2001) (citation omitted). Therefore, “[s]uch a determination remains for this
court to make for itself.” K & T Enterprises, Inc. v. Zurich Ins. Co., 97 F.3d 171, 175
(6th Cir. 1996).6
Next, citing the MSA, the PMs argue that judicial review of the Panel’s decision is
governed by the FAA. In advancing this argument, the PMs correctly note that, pursuant
to MSA § XI(c), NPM Adjustment disputes are subject to an “arbitration [that] ‘shall be
governed by the [FAA].’” (Emphasis added). But, they fail to acknowledge that the
MSA does not mandate that judicial review of such an arbitration award would be
governed by the FAA as well. Rather MSA § XVIII(n), entitled “Governing Law,”
provides that the MSA “shall be governed by the laws of the relevant Settling State,
without regard to conflict of law rules of such Settling State.” See also MSA § VII(a)
(stating that the MSA Court retains exclusive jurisdiction); and MSA § II(p) (defining
“Court” as the “respective court in each Settling State”).
6
Even if the standard were waivable, this Court could exercise its discretion to
entertain Maryland’s argument. Md. Rule 8-131(a) (“Ordinarily, the appellate court will
not decide any other issue unless it plainly appears by the record to have been raised in or
decided by the trial court, but the Court may decide such an issue if necessary or
desirable to guide the trial court or to avoid the expense and delay of another appeal.”)
(Emphasis added).
21
Alternatively, the PMs contend that “the FAA standard would govern under
constitutional preemption principles” because applying a broader state law review
standard “would undercut the FAA’s national policy favoring arbitration with just [a]
limited review” and “would thwart the FAA’s primary purpose of ensuring that private
agreements to arbitrate are enforced according to their terms.” (Citations omitted).
Contrary to the PMs’ contention, however, the Maryland Court of Appeals has repeatedly
stated that “our procedural rules are not preempted by national policy favoring
arbitration[.]” Addison v. Lochearn Nursing Home, LLC, 411 Md. 251, 287 (2009)
(citing Wells v. Chevy Chase Bank, F.S.B., 363 Md. 232, 242 (2001) (“we conclude that
Maryland procedural law . . . is not preempted by the FAA”); accord Walther v.
Sovereign Bank, 386 Md. 412, 423 (2005) (“In enforcing . . . the FAA, however, state
courts are not bound by the federal procedural provisions of the FAA . . . but may
generally apply their own procedures.”).7 In fact, the United States Supreme Court has
stated that “[t]he FAA contains no express pre-emptive provision, nor does it reflect a
congressional intent to occupy the entire field of arbitration.” Volt Info. Sciences, Inc. v.
Bd. of Trustees of Leland Stanford Junior Univ., 489 U.S. 468, 477 (1989) (citation
omitted). Instead, “state law may . . . be pre-empted to the extent that it actually conflicts
7
We likewise reject the PMs’ contention, based on the Missouri Court of
Appeals’s decision in Edward D. Jones & Co. v. Schwartz, 969 S.W.2d 788 (Mo. Ct.
App. 1998), that the matter at hand is “substantive rather than procedural.” Although the
Court in that case acknowledged that the FAA “create[d] a body of substantive federal
law on arbitration[,]” it nonetheless “utilize[ed] Missouri procedural rules” while
“apply[ing] federal substantive law” in a case involving arbitration pursuant to the FAA.
Id. at 793, 795.
22
with federal law—that is, to the extent that it ‘stands as an obstacle to the
accomplishment and execution of the full purposes and objectives of Congress.’” Id.
(quoting Hines v. Davidowitz, 312 U.S. 52, 67 (1941)).
Therefore, in order for the PMs to prevail on their argument, it must be evident
that application of the Maryland standard of review would not only serve to frustrate the
underlying goals of the FAA, but would also result in a failure to carry out the arbitration
provision of the MSA as the parties had intended. Application of the Maryland standard
of review does neither. As the PMs recognize in their briefs and as we shall further
explain below, “[t]he Maryland arbitration statute is virtually identical in substance to the
FAA,” and would also promote the goal of enforcing arbitration agreements. (Citation
omitted). See Hall St. Assocs., L.L.C. v. Mattel, Inc., 552 U.S. 576, 590 (2008) (“The
FAA is not the only way into court for parties wanting review of arbitration awards: they
may contemplate enforcement under state statutory or common law, for example, where
judicial review of different scope is arguable.”). And, with regard to the terms of the
parties’ agreement to arbitrate, we have already explained that application of Maryland
law would not violate any MSA provision governing post-arbitration judicial review.
Having determined that Maryland standard of review applies in reviewing the
Panel’s decisions, we direct our attention to the applicable statute governing the vacation
of an arbitration award, Md. Code (1973, 2013 Repl. Vol.), § 3-224(b) of the Courts &
Judicial Proceedings Article (“CJP”), which provides:
The court shall vacate an award if:
23
(1) An award was procured by corruption, fraud, or other undue
means;
(2) There was evident partiality by an arbitrator appointed as a
neutral, corruption in any arbitrator, or misconduct prejudicing the
rights of any party;
(3) The arbitrators exceeded their powers;
(4) The arbitrators refused to postpone the hearing upon sufficient
cause being shown for the postponement, refused to hear evidence
material to the controversy, or otherwise so conducted the hearing,
contrary to the provisions of § 3-213 of this subtitle, as to prejudice
substantially the rights of a party; or
(5) There was no arbitration agreement as described in § 3-206 of
this subtitle, the issue was not adversely determined in proceedings
under § 3-208 of this subtitle, and the party did not participate in the
arbitration hearing without raising the objection.
Here, Maryland’s issues with the Panel’s decisions are rooted in CJP § 3-224(b)(3) & (4).
In the past, Maryland courts have held that “arbitrators exceed their powers not
only when the substance of their award lacks a scintilla of rationality, but also where the
award is founded upon a mistaken assertion of jurisdiction.” Snyder v. Berliner Const.
Co., 79 Md. App. 29, 37 (1989) (citation & footnote omitted); see also Downey v. Sharp,
428 Md. 249, 258 (2012) (noting that “awards which were ‘completely irrational,’ or
which demonstrated ‘manifest disregard of the law,’ or which were contrary to the State’s
public policy, had been overturned”). Thus, “‘an award issued by an arbitration panel
acting without jurisdiction should be accorded no deference at all on appeal.’” Snyder,
79 Md. App. at 38 (quoting Stephen L. Messersmith, Inc. v. Barclay Townhouse Assocs.,
313 Md. 652, 664 (1988)).
24
By contrast, “factual findings by an arbitrator are virtually immune from challenge
and decisions on issues of law are reviewed using a deferential standard on the far side of
the spectrum away from a usual, expansive de novo standard.” Mandl v. Bailey, 159 Md.
App. 64, 92 (2004) (citations omitted); see also Downey, 428 Md. at 266 (“reviewing
courts generally defer to the arbitrator’s findings of fact and applications of law” )
(citations omitted). As a result, “courts are fairly reluctant to disturb the award of an
arbitrator where the award reflects the honest decision of the arbitrator and is the product
of a full and fair hearing of the parties.” Balt. Teachers Union, Am. Fed’n of Teachers,
Local 340, AFL-CIO v. Mayor & City Council of Balt., 108 Md. App. 167, 181 (1996)
(citations omitted).
With regard to the appellate process, the parties do not dispute – and we agree –
that this Court’s review of the circuit court’s decision is de novo, regardless of whether
the circuit court disposed of the outstanding motions before it pursuant to the FAA or the
MUAA. See First Options of Chicago, Inc. v. Kaplan, 514 U.S. 938, 947-48 (1995)
(“when reviewing a district court decision that refuses to vacate, or confirms, an
arbitration award,” a court of appeals should “accept[] findings of fact that are not
‘clearly erroneous’ but decid[e] questions of law de novo”) (internal citations omitted);
Delta Queen Steamboat Co. v. Dist. 2 Marine Engineers Beneficial Ass’n, AFL-CIO, 889
F.2d 599, 602 (5th Cir. 1989) (“Thus, since this jurisdictional challenge focuses upon
whether the award is grounded in the . . . agreement, we will review the [trial] court’s
decision de novo.”) (Citation omitted); Stephen L. Messersmith, Inc., 313 Md. at 664
(“the appropriate standard of review when an arbitration award is attacked for lack of
25
jurisdiction . . . is . . . de novo”); Prince George’s Cnty., Md. ex rel. Prince George’s
Cnty. Police Dep’t v. Prince Georges Cnty. Police Civilian Employees Ass’n, 219 Md.
App. 108, 119 (2014) (“A circuit court’s decision to grant or deny a petition to vacate or
confirm an arbitration award is akin to an order granting or denying a motion for
summary judgment. The standard of review is de novo.”) (Internal citations omitted),
cert. granted, 441 Md. 217 (2015). “Therefore, we review that court’s disposition for
legal error.” Montgomery Cnty., Maryland v. Fraternal Order of Police, Montgomery
Cnty. Lodge 35, Inc., 427 Md. 561, 572 (2012) (citation omitted). To that end, we accept
any relevant factual findings by the circuit court that are not “clearly erroneous[.]” See
First Options of Chicago, Inc., 514 U.S. at 947-48.
V. DISCUSSION
A. Partial Settlement Award
Maryland first argues that “the Panel exceeded its powers when it amended the
MSA without Maryland’s consent,” by ratifying the Term Sheet and by issuing the Partial
Settlement Award. According to Maryland, the Partial Settlement Award “impermissibly
allowed the contested Term Sheet States to bypass a diligence inquiry and treated them as
not subject to the NPM Adjustment.” Maryland further contends that, in ruling as it did,
the Panel’s actions “conflicted with rules of conduct and ethics for arbitrators” and
“detrimentally affected Maryland.” Accordingly, Maryland argues that the circuit court
erred in refusing to vacate the Partial Settlement Award, and it now urges us to reverse
that judgment and remand with instructions to have the Independent Auditor “treat all of
26
the Term Sheet States [whose diligence was contested] as non-diligent for the purpose of
calculating Maryland’s NPM Adjustment liability for 2003.”8
In response, the PMs aver that “the circuit court correctly held that the Panel did
not exceed its powers in entering the [Partial] Settlement Award’s pro rata judgment-
reduction ruling,” and its decision “furthered the strong policy in favor of settlements.”
According to the PMs, the court acted properly in applying the FAA standard and finding
that the Panel not only had jurisdiction to interpret the MSA, but also acted in good faith
in issuing the Partial Settlement Award.9 Alternatively, the PMs contend that, even when
reviewed under Maryland’s standard, “the Panel’s pro rata judgment-reduction ruling
was also a rational interpretation of the MSA.” In that regard, the PMs argue that “MSA
§ IX(d)(2) simply does not say what [Maryland] alleges[;]” rather, they insist that the
Panel’s interpretation was warranted because “§ IX(d)(2) does not ‘directly speak’ to, and
is indeed ‘silent on,’ the proper method for reallocating the NPM Adjustment after a
partial settlement.” Finally, the PMs contend that Maryland waived its argument because
it vehemently opposed the Panel’s adoption of the proportionate fault judgment-reduction
8
In its reply brief, Maryland notes that Com. ex rel. Kane, supra, 114 A.3d 37, is
“the only appellate ruling on point,” and that the Commonwealth Court of Pennsylvania,
in that case, correctly “affirmed a ruling by a Pennsylvania trial court that had vacated the
Partial [Settlement] Award as to Pennsylvania and directed that the contested Term Sheet
States be deemed non-diligent for purposes of calculating Pennsylvania’s NPM
Adjustment obligation.”
As we previously explained, the FAA’s vacatur standards do not apply here.
9
Therefore, we need not address this argument.
27
method, which would have allowed the Panel to conduct diligence hearings for any Term
Sheet States.
In its reply brief, Maryland argues that the PMs’ argument “begins at the wrong
place.” We agree. As Maryland stated, in pertinent part:
The [PMs’] argument takes as its starting point a presumption that the Panel
was confronted with a need to fashion an appropriate method of judgment
reduction due to an absence of guidance from the MSA. Leaping from that
faulty premise, they would ask this Court to determine that the Panel’s
choice of a pro rata methodology was, in that context, a rational one.
However, the issue raised in this appeal is not whether the Panel made the
appropriate selection among available judgment reduction methodologies,
but whether it was empowered to look outside the MSA to find a judgment
reduction methodology at all.
(Internal citations omitted). Our analysis begins with the MSA.
MSA § XI(c) provides that “[a]ny dispute, controversy or claim arising out of or
relating to calculations performed by, or any determinations made by, the Independent
Auditor . . . shall be submitted to binding arbitration before a panel of three neutral
arbitrators” in an arbitration governed by the FAA. The Supreme Court has stated that, in
order “[t]o resolve disputes about the application of a[n] . . . agreement, an arbitrator
must find facts” and is free to “interpret[] . . . the contract.” United Paperworkers Int’l
Union, AFL-CIO v. Misco, Inc., 484 U.S. 29, 38 (1987). Moreover, when “‘parties . . .
attempt to settle an issue, otherwise arbitrable, by agreement, any disagreement as to the
existence or effect of that settlement agreement would itself be a matter for the arbitrator
to decide.’” United Steel, Paper & Forestry, Rubber, Mfg., Energy, Allied Indus. & Serv.
Workers Int’l Union v. TriMas Corp., 531 F.3d 531, 538-39 (7th Cir. 2008) (quoting
Employees Protective Ass’n v. Norfolk & Western Rwy. Co., 571 F.2d 185, 193 (4th Cir.
28
1977)); see also Shaw’s Supermarkets, Inc. v. United Food & Commercial Workers
Union, Local 791, AFL-CIO, 321 F.3d 251, 254 (1st Cir. 2003) (stating that, when parties
enter into a valid agreement to arbitrate, “other issues relating to the substance of the
dispute or the procedures of arbitration are for the arbitrator”) (citation omitted).10
Therefore, the circuit court did not err in concluding that “the Panel did not lack
jurisdiction . . . in interpreting the MSA and determining the appropriate method for
reallocating the 2003 NPM Adjustment post-settlement.”
Where the Panel erred, however, was in reallocating the 2003 NPM Adjustment
post-settlement without first determining the diligence of certain states. Stated
differently, by ratifying the Proposed Stipulated Partial Award and issuing the Partial
Settlement Award, the Panel disregarded MSA § IX(d)(2)(B), which provides that “[a]
Settling State’s Allocated Payment shall not be subject to a NPM Adjustment . . . if such
Settling State continuously had a Qualifying Statute . . . and diligently enforced the
provisions of such statute during such entire calendar year.” (Emphasis added). The
Supreme Court has stated that an “arbitrator may not ignore the plain language of the
contract.” United Paperworkers Int’l Union, AFL-CIO, 484 U.S. at 38 (citation omitted).
But, in this case, certain Term Sheet States’ Allocated Payments were deemed not subject
to an NPM Adjustment even though the Panel never found that such states diligently
enforced their respective Qualifying Statutes. As such, the Panel’s error did not lie
10
Because the MSA provided that the arbitration would be governed by the FAA,
we look to federal cases to delineate the scope of the Panel’s jurisdiction in carrying out
said arbitration. As previously explained, however, the Panel’s rulings are subject to
Maryland’s vacatur standards on judicial review.
29
simply in reallocating the 2003 NPM Adjustment and in doing so according to the pro
rata method of judgment reduction;11 its error was in doing both before determining the
diligence of all contested states.12
We agree with the Commonwealth Court of Pennsylvania that “[a]lthough the
MSA does not address the effect of a partial settlement on the reallocation, it is not
ambiguous.” Com. ex rel. Kane, 114 A.3d at 62. Indeed, the PMs’ main contention is
not that the MSA was ambiguous; rather, they argue in large part that the Panel properly
issued the Partial Settlement Award because the MSA was silent on how to reallocate the
NPM Adjustment “where only some parties settle and consent.” We have previously
recognized, however, that “[a] contract’s silence on a particular issue does not, by itself,
create ambiguity as a matter of law.” Azat v. Farruggio, 162 Md. App. 539, 551 (2005)
(citing Richard A. Lord, Williston on Contracts, § 30.4 at 47-51 (4th ed. 1999)). Silence
creates ambiguity only “when it involves a matter naturally within the scope of the
contract.” Id. (citation omitted). Here, although the MSA was silent on the effect of a
partial settlement regarding the NPM Adjustment, that settlement – or Term Sheet – was
not a matter naturally within the scope of the MSA and, thus, did not create an ambiguity.
As such, the Panel was not empowered to bypass the diligence determination in
reallocating the NPM Adjustment. See Com. ex rel. Kane, 114 A.3d at 63 (“Regardless
Therefore, it matters not that Maryland opposed the Panel’s adoption of the
11
proportionate fault method of judgment reduction.
We reach this conclusion regardless of which ethical standards the parties deem
12
appropriate in this instance.
30
of who bore the burden, relief from the NPM Adjustment and Reallocation Provision
depended on a determination of diligence.”).
Likewise, the Panel erred in concluding: “Where multiple parties have a potential
shared contractual obligation and some of them settle and some do not, the non-settling
parties cannot necessarily block the settlement.” Although “[t]he general rule . . . is that a
non-settling party does not have standing to object to a settlement between other parties,”
as the Panel noted, that rule cannot apply in cases such as this, where the settlement (i.e.,
Term Sheet) went against the provisions of an underlying agreement (i.e., MSA)
involving both the settling and non-settling parties (i.e., Term Sheet and Non-Term Sheet
States, respectively). By issuing the Partial Settlement Award, the Panel violated MSA §
XVIII(j), which governs “Amendment and Waiver,” and states:
This Agreement may be amended by a written instrument executed by all
Participating Manufacturers affected by the amendment and by all Settling
States affected by the amendment. The terms of any such amendment shall
not be enforceable in any Settling State that is not a signatory to such
amendment. The waiver of any rights conferred hereunder shall be
effective only if made by written instrument executed by the waiving party
or parties. The waiver by any party of any breach of this Agreement shall
not be deemed to be or construed as a waiver of any other breach, whether
prior, subsequent or contemporaneous, nor shall such waiver be deemed to
be or construed as a waiver by any other party.
As Maryland correctly notes, the Panel’s Partial Settlement Award “imposed an
unauthorized amendment to the MSA by changing the MSA’s method for reallocating the
NPM Adjustment among states that did not prove their diligence.” See Com. ex rel.
Kane, 114 A.3d at 63 (“By treating the Term Sheet States as diligent and allowing them
to shift their share of the reallocation, the panel departed from the MSA’s clear terms and
31
‘amended’ the MSA without agreement of ‘all’ parties ‘affected by the amendment.’”).
Accordingly, the Panel erred in concluding that the Partial Settlement Award and the
Term Sheet “do not legally prejudice or adversely affect” the Non-Term Sheet States.
And, we need not engage in speculation as to how much Maryland stands to gain or lose
to determine that it and the other non-diligent, Non-Term Sheet States were adversely
affected by the Panel’s ruling.
The PMs place great weight on the fact that no Settling State contested the
diligence of other Settling States. Their argument, however, is flawed because it assumes
that a Term Sheet State whose diligence had been contested by another Settling State
would have benefited by a diligence determination by the Panel. But, we do not know
whether such Term Sheet State would have been found diligent, as was the case with
Term Sheet States whose diligence was contested by the PMs, but were deemed not
subject to the 2003 NPM Adjustment.
In sum, the Panel exceeded its powers, in violation of CJP § 3-224(b)(3), when it
reallocated the 2003 NPM Adjustment without first determining the diligence of all
contested states. Not only did the Panel lack jurisdiction to issue the Partial Settlement
Award pursuant to MSA § XVIII(j), its decision lacked rationality in light of MSA §
IX(d)(2)(B). In turn, the circuit court erred in affirming the Panel’s ruling.
In order to bring the Partial Settlement Award in line with the MSA, we now grant
Maryland’s request and reverse the circuit court’s denial of Maryland’s Petition to Vacate
Arbitration Award. We remand the case to the circuit court so that it may vacate the
Partial Settlement Award and instruct the Independent Auditor to treat the 20 Term Sheet
32
States, whose diligence was contested but not determined,13 as non-diligent, when
reallocating the 2003 NPM Adjustment. As Maryland states, “given that the arbitration
was closed,” this is “the only possible remedy at this point.”
B. Evidentiary Hearing
Next, Maryland argues that “the Panel’s Final Award should be vacated because
the Panel’s refusal to hear material evidence deprived Maryland of a full and fair
hearing.” Specifically, Maryland avers that in implementing the Partial Settlement
Award, the Panel “refus[ed] to allow Maryland and other states to put at issue the
diligence of the contested Term Sheet States,” but later “considered the evidence
regarding all of the states for which it made diligence determinations when the Panel
rendered its [diligence] decisions.” Acknowledging that it did not advocate comparative
diligence determinations nor attempt to introduce evidence regarding the diligence of
other states, Maryland contends that “once the Panel [decided] to engage in a
comparative analysis, and actually did so in the context of an arbitration governed by the
ARA, it was improper – and beyond any legitimate justification – for the Panel to refuse
to hear material evidence regarding the contested Term Sheet States.” As such, Maryland
argues that the circuit court erred failing to vacate the Final Award.
In response, the PMs argue that the circuit court correctly held that the Panel did
not commit evidentiary misconduct and properly refused to vacate the Final Award. In
making their argument, the PMs emphasize that: (1) “Maryland never requested, and
To be clear, this includes Settling States that signed the Term Sheet except those
13
whose diligence was not contested or those that were found by the Panel to be diligent.
33
actively opposed, [a] comparative state analysis;” (2) the Panel found Maryland to be
non-diligent “based solely on an objective analysis of state-specific circumstances” and
“not on a relative analysis that compared [Maryland] against other contested states;” and
(3) Maryland fails to demonstrate that any prejudice occurred as a result of the Panel’s
alleged error. Applying the vacatur standards of the FAA, the PMs assert that the circuit
court properly denied Maryland’s Petition to Vacate Arbitration Award Finding that
[Maryland] Did Not Diligently Enforce its Qualifying Statute During 2003.
Following the motions hearing in this case, the circuit court found that the Panel
did not refuse to hear pertinent and material evidence as Maryland alleged. In pertinent
part, the court reasoned that Maryland never requested the Panel to consider the
enforcement record of all contested Term Sheet States; that the Panel’s diligence
determination focused on the objective standard; and that “[e]ven if some, most or all of
the ‘term sheet states’ were less diligent than Maryland, from the facts there is no
guarantee that the Panel would have found Maryland to be diligent.”
Although the circuit court erred in applying the FAA’s vacatur standards in issuing
its ruling, we ultimately reach the same conclusion after applying the Maryland standard
of review. Initially, we note that, as we are remanding the case with instructions for the
Independent Auditor to consider all contested Term Sheet States as non-diligent,
Maryland will already receive part of the relief it seeks when the 2003 NPM Adjustment
is reallocated among a larger number of non-diligent states. But, to the extent that
Maryland challenges the Panel’s finding that Maryland was not diligent in enforcing its
34
Qualifying Statute, we perceive no error on the Panel’s part and, accordingly, affirm the
circuit court’s judgment.
As previously mentioned, CJP § 3-224(b)(4) authorizes courts to vacate an arbitral
award when the arbitrators “refused to hear evidence material to the controversy . . . as to
prejudice substantially the rights of a party.” “The party challenging the arbitration
award bears the burden of proving the existence of one of the grounds for vacating it.”
Mandl, supra, 159 Md. App. at 86 (citations omitted). The question we must address on
appeal, then, is whether, on the facts, the Panel “as a matter of law improperly refused to
hear evidence material to the parties’ controversy, to the substantial prejudice of
[Maryland’s] rights.” Id. at 91-92 (citing CJP § 3-224(b)(4)).
Citing the ARA and the Panel’s July 1, 2011 order regarding burden of proof,
Maryland contends that “[t]he Panel’s failure to hear the contested Term Sheet States’
enforcement records violated the Panel’s own prior orders and Maryland’s legitimate
contract expectations.” In particular, Maryland looks to the Panel’s statement that “‘the
reallocation provisions of the MSA do not apply unless and until diligent enforcement
determinations are made for those states whose diligence is contested by either the [PMs]
or the states,’” (emphasis added by Maryland), as well as the following ARA provision:
The Arbitration panel shall not disclose or otherwise make known its
determinations as to whether any Settling State diligently enforced a
Qualifying Statute during 2003 until after the conclusion of the
presentation of all evidence and written or oral argument in the Arbitration
proceeding with respect to the diligent enforcement of all Settling States
that join the arbitration by the date that the third arbitrator is selected and
whose diligent enforcement the Signatory PMs contested in the Arbitration
....
35
ARA § 2(i) (emphasis added by Maryland).
Maryland’s reliance on those statements, however, is misplaced because in issuing
the Partial Settlement Award, the Panel believed (albeit mistakenly) that diligent
enforcement determinations had already been made for all contested states. More
importantly, those statements do not provide support for Maryland’s assertion that “once
the Panel [decided] to engage in a comparative analysis, . . . it was improper . . . for the
Panel to refuse to hear material evidence regarding the contested Term Sheet States.”
Nothing in the record reflects that the parties to the ARA and the Panel agreed to employ
a comparative method in determining each state’s diligence; nor does Maryland point to
any case law to indicate that such was the proper procedure.
Overall, Maryland failed to meet its burden of proving that the Panel refused to
hear evidence material to the controversy, to the substantial prejudice of Maryland’s
rights, when the Panel found that Maryland was not diligent in enforcing its Qualifying
Statute. We agree with the circuit court that “the Panel’s diligence determination focused
on the objective standard and assessing diligence that was common to all states, and then
applying that standard to each State’s individual enforcement for 2003.” It was not
irrational for the Panel to do so. See Downey, supra, 428 Md. at 258; Snyder, supra, 79
Md. App. at 37. As the Panel explained in its Final Award for Maryland, “[i]t is . . . not a
useful exercise, or even valid, to compare the decision as to one State against the decision
as to another” because the Panel considered the various factors relating to diligence “in
the over-all [sic] context of a Settling State’s existing policies and circumstances in
2003.”
36
Furthermore, based on the record, there was enough evidence to support the
Panel’s finding of non-diligence on Maryland’s part. Assessing Maryland based on the
eight relevant factors, the Panel first noted that Maryland’s collection rate of 47% for
2003 was less than its rates in the year before (75.4%) and after (55.3%). Second, the
Panel stated that although “[e]scrow was not paid on 68.2 million NPM cigarettes sold in
2002” and “Maryland identified lawsuits as being an important part of the enforcement
effort,” it “filed only one lawsuit in 2003.” Third, with regard to gathering reliable data,
the Panel found that Maryland “received little help and insufficient sales data from the
Comptroller’s Office, which basically was a non-participant in enforcement efforts.”
Fourth, the Panel determined that “Maryland’s enforcement efforts were seriously
hampered by lack of sufficient[ly] committed and trained personnel.” Fifth, the Panel
noted that although Maryland may have been well-positioned for diligent enforcement in
2004, its efforts were “not enough to credit Maryland for an ‘ongoing and intentional
consideration of the requirements of a State’s Qualifying Statute.’” Sixth, the Panel
recognized that “[a]lthough Maryland passed its Qualifying Statute and Complementary
Legislation in a timely manner, it did little to implement it until . . . toward the end of
2003.” Seventh, the Panel concluded that Maryland’s record in the area of “Actions
Short of Legislation” was “extremely poor.” For example, “it conducted no desk or field
audits,” “conducted retail inspections for state excise tax but none for escrow
compliance,” and “sent notice letters, but only two demand letters were sent to non-
compliant NPMs.” Lastly, the Panel found “little, if any, information” about the eighth
factor, “Efforts to be Aware of NAAG and Other States’ Enforcement Efforts.” As
37
“factual findings by an arbitrator are virtually immune from challenge,” Mandl, 159 Md.
App. at 92, we cannot say that the circuit court erred in refusing to vacate the Panel’s
finding of non-diligence.
Finally, we agree with the circuit court that “[e]ven if some, most or all of the
‘term sheet states’ were less diligent than Maryland, from the facts there is no guarantee
that the Panel would have found Maryland to be diligent.” As the PMs state in their
brief, Maryland “failed to identify adequate evidence that it would have benefited from a
comparison to the contested [Term Sheet] States,” because the most that Maryland can
assert is that “some ‘evidence . . . suggests that the contested [Term Sheet] States would
not have compared favorably.’” The use of such conclusory statements, however, is
inadequate to show substantial prejudice. See, e.g., Owens-Corning Fiberglas Corp. v.
Garrett, 343 Md. 500, 525 (1996) (stating that “conclusory allegations” of prejudice are
“certainly not sufficient”); Forensic Advisors, Inc. v. Matrixx Initiatives, Inc., 170 Md.
App. 520, 530 (2006) (stating that “a particular and specific demonstration of fact, as
distinguished from general, conclusory statements,” is necessary to reveal “some
injustice, prejudice, or consequential harm”) (citation omitted); Gen. Acc. Ins. Co. v.
Scott, 107 Md. App. 603, 616 (1996) (stating that “conclusory allegations” are
“insufficient, as a matter of law, to raise a genuine dispute as to whether [a party]
suffered actual prejudice”).
C. State-Specific Arbitration
Finally, Maryland argues that the circuit court erred in denying Maryland’s motion
to compel state-specific arbitration. First, Maryland contends that pursuant to the plain
38
meaning of the MSA, Maryland, by itself, constitutes a single “side” to the dispute to be
submitted to arbitration, “with at least the [PMs], and perhaps other states, on the other
side.”14 Next, Maryland avers that “[n]othing in . . . the MSA’s arbitration clause, or any
other provision of the MSA, can reasonably be read to require [a multi-state arbitration].”
Similarly, Maryland argues that although this Court, in Philip Morris Inc., supra, 179
Md. App. 140, held that Maryland must arbitrate the dispute over the 2003 NPM
Adjustment, we did not decide “whether [Maryland] was required to arbitrate that dispute
in a multi-state proceeding.” Lastly, Maryland contends that “the public interest supports
a Maryland-specific arbitration” as it would “ensur[e] that a panel of arbitrators could
give their attention to Maryland’s enforcement of [its] statute” and “Maryland’s interest
in defending its practices would no longer be frustrated by the need to compromise with
other states that have different interests.”
In response, the PMs contend that the circuit court acted properly in denying
Maryland’s motion for a state-specific arbitration. According to the PMs, “this Court in
Philip Morris . . . already decided that the MSA requires NPM Adjustment disputes . . . to
14
As previously mentioned, MSA § XI(c) provides, in pertinent part:
Any dispute, controversy or claim arising out of or relating to calculations
performed by, or any determinations made by, the Independent Auditor . . .
shall be submitted to binding arbitration before a panel of three neutral
arbitrators, each of whom shall be a former Article III federal judge. Each
of the two sides to the dispute shall select one arbitrator. The two
arbitrators so selected shall select the third arbitrator.
(Emphasis added).
39
be arbitrated in a nationwide arbitration.” In addition, the PMs argue that “the MSA’s
text, its structure, and extensive, uniform authority from other [jurisdictions] . . . all
confirm the trial court’s decision.” Lastly, the PMs aver that Maryland’s policy argument
is “irrelevant and meritless” because it does not explain how “the myriad proceedings
necessary to determine the diligence of each of the other 27 States would function more
equitably than a nationwide arbitration.” We agree with the PMs.
In Philip Morris, Inc., 179 Md. App. at 162-63, we determined that the structure of
the MSA requires arbitration due, in part, to the “[n]eed for uniformity:”
The State contends that “[a] nationwide arbitration concerning the
diligence of [fifty-two] states and territories in enforcing their own laws
might well represent the ultimate in ‘chaos.’”
The State, however, cannot explain how a proceeding that is subject
to one final and binding determination would be less workable or
expeditious than litigating the issue fifty-two times in fifty-two separate
court systems with the imminent possibility of delays and appeals.
The MSA’s payment structure is nationwide and unitary. The
independent auditor calculates and determines the participating
manufacturers’ annual payments and then allocates those funds among the
settling states. In the case of diligent enforcement, a single decision-maker
is vitally important because the determination for one state affects every
other settling state pursuant to § IX(d)(2)(C)’s “reallocation” provision.
The question of diligent enforcement cannot be made in a vacuum.
We concur with the numerous jurisdictions that have held that the present
dispute must be resolved under one clear set of rules that apply with equal
force to every settling state. We find the rationale of the Superior Court of
Connecticut particularly compelling:
The problem is even more acute, however, when the
resolution of a dispute as to calculations and determinations
by the Independent Auditor will necessarily have different
effects on different Settling States. Unless such disputes are
presented to and decided by tribunals that have the power to
40
hear from and bind each affected Settling State as a party,
great mischief can be done and substantial unfairness can
result. Where, for example, as in this case, it is claimed that
an individual Settling State is exempt from the NPM
Adjustment for a given year because it diligently enforced a
Model Statute that was in full force and effect throughout that
year, the decision of the tribunal deciding that issue will not
only affect the interests of the Settling State seeking to
qualify for the exemption, but those of all other Settling
States as well. This is so because the granting of an
exemption to one Settling State will inexorably lead to the
reallocation of its allocated portion of the NPM Adjustment to
all other non-exempt Settling States. Each Settling State thus
has a vital interest in the granting or denial of each other
Settling State’s individual claim for exemption, and for
obvious reasons, their interests are conflicting. Submitting
such a dispute to a neutral panel of competent arbitrators
affords all interested parties the right to be heard on a level
playing field where no interested party enjoys an apparent
home-field advantage.
Connecticut v. Philip Morris, Inc., 279 Conn. 785, 905 A.2d 42, 50-51
(2006) . . . .
Although Maryland is correct that this Court’s original opinion included language that
more definitively supported a requirement that Maryland participate in multi-state
arbitration, and that such language was removed pursuant to Maryland’s motion to
reconsider, the final version of our opinion clearly still contemplated a single, nationwide
arbitration. 15 To the extent that we previously did not hold as such, we do so now.
First, there is no merit to Maryland’s argument that, when considering the terms of
the MSA, Maryland constitutes a single “side” to the dispute to be submitted to
arbitration, “with at least the [PMs], and perhaps other states, on the other side.” When
15
We originally filed our opinion in Philip Morris, Inc. on February 1, 2008, and
filed the final version on March 27, 2008.
41
the Panel convened to hear this matter, the parties agreed that the dispute centered on
whether the PMs were entitled to the 2003 NPM Adjustment. Particularly, “the
participating manufacturers requested that the auditor apply the 2003 NPM Adjustment to
their April 2006 payments. Maryland and the other settling states, however, urged the
auditor to deny the NPM Adjustment on the ground that the settling states ‘diligently
enforced’ their qualifying statutes.” Philip Morris Inc., 179 Md. App. at 148. Thus, the
circuit court correctly recognized the “two sides to the dispute” to be “the MSA States in
opposition to the downward adjustment, and the PMs.”
Next, in addition to our previous determination that having “a single decision-
maker is vitally important” in light of the MSA’s “nationwide and unitary” payment
structure, id. at 162, Maryland’s proposed state-specific arbitration would not necessarily
advance the public interest. As the PMs point out, “every State would have an interest in
the decision on diligence for every other state” and in each state-specific proceeding, “up
to 27 other States would need to intervene to protect their interest, which would multiply
exponentially the cost, complexity, and burden of resolving the 2004 NPM Adjustment
dispute.” This would have a tremendous effect on all parties, especially the SPMs, which
are smaller companies with more limited resources.
Lastly, our holding is supported by courts in other jurisdictions. See McGraw v.
Am. Tobacco Co., 681 S.E.2d 96, 112 (W. Va. 2009) (“All courts addressing arguments .
. . against the requirement of a single, nationwide arbitration of the diligent enforcement
determination have consistently and logically rejected the same. Both the structure and
plain meaning of the MSA require a uniform determination of this issue due to the impact
42
the determination relevant to one settling state will have upon all other settling states.”);
State, ex rel. Carter v. Philip Morris Tobacco Co., 879 N.E.2d 1212, 1220 (Ind. Ct. App.
2008) (“Both the language and the structure of the MSA require that the dispute
concerning the 2003 NPM Adjustment, including the Settling States’ claims of diligent
enforcement of their Qualifying Statutes, must be submitted to a single, national
arbitration panel.”); State ex rel. Riley v. Lorillard Tobacco Co., 1 So. 3d 1, 14 (Ala.
2008) (“we conclude that the agreement requires a national, as opposed to a local,
arbitration proceeding”); State v. Philip Morris USA Inc., 945 A.2d 887, 894 (Vt. 2008)
(“Other courts addressing this issue, however, have found ‘compelling logic’ in having
disputes over diligent enforcement handled by one arbitration panel rather than separate
courts in each settling state . . . . We agree.”) (Citation omitted); State v. Phillip Morris,
Inc., 905 A.2d 42, 51 n.12 (Conn. 2006) (noting that the language of the MSA “envisions
that the settling states would select one arbitrator and the participating manufacturers
would select one arbitrator”) (citation omitted); State of N.M. ex rel. N.M. Attorney Gen.
Gary K. King, 194 P.3d 749, 755 (N.M. Ct. App. 2008) (affirming an order “compelling
arbitration before a single, nationwide arbitration panel”); State v. Philip Morris Inc., 858
N.Y.S.2d 134 (N.Y. App. Div. 2008) (“This Court rejected . . . arguments that each
Settling State constituted a ‘side’ to the dispute, under section XI (c) of the Master
Settlement Agreement, with the right to select its own arbitrator”) (citation omitted);
People v. Lorillard Tobacco Co., 865 N.E.2d 546, 554 (Ill. App. Ct. 2007) (“Moreover,
we agree with those courts before us that have pointed out the ‘compelling logic to
having these disputes handled by a single arbitration panel of three federal judges, rather
43
than numerous state and territorial courts.’”) (Citation omitted). Accordingly, the circuit
court did not err in denying Maryland’s motion to compel a state-specific arbitration.
VI. CONCLUSION
For all of the foregoing reasons, we reverse the circuit court’s denial of
Maryland’s Petition to Vacate Arbitration, and affirm its denial of Maryland’s Motion to
Compel a Maryland-Specific Arbitration on the Issue of Whether Maryland Diligently
Enforced during 2004 and Petition to Vacate Arbitration Award Finding that [Maryland]
Did Not Diligently Enforce its Qualifying Statute During 2003. We remand the case with
instructions to have the Independent Auditor treat all 20 of the contested Term Sheet
States as non-diligent when calculating Maryland’s 2003 NPM Adjustment liability.
JUDGMENT OF THE CIRCUIT COURT
FOR BALTIMORE CITY AFFIRMED IN
PART AND REVERSED IN PART. CASE
REMANDED FOR PROCEEDINGS NOT
INCONSISTENT WITH THIS OPINION
COSTS TO BE DIVIDED EQUALLY
BETWEEN THE PARTIES.
44