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ITG Brands, LLC v. Reynolds American, Inc.

Court of Chancery of Delaware

September 23, 2019

ITG BRANDS, LLC, Plaintiff,
v.
REYNOLDS AMERICAN, INC. and R.J. REYNOLDS TOBACCO COMPANY, Defendants. REYNOLDS AMERICAN INC., and R. J. REYNOLDS TOBACCO COMPANY, Counter-Plaintiffs,
v.
ITG BRANDS, LLC, Counter-Defendant.

          Date Submitted: June 4, 2019

          Stephen C. Norman and Matthew F. Davis, POTTER ANDERSON & CORROON LLP, Wilmington, Delaware; Robert J. Brookhiser and Elizabeth B. McCallum, BAKER & HOSTETLER LLP, Washington, D.C.; Attorneys for Plaintiff and Counterclaim Defendant.

          Gregory P. Williams, Rudolf Koch, Robert L. Burns, and Matthew D. Perri, RICHARDS, LAYTON & FINGER, P.A., Wilmington, Delaware; Peter J. Biersteker, C. Kevin Marshall, and William D. Coglianese, JONES DAY, Washington, D.C.; Attorneys for Defendants and Counterclaim Plaintiffs.

          MEMORANDUM OPINION

          BOUCHARD, C.

         In July 2014, Reynolds American Inc. agreed to sell four cigarette brands owned by its subsidiary, R.J. Reynolds Tobacco Company, to ITG Brands, LLC for approximately $7.1 billion. As part of the transaction, ITG Brands agreed to use its "reasonable best efforts" to assume Reynolds Tobacco's obligations for post-closing sales of the four cigarette brands under agreements that Reynolds Tobacco entered into in the late 1990's with four states-Florida, Minnesota, Mississippi, and Texas. The purpose of those agreements was to settle lawsuits accusing the cigarette manufacturers of misrepresenting the risks and addictiveness of smoking. Although the sale of the four cigarette brands closed in June 2015, ITG Brands has yet to assume-over four years later-Reynolds Tobacco's obligations under its agreements with three of the four states, namely Florida, Minnesota, and Texas.

         This opinion concerns the second round of disputes in this action. In round one, the court ruled in Reynolds' favor that ITG Brands' obligation to use its reasonable best efforts to assume Reynolds Tobacco's obligations under the settlement agreements did not terminate when the sale transaction closed but continues until ITG Brands actually has made reasonable best efforts to assume those obligations.[1] Round two concerns two other questions involving the interpretation of the Asset Purchase Agreement governing the sale of the four cigarette brands.

         The first question, on which the parties have cross-moved for partial judgment on the pleadings, is whether ITG Brands must indemnify Reynolds for the amount of a judgment a Florida state court entered against Reynolds Tobacco in August 2018 for approximately $93 million in unpaid settlement payments concerning post-closing sales of the four cigarette brands that Reynolds sold to ITG Brands. As discussed below, because the parties each have advanced reasonable interpretations of the Asset Purchase Agreement that could lead to different results on this question, their cross-motions must be denied.

         The second question, on which only Reynolds has moved for partial judgment on the pleadings, concerns state "equity fee" statutes that impose fees on tobacco companies based on their cigarette sales to pay for health care costs in that state. Specifically, Reynolds asks for a declaration that ITG Brands is not entitled under the Asset Purchase Agreement to demand, as a condition of joining the settlement agreements, protection from making payments under equity fee statutes in states that have not enacted one. This issue only concerns Reynolds Tobacco's settlement agreement with Florida. For the reasons discussed below, this motion will be granted because the plain language of the Asset Purchase Agreement supports Reynolds' position on this issue.

         I. BACKGROUND

         The background of this action is described in a Memorandum Opinion the court issued on November 30, 2017 (the "2017 Opinion").[2] This opinion recites only facts that are directly relevant to the current disputes. Those facts are drawn from the 2017 Opinion and the parties' submissions.[3] Any additional facts are either not subject to reasonable dispute or otherwise subject to judicial notice.

         In the mid-1990s, several states sued R.J. Reynolds Tobacco Company ("Reynolds Tobacco"), Lorillard Tobacco Company, and other major cigarette manufacturers for publicly misrepresenting the health risks and addictiveness of smoking.[4] In 1997 and 1998, Reynolds Tobacco and other manufacturers-the "Settling Defendants"-entered into separate settlement agreements with four states: Florida, Minnesota, Mississippi, and Texas. The Asset Purchase Agreement at issue in this case defines these four states as the "Previously Settled States" and their agreements with the Settling Defendants as the "PSS Agreements."[5] Reynolds Tobacco's 1997 settlement agreement with Florida is referred to hereafter as the "Florida Settlement Agreement."

         Under the Florida Settlement Agreement, the Settling Defendants agreed to collectively pay Florida $750 million followed by annual payments, with each Settling Defendant's annual payment determined "pro rata in proportion equal to its respective Market Share" for that year.[6] Significantly, none of the settlement agreements with the Previously Settled States has a provision requiring a party who acquires a cigarette brand from a Settling Defendant to assume that Settling Defendant's payment obligations upon the transfer of the cigarette brand and there is no mechanism in those agreements for a transferee to join them.[7]

         After Reynolds Tobacco entered into settlement agreements with three of the four Previously Settled States (Minnesota, Mississippi, and Texas), those states enacted what are called "direct-pay" or "equity fee" statutes.[8] These statutes impose fees on tobacco companies that have not entered into a settlement agreement with the state based on their cigarette sales.[9] The purpose of equity fee statutes is to compensate the states for costs attributable to cigarette use, in particular health care costs.[10] Florida did not have an equity fee statute when Reynolds Tobacco entered into the Florida Settlement Agreement and has not enacted one since then.[11]

         On July 15, 2014, Reynolds American, Inc., the parent of Reynolds Tobacco (together, "Reynolds"), and Lorillard, Inc., the parent of Lorillard Tobacco Company, entered into a merger agreement.[12] At the same time, in order to facilitate regulatory approval of the merger, Reynolds American and ITG Brands entered into an Asset Purchase Agreement dated as of July 15, 2014 (the "Asset Purchase Agreement" or "APA"). In the APA, Reynolds American agreed to sell to ITG Brands for approximately $7.1 billion four cigarette brands: Winston, Salem, Kool, and Maverick.[13] The APA defines the terms "Acquired Brands" and "Acquired Tobacco Cigarette Brands" to include these four brands.[14] The Reynolds-Lorillard merger and the sale of the Acquired Brands to ITG Brands both closed on June 12, 2015 (the "Closing").[15]

         Attached to the Asset Purchase Agreement is a document entitled "Agreed Assumption Terms" that is part of the APA.[16] Section 2.2 of the Agreed Assumption Terms requires that ITG Brands "use its reasonable best efforts" to reach agreements with the Previously Settled States to assume Reynolds Tobacco's settlement obligations with respect to post-Closing sales of the Acquired Brands.[17]

         After the Closing, neither Reynolds nor ITG Brands made payments to Florida for post-Closing sales of the Acquired Brands.[18] On January 18, 2017, Florida sued Reynolds Tobacco in Florida state court and filed a motion to join ITG Brands as a defendant in order to enforce the Florida Settlement Agreement against both Reynolds Tobacco and ITG Brands. [19]

         On August 15, 2018, the Florida state court entered a final judgment against Reynolds Tobacco, but not ITG Brands, making Reynolds Tobacco liable for approximately $93 million in unpaid settlement payments from the Closing through April 30, 2018 (the "Florida Judgment").[20] The Florida court further held that "unless and until ITG [Brands] becomes a Settling Defendant, . . . Reynolds [Tobacco] is liable to make Annual Payments to" Florida for sales of the Acquired Brands.[21] Reynolds subsequently posted supersedeas bonds totaling over $114 million and appealed the Florida Judgment.[22] The appeal remains pending.

         II. PROCEDURAL HISTORY

         On February 17, 2017, ITG Brands filed this action asserting five claims for injunctive and declaratory relief. On May 16, 2017, ITG Brands filed a motion for partial judgment on the pleadings on Count II of its complaint, seeking a declaration that any obligation ITG Brands owed to use its reasonable best efforts to reach an agreement to join the Florida Settlement Agreement terminated at the Closing. On June 23, 2017, Reynolds filed a cross-motion for partial judgment on the pleadings, seeking a declaration that ITG Brands' duty to use its reasonable best efforts to reach an agreement to join the Florida Settlement Agreement did not terminate due to the Closing. In the 2017 Opinion, the court ruled in Reynolds' favor on both motions.

         On September 28, 2018, Reynolds filed an amended pleading, asserting four counterclaims. On January 4, 2019, Reynolds filed a second motion for partial judgment on the pleadings, seeking declarations to resolve its Counterclaim III and to partially resolve its Counterclaim I. On March 11, 2019, ITG Brands filed a cross-motion for partial judgment on the pleadings with respect to Reynolds' Counterclaim III but not with respect to its Counterclaim I.

         III. ANALYSIS

         The parties' motions tee up two questions. The first question is whether ITG Brands must indemnify Reynolds for any liability imposed on Reynolds Tobacco for post-Closing settlement payments on the Acquired Brands, in particular the Florida Judgment, under subsections (iv) and/or (v) of Section 2.01 of the APA. The second question is whether ITG Brands is entitled under Section 2.2 of the Agreed Assumption Terms to receive protection from a state that does not have an equity fee statute (i.e., Florida) for the possibility that it may enact one in the future. These questions are addressed below in Sections B and C, respectively.

         A. Legal Framework

         This court may grant a motion for judgment on the pleadings "when no material issue of fact exists and the movant is entitled to judgment as a matter of law."[23] Judgment on the pleadings "is a proper framework for enforcing unambiguous contracts because there is no need to resolve material disputes of fact."[24] Put differently, "[w]hen analyzing a contract on a motion for judgment on the pleadings, this Court will grant such a motion only if the contract provisions at issue are unambiguous."[25]

         Delaware law, which governs the APA, [26] "adheres to the objective theory of contracts, i.e., a contract's construction should be that which would be understood by an objective, reasonable third party."[27] When interpreting a contract, this court "will give priority to the parties' intentions as reflected in the four corners of the agreement, " construing the agreement as a whole and giving effect to all of its provisions.[28] A court will "construe the contract in accordance with [its] plain meaning and will not resort to extrinsic evidence to determine the parties' intentions."[29] In discerning the plain meaning of a contract, the court may look to the grammatical construction of a contractual provision.[30]

         Under Delaware law, "[a]mbiguity does not exist simply because the parties disagree about what the contract means. . . . Rather, contracts are ambiguous when the provisions in controversy are reasonably or fairly susceptible of different interpretations or may have two or more different meanings."[31] "Clear and unambiguous language . . . should be given its ordinary and usual meaning."[32]

         B. The Parties' Cross-Motions Concerning Section 2.01(c) of the APA Must Be Denied Because Each Side Has Advanced a Different Interpretation That is Reasonable

         Reynolds seeks entry of partial judgment on the pleadings on its Counterclaim III "in the form of a declaration that, to the extent that [Reynolds Tobacco] is held to bear any liability for post-Closing settlement payments on the Acquired Brands, ITG Brands in the APA assumed this liability."[33] Reynolds asserts it is entitled to this relief under the plain terms of subsections (iv) and/or (v) of Section 2.01 of the APA. Section 2.01 enumerates a series of "Assumed Liabilities" for which ITG Brands is obligated to indemnify Reynolds Tobacco under Section 11.02(a)(vi) of the APA.[34]

         Reynolds seeks declaratory relief now even though it acknowledges that indemnification "is not yet ripe" because "the litigation in Florida has not concluded."[35] In this respect, Reynolds focuses on the Florida Judgment, as will the court, while pointing out that two of the other Previously Settled States (Minnesota and Texas) also are seeking judgments against Reynolds concerning ITG Brands' post-Closing sales of the Acquired Brands.[36]

         ITG Brands counters that the subsections 2.01(c)(iv) and (v) do not apply to the Florida Judgment "because section 2.01(c)(vii), along with the Agreed Assumption Terms referenced in that Article, govern assumption of settlement liabilities."[37] ITG Brands has cross-moved for judgment on the pleadings "that sections 2.01(c)(vii) and 11.02(a)(v) exclusively govern any obligation it may have to reimburse Reynolds for settlement payments."[38]

         The three subsections of Section 2.01(c) on which the parties rely- subsections (iv), (v), and (vii)-are recited below:

(c) Assumed Liabilities. Upon the terms and subject to the conditions set forth in this Agreement (including Section 2.01(d)), the Acquiror hereby agrees, effective as of the Closing . . . to assume and thereafter to pay, discharge and perform in accordance with their terms only the following Liabilities of the Sellers, and no other Liabilities of the Sellers or any other Person or any other Liabilities whatsoever (the "Assumed Liabilities"): . . .
(iv) all Liabilities (other than Excluded Liabilities) to the extent arising, directly or indirectly, out of . . . the use of the Transferred Assets, in each case from and after the Closing;
(v) other than Straddle Tobacco Action Liabilities, all Liabilities arising out of or in connection with any Action to the extent relating to the development, manufacture, packaging, labeling, production, delivery, sale, resale, distribution, marketing, promotion, use or consumption of, or exposure to, tobacco products, including smoking and health-related claims, in each case, to the extent relating to the period commencing after the Closing Date and related to one or more of the Acquired Tobacco Cigarette Brands . . .
(vii) subject to the Agreed Assumption Terms, all Liabilities under the State Settlements in respect of the Acquired Tobacco Cigarette Brands that relate to the period after the Closing Date . . . .[39]

         The Asset Purchase Agreement defines the term "Liability" broadly to mean "liabilities, claims, demands, expenses, commitments, Losses, costs or obligations of every kind and description."[40] Section 2.01(d) is a reciprocal provision to Section 2.01(c) that specifies certain Liabilities that ITG Brands did not assume, which are defined as the "Excluded Liabilities."[41]

         In my opinion, for the reasons discussed below, Reynolds and ITG Brands both have advanced reasonable interpretations of the APA that could lead to different outcomes concerning whether ITG Brands would be required to indemnify Reynolds for the Florida Judgment, assuming it is upheld on appeal.

         Beginning with Reynolds, its primary contention is that ITG Brands is obligated to pay the Florida Judgment under Section 2.01(c)(v).[42] To repeat, that provision states that ITG Brands assumed "all Liabilities arising out of or in connection with any Action to the extent relating to the . . . sale, . . . use or consumption of . . . tobacco products . . . to the extent relating to the period commencing after the Closing Date and related to one or more of the Acquired Tobacco Cigarette Brands."[43] Thus, to be assumed by ITG Brands under Section 2.01(c)(v), the liability must: (i) arise out of an "Action, " (ii) relate to the sale or consumption of "Acquired Tobacco Cigarette Brands, " and (iii) relate to the post-Closing period. The Florida Judgment satisfies each of these requirements.

         The APA defines "Action" to mean "any claim, suit, . . . or other proceeding of any nature . . . by or before any court, arbitrator or Governmental Authority or similar body."[44] A Florida state court entered the Florida Judgment in a proceeding in which Florida sued both Reynolds and ITG Brands to obtain payments due under the Florida Settlement Agreement.[45] This lawsuit plainly constitutes an "Action" under the APA because it is a "suit" before a "court, " and the Florida Judgment unquestionably arose out of that action.[46] Thus, the first requirement of Section 2.01(c)(v) is satisfied. ITG Brands does not contend otherwise.

         The APA defines "Acquired Tobacco Cigarette Brands" to include the Winston, Salem, Kool, and Maverick brands that Reynolds transferred to ITG Brands.[47] By its terms, the Florida Judgment pertains to these cigarette brands. It expressly provides that "unless and until ITG becomes a Settling Defendant, the Court holds that Reynolds is liable to make Annual Payments to the State under the Florida Settlement Agreement for the sales of cigarettes under the Winston, Kool, Salem, and Maverick brands it transferred to ITG."[48] Thus, the second requirement of Section 2.01(c)(v) is satisfied. Again, ITG Brands does not contend otherwise.

         Finally, the Florida Judgment expressly pertains only to sales made during the post-Closing period. As noted above, the transaction whereby ITG Brands purchased the Acquired Brands closed on June 12, 2015. Referencing that date, the order granting Florida's enforcement motion explains that Florida filed its motion "[b]ecause Reynolds modified its payments under the Florida Agreement subsequent to the mid-2015 closing and justified the new payments exclusively on the fact that [ITG Brands], not Reynolds, was selling the cigarettes under the four brands."[49]Paralleling that time frame, the Florida Judgment expressly provides that the awarded amount is based on "all payments due as of the date of this Judgment for the period of June 12, 2015 through April 30, 2018."[50]

         ITG Brands contends that Section 2.01(c)(v) does not apply to the Florida Judgment on the theory that the Florida Judgment "relates to Reynolds' own pre- closing conduct and to its pre-closing decision to enter into the settlements requiring the payments at issue."[51] This argument is without merit because it is directly contradicted by the plain terms of the Florida Judgment and the order granting Florida's enforcement motion. As just explained, they both expressly provide that the liability pertains only to sales of the Acquired Tobacco Cigarette Brands made during the post-Closing period.[52]

         In sum, for the reasons discussed above, Reynolds has articulated a reasonable interpretation of Section 2.01(c)(v) of the APA that supports the conclusion that ITG Brands would be obligated to indemnify Reynolds for the amount of the Florida Judgment if it is upheld on appeal.

         Turning to ITG Brands, its core argument looks beyond the four corners of Section 2.01(c)(v) to consider the interplay of that provision with Section 2.01(c)(vii) of the APA, which governs "Liabilities under the State Settlements in respect of the Acquired Tobacco Cigarette Brands" for the post-Closing period. Relying on the specific-over-the-general rule of contract interpretation, ITG Brands argues that Section 2.01(c)(vii) and not Section 2.01(c)(v) was intended to determine whether ITG Brands is obligated to indemnify Reynolds for any liability imposed on Reynolds Tobacco for post-Closing settlement payments on the Acquired Brands under its settlement agreements with the Previously Settled States. In support of this argument, ITG Brands relies heavily on our Supreme Court's decision in DCV Holdings, Inc. v. ConAgra, Inc. [53]

         In that case, DCV Holdings acquired a company that "suffered a decline in profits" and was "implicated . . . in antitrust violations."[54] DCV Holdings sued the sellers of the company seeking, among other relief, indemnification under the Purchase Agreement for liabilities resulting from the antitrust violations.[55] Two provisions of that contract were at issue: Sections 3.9 and 3.13.

         Section 3.9 was "an all-inclusive warranty" that did not contain a knowledge qualifier.[56] It stated: "None of the Companies has any liabilities or obligations of any nature" other than three inapplicable exceptions.[57] By contrast, Section 3.13 focused on violations of law and contained a knowledge qualifier. It stated: "To the knowledge of Sellers, the business is not being and has not been conducted, and none of the Companies has been, or is in violation of any applicable Law . . . ."[58]Determining whether or not DCV Holdings was entitled to indemnification for the costs associated with the antitrust violations turned on which of these two provisions applied to the parties' dispute.[59]

         In analyzing this question, our Supreme Court explained that "the specific provision ordinarily qualifies the meaning of the general one" in situations "where specific and general provisions conflict."[60] Applying this rule of contract interpretation, the high court affirmed the Superior Court's ruling that Section 3.13, and not Section 3.9, controlled. It reasoned that "[t]he more specific Section 3.13, which limits that section's scope to violations of the law that were known to the Sellers, is the narrower of the two provisions."[61] The high court also found that the Superior Court "did not err in holding that Sections 3.13 and 3.9 were in conflict" based on the fact that the two sections would lead to opposite results concerning liability.[62]

         Turning to this case, ITG Brands argues that subsection (vii) of Section 2.01(c) is a more specific provision than subsection (v) because subsection (vii) specifically concerns "Liabilities under the State Settlements in respect of the Acquired Tobacco Cigarette Brands" for the post-Closing period while subsection (v) encompasses a wide range of liabilities for the post-Closing period arising from legal proceedings. ITG Brands argues further that Sections 2.01(c)(v) and 2.01(c)(vii) conflict because they could lead to different outcomes over whether ITG Brands would be liable for the Florida Judgment. Thus, according to ITG Brands, subsection (vii) and not subsection (v) should control here.

         The potential for conflict between these two provisions does exist. As discussed above, Reynolds has advanced a reasonable interpretation of Section 2.01(c)(v) whereby ITG Brands would be liable for the Florida Judgment if it is upheld on appeal. And, as Reynolds acknowledges, it is possible that ITG Brands may not incur this same liability under Section 2.01(c)(vii).[63] This is because the assumption of liabilities under subsection (vii) is expressly made "subject" to the Agreed Assumption Terms, Section 2.2 of which provides that ITG Brands "shall use its reasonable best efforts" to assume Reynolds' obligations under the settlement agreements with the Previously Settled States.[64] Thus, the possibility exists that ITG Brands ultimately may not assume Reynolds' obligations under the Florida Settlement Agreement under Section 2.10(c)(vii), i.e., if ITG Brands failed to join that agreement after using its "reasonable best efforts" to do so.

         Reynolds argues that DCV Holdings is distinguishable because the contract there "involved language expressly making one provision more specific than another on the same question" while, here, Sections 2.01(c)(v) and 2.01(c)(vii) of the APA "appear in parallel in § 2.01(c)'s list of seven Assumed Liabilities."[65] According to Reynolds, "[n]othing makes §2.01 (c)(vii) more 'specifically' on point than [§2.01(c)(v)] in the circumstances of the Liabilities at issue in these motions-the absence of a joinder or a question of breach of the obligation to pursue ...


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