In October, the Second Circuit held that two New York statutes requiring tobacco companies that decline to participate in the State’s Master Settlement Agreement with the tobacco industry pay into an escrow account do not violate the Sherman Act. New York enacted the statutes in question in order to enforce the landmark 1998 Master Settlement Agreement (MSA) between the country’s four largest tobacco companies and 46 states. The statutes provide non-participating tobacco companies operating in the State the choice of becoming signatories to the MSA or making annual payments into an escrow account. Plaintiff cigarette importers claimed that the statutes constituted per se violations of the antitrust laws because they “coerced” companies to join the alleged “output cartel” created by the MSA.[1] The Second Circuit rejected this claim, holding first that the statutes involved no private collusion implicating the antitrust laws, and second, that even if the statutes were not unilaterally imposed by the government, they would be immune from antitrust challenge under the so-called “state action” doctrine because of the State’s involvement.


Plaintiffs Freedom Holdings, Inc., and International Tobacco Partners, Ltd., cigarette importers, filed suit in the Southern District of New York on April 16, 2002, alleging that New York’s “Escrow Statute” and “Contraband Statute” violated Section 1 of the Sherman Act.[2] The statutes had been put into effect by the New York legislature to further the goals of the MSA, signed in November 1998. The MSA is an agreement between the country’s four major cigarette manufacturers and 52 states and territories (“the states”), which released the tobacco manufacturers from liability in return for substantial annual payments, designed to compensate the states for health-care expenses related to tobacco use.[3] Because of these substantial payments, the companies feared those tobacco manufacturers that elected not to participate in the MSA would have a significant cost advantage and gain market share from the participating manufacturers (PMs), endangering the public health gains sought to be achieved by the MSA.[4] Accordingly, as part of the agreement, the states agreed to enact statutes requiring those tobacco manufacturers that elected not to participate in the MSA, or “non-participating manufacturers” (NPMs), to annually pay a portion of their revenues into an escrow account in order to “effectively and fully neutralize [] the cost disadvantages that the Participating Manufacturers experience vis-à-vis Non- Participating Manufacturers” as a result of the MSA.[5] New York enacted such a law, referred to as the “Escrow Statute,” in 1999.[6] In later years, as NPMs gained market share, a number of states enacted complementary statutes, designed to “bolster the State[s’] ability to diligently enforce” their escrow statutes by requiring annual certification by all tobacco product manufacturers that they are PMs, or alternatively that they have complied with the Escrow Statute; distributors are prevented from affixing tax stamps to cigarettes if a manufacturer has not so certified.[7] New York enacted such a statute, referred to by this court as the “Contraband Statute,” in 2001.[8]

The district court dismissed plaintiffs’ initial complaint for failure to state a claim.[9] Plaintiffs appealed, and the Second Circuit originally reversed.[10] Taking plaintiffs’ allegations as true at the dismissal stage, the Second Circuit held that plaintiffs had adequately stated an antitrust claim “by alleging that ‘the combination of the MSA, the Escrow Statutes, and the Contraband Statutes, allows OPMs to set supracompetitive prices that effectively cause other manufacturers either to charge similar prices or to cease selling.’”[11] The court stressed that it was unable to determine at the pleading stage whether the State was protected by state action immunity, because the MSA scheme was too complex to allow the court to determine whether New York, in enacting the statutes, was “motivated by legitimate policy goals,” as required for state action immunity to apply, or whether it was driven by “an impermissible desire to share in monopoly profits,” in which case the doctrine would not apply.[12] Further, because the State had yet to make a required evidentiary showing that it actively supervised pricing decisions made by PMs, as required for the state action doctrine to apply, the court declined to extend immunity at the pleading stage. On remand, after considerable pretrial discovery, the district court entered summary judgment for the defendants. In doing so, the district court made a number of findings of fact, including that the structure of the MSA did not favor the major cigarette companies over NPMs, that NPMs had, in fact, “prospered” under the MSA structure, that NPMs had no economic incentive to join the MSA, and that plaintiffs had failed to show that the MSA caused NPMs to lose pricing autonomy.[13] Alternatively, the district court held the challenged statutes were shielded by state action immunity.[14] Plaintiffs appealed, and the Second Circuit’s decision followed.

The Second Circuit’s Decision

The Second Circuit employed a two-step inquiry in analyzing plaintiffs’ claim that the Sherman Act preempted New York’s Escrow and Contraband Statutes. First, plaintiffs were required to show an “irreconcilable conflict” between the challenged statutes and the Sherman Act.[15] Such a violation would only be found “‘when the conduct contemplated by the statute is in all cases a per se violation’ of the antitrust laws.”[16] In order to establish a per se violation, plaintiffs also needed to show that the statutes provided some degree of regulatory control by private parties.[17] Second, even if plaintiffs were able to show the statutes mandated or authorized a per se violation, state action immunity could still save the statutes from preemption.[18] Per Se Violation of Antitrust Law

The Sherman Act proscribes only the acts of private parties; thus, the threshold question was “whether the challenged statutes are unilateral acts of a state falling outside federal antitrust law.”[19] The court recognized a “distinction between laws whose restraints are the product” of such unilateral state action, and thus not subject to an antitrust analysis, and “those whose restraints are ‘hybrid,’” and as a result could be subject to antitrust analysis. [20] “Hybrid restraints” were defined as legislation conferring a degree of regulatory power on private parties.

The Second Circuit held the challenged statutes were unilateral state action, and therefore not subject to an antitrust analysis. “On their face, the New York Escrow and Contraband Statutes mandate and enforce payments that . . . are ‘unilaterally imposed by government . . . to the exclusion of private control.’”[21] In reversing the dismissal of plaintiffs’ complaint, the Second Circuit had earlier held that plaintiffs stated a possible claim of a hybrid restraint by alleging the function of the Escrow Statute was to coerce NPMs to join the MSA.[22] After discovery, however, the district court had determined that the plaintiffs failed “to prove the linchpin of their hybrid restraint trade,” i.e., that the challenged statutes compelled NPMs to join the MSA.[23]

Specifically, according to the Second Circuit, the payments imposed by the statute were analogous to the imposition of a flat tax — the tax may be passed onto consumers in the form of higher prices, but “where, as here, the state alone imposes the increased cost, there is no private collusion implicating the antitrust laws.”[24] The Second Circuit added that there was “substantial testimonial and documentary evidence” indicating that even under the challenged statutes, NPMs retained pricing autonomy, “which they have exercised to gain substantial market share at the expense of OPMs.”[25] Thus, the court held, the challenged New York statutes “do not manifest a hybrid restraint of trade because they do not mandate or authorize any private party to exercise anticompetitive regulatory authority.”[26]

The Second Circuit’s rejection of plaintiff’s per se antitrust claim “obviate[d] the need for detailed analysis of whether” the statutes also were shielded from application of the antitrust laws by state action immunity.[27] However, the court also employed such an analysis “‘out of an abundance of caution.’”[28] The Second Circuit applied the two-part test set down by the Supreme Court in California Retail Liquor Dealers Association v. Midcal Aluminum, Inc.[29] (“the Midcal test”) to determine whether antitrust immunity applied. First, the court examined whether the MSA regime was “clearly articulated and affirmatively expressed as state policy.”[30] Next, the court determined whether, in addition to meeting the “clearly articulated” prong, the State “actively supervised” enforcement of the statutes in question.[31]

The court first noted that under the required “clearly articulated” prong, the State’s policy goals in enacting the statutes must be more than “simply protecting private parties from competition.”[32] Plaintiffs argued that the states themselves “‘engage[d] in interstate commerce as commercial participants’” and required NPMs to become active cartel participants, and thus immunity was not available.[33] However, the court declared that the trial record could not support such a determination — New York neither manufactured nor distributed cigarettes, but rather simply regulated cigarette manufacturers.[34] Thus, the statutes clearly were articulated as state policy, and the goals of this policy were sufficient to qualify for immunity under the first Midcal prong of the state action doctrine.

The court then examined the second Midcal prong, whether the flat-tax scheme set up by the statutes was “actively supervised by the State.”[35] Plaintiffs argued that the challenged statutes, by raising manufacturers’ costs, had the effect of raising cigarette prices.[36] The court responded, however, that the amount of “markup” in cigarette prices that resulted from these statutes was dictated by the State, not by cigarette manufacturers.[37] “Accordingly, because the statute[s] specif[y] the exact component of the inflated price attributable to the state, there is nothing that the state can actively supervise except to see the that statutory requirements are obeyed . . . .”[38] Accordingly, the court concluded that New York’s Escrow and Contraband Statutes qualified for state action immunity from antitrust challenge.


The Second Circuit’s holding that the New York statutes, although in furtherance of the MSA, were unilaterally imposed by the government and thus not subject to federal antitrust laws is in line with the decisions of other circuits, including the Fifth, Sixth, Eighth, Ninth and Tenth Circuits.[39] It seems clear at this point, therefore, that an NPM would find it difficult to successfully challenge the statutes enacted by states in furtherance of the MSA. It appears that such a challenge would be precluded both as unilateral state action not subject to an antitrust analysis, and under the doctrine of state action immunity.