USVI Public Records

Document text (beginning — full text at the TXT link above)

NEW ISSUE – BOOK–ENTRY ONLY FITCH RATINGS: Series 2006A – “BBB” Series 2006B – “BBB–” Series 2006C – “BB” Series 2006D – Unrated (See “RATINGS” herein) In the opinion of Transaction Counsel, under existing law and assuming compliance with the tax covenants described herein, interest on the Series 2006 Bonds is excluded from gross income for federal income tax purposes under Section 103 of the Internal Revenue Code of 1986, as amended (the “Code”) Transaction Counsel is also of the opinion that such interest is not treated as a preference item in calculating the alternative minimum tax imposed under the Code with respect to individuals and corporations. Interest on the Series 2006 Bonds is, however, included in the adjusted current earnings of certain corporations for purposes of computing the alternative minimum tax imposed on such corporations. Transaction Counsel is further of the opinion that the Series 2006 Bonds and the interest thereon are exempt from personal income tax imposed by the United States Virgin Islands, any state, other territory or possession of the United States or any political subdivision thereof, or by the District of Columbia. See “TAX MATTERS” herein regarding certain other tax considerations. $7,290,008.85 TOBACCO SETTLEMENT FINANCING CORPORATION Tobacco Settlement Asset–Backed Bonds, Subordinate Series 2006 Turbo Capital Appreciation Bonds $4,764,709.50 Subordinate Series 2006A Turbo Capital Appreciation Bonds $512,471.35 Subordinate Series 2006B Turbo Capital Appreciation Bonds $867,690.00 Subordinate Series 2006C Turbo Capital Appreciation Bonds $1,145,138.00 Subordinate Series 2006D Turbo Capital Appreciation Bonds Dated Date: Date of Delivery. Maturity Date: As shown on inside cover. The Tobacco Settlement Financing Corporation (the “Corporation”) is a special purpose, independent instrumentality of the United States Virgin Islands (the “Virgin Islands”), created by Bill No. 24-0078 of the Twenty-Fourth Legislature of the United States Virgin Islands, Tobacco Settlement Financing Act of 2001 (the “Act”). See “THE CORPORATION” herein. The Corporation’s Tobacco Settlement Asset–Backed Bonds, Subordinate Series 2006A Turbo Capital Appreciation Bonds (the “Series 2006A Bonds”), Subordinate Series 2006B Turbo Capital Appreciation Bonds (the “Series 2006B Bonds”), Subordinate Series 2006C Turbo Capital Appreciation Bonds (the “Series 2006C Bonds”), and Subordinate Series 2006D Turbo Capital Appreciation Bonds (the “Series 2006D Bonds”, and together with the Series 2006A Bonds, the Series 2006B Bonds and the Series 2006C Bonds, the “Series 2006 Bonds”) are to be issued pursuant to an Amended and Restated Indenture, dated as of November 1, 2001, as amended and restated as of March 15, 2006, by and between the Corporation and The Bank of New York Trust Company, N.A., as indenture trustee (the “Indenture Trustee”), as supplemented by the Series 2006 Supplement, dated as of March 15, 2006 (collectively, the “Indenture”). Interest on the Series 2006 Bonds is not paid currently but accretes from the Date of Delivery, which interest shall be compounded every May 15 and November 15, commencing May 15, 2006 and is paid at maturity or upon prior redemption. The Corporation previously purchased all of the right, title and interest of the Virgin Islands in and to the payments required to be made after February 1, 2001, to the Virgin Islands under the Master Settlement Agreement entered into on November 23, 1998 (the “MSA”), by participating cigarette manufacturers (the “PMs”), the Virgin Islands, 46 states and five other U.S. jurisdictions, in settlement of certain cigarette smoking–related litigation, including the Virgin Islands’ right to receive future initial, annual and strategic contribution payments (such payments as more fully defined herein, the “TSRs”) to be made by the PMs under the MSA. The Series 2006 Bonds are subordinate in right of payment and in lien priority to the prior payment in full of all the indebtedness under the Corporation’s Tobacco Settlement Asset-Backed Bonds, Series 2001 (the “Series 2001 Bonds”, and together with any Additional Bonds (as hereinafter defined) issued under the Indenture which may be issued on a senior basis to the Series 2006 Bonds, the “Senior Bonds”), as provided in the Indenture. So long as any Senior Bonds remain outstanding, no payments will be made on the Series 2006 Bonds, the Indenture Trustee, the Bondholders, and the Beneficial Owners cannot exercise any rights or remedies with respect to the Series 2006 Bonds, and no default or event of default can exist or be declared with respect to the Series 2006 Bonds. If the Senior Bonds are not paid in accordance with their terms or there is a default or event of default with respect to the Senior Bonds, Bondholders and Beneficial Owners may suffer a complete loss of their investment and have no remedy for the loss. The proceeds of the Series 2006 Bonds will be used for the benefit of the Virgin Islands and its residents to finance several capital hospital and health department projects. See “ESTIMATED SOURCES AND USES OF PROCEEDS” herein. The amount of TSRs received is dependent on many factors, including future cigarette consumption and the financial capability of the PMs as well as litigation affecting the MSA, related state legislation and state enforcement thereof and the tobacco industry. Payments by the PMs under the MSA are subject to certain adjustments, some of which may be material. Bondholders should assume that future annual payments and strategic contribution payments, including the annual payment due on April 17, 2006, could be reduced. See “RISK FACTORS” herein. Numerous lawsuits have been filed challenging the MSA and related statutes, including two cases (Grand River and Freedom Holdings, both discussed in “RISK FACTORS” herein), that are pending in the U.S. District Court for the Southern District of New York. The courts in the Grand River and Freedom Holdings actions are considering plaintiffs’ allegations of an illegal output cartel under the federal antitrust laws and their allegations of violations under the Commerce Clause of the U.S. Constitution. A final determination in any of the pending or future lawsuits that the MSA or state legislation enacted pursuant to the MSA is void or unenforceable could have a materially adverse effect on the payments by PMs under the MSA and the amount or the timing of receipt of TSRs available to the Corporation to pay the Accreted Value of the Series 2006 Bonds and make Turbo Redemptions (herein defined), and could result in the complete loss of a Bondholder’s investment. See “RISK FACTORS” and “LEGAL CONSIDERATIONS” herein. The Series 2006 Bonds are limited obligations of the Corporation, payable from and secured solely by the Collateral pledged under the Indenture. The Bondholders have no recourse to other assets of the Corporation, including, but not limited to, any assets pledged to secure payment of any other debt obligation of the Corporation. If, notwithstanding the limitation on recourse described in the preceding sentence, any Bondholders are deemed to have an interest in any asset of the Corporation pledged to the payment of other debt obligations of the Corporation, the Bondholders’ interest in such asset shall be subordinate to the claims and rights of the holders of such other debt obligations and the Indenture will constitute a subordination agreement for purposes of Section 510(a) of the U.S. Bankruptcy Code. Neither the Indenture nor the Series 2006 Bonds creates an indebtedness or liability of the Virgin Islands for any purpose, including any constitutional or statutory limitations. The Corporation’s revenues are not funds of the Virgin Islands. THE SERIES 2006 BONDS SHALL NOT CONSTITUTE DEBT OF THE VIRGIN ISLANDS, THE SERIES 2006 BONDS ARE NEITHER GENERAL NOR MORAL OBLIGATIONS OF THE VIRGIN ISLANDS AND ARE NOT SECURED BY A PLEDGE OF THE FULL FAITH AND CREDIT OF THE VIRGIN ISLANDS AND THE HOLDERS OF THE SERIES 2006 BONDS MAY NOT REQUIRE THE LEVY OR IMPOSITION OF TAXES. THE CORPORATION HAS NO TAXING POWER. The Series 2006 Bonds are subject to mandatory redemption in whole or in part on each May 15 and November 15 on and after the date on which all Senior Bonds have been paid in full (as more fully defined herein, the “Crossover Date”) from amounts on deposit in the Turbo Redemption Account at the redemption price of 100% of the Accreted Value thereof. The Series 2006 Bonds are also subject to optional redemption at the redemption prices described herein. In addition, the Series 2006 Bonds are subject to extraordinary prepayment on or after the Crossover Date upon an Event of Default under the Indenture and from Lump Sum Payments at the redemption price of 100% of the Accreted Value thereof. See “THE SERIES 2006 BONDS” herein. The Series 2006B Bonds are subordinate to the Series 2006A Bonds, and the Holders of the Series 2006B Bonds are not entitled to receive any payment, including any extraordinary prepayment, until all Holders of Series 2006A Bonds and any other Bonds (herein defined) senior to the Series 2006B Bonds issued under the Indenture have been fully paid, regardless of the occurrence of an Event of Default. The Series 2006C Bonds are subordinate to the Series 2006B Bonds, and Holders of the Series 2006C Bonds are not entitled to receive any payment, including any extraordinary prepayment, until Holders of all Series 2006B Bonds and any other Bonds senior to the Series 2006C Bonds issued under the Indenture have been fully paid, regardless of the occurrence of an Event of Default. The Series 2006D Bonds are subordinate to the Series 2006C Bonds, and Holders of the Series 2006D Bonds are not entitled to receive any payment, including any extraordinary prepayment, until Holders of all Series 2006C Bonds and any other Bonds senior to the Series 2006D Bonds issued under the Indenture have been fully paid, regardless of the occurrence of an Event of Default. The Series 2006 Bonds are initially issued only as fully registered bonds without coupons, and, when issued, will be registered in the name of Cede & Co., as registered owner and nominee of The Depository Trust Company, New York, New York (“DTC”). Individual purchases of beneficial ownership interests may be made in denominations of $5,000 of Accreted Value at maturity or any integral multiple thereof in the case of the Series 2006A Bonds and the Series 2006B Bonds, and $100,000 of Accreted Value at maturity or any integral multiple thereof in the case of the Series 2006C Bonds and the Series 2006D Bonds (each an “Authorized Denomination”). See Inside Front Cover for Maturity Schedules, Initial Principal Amounts, Accreted Value at Maturity and Yield to Maturity Date. See “RISK FACTORS” for a discussion of certain factors that should be considered in connection with an investment in the Series 2006 Bonds. This cover page contains information for quick reference only. It is not a summary of this issue. Potential purchasers must read the entire Offering Circular to obtain information essential to making an informed investment decision. The Series 2006 Bonds are offered when, as and if issued and accepted by the Underwriter, subject to the approval of validity by Buchanan Ingersoll PC, New York, New York, Transaction Counsel. Certain legal matters will be passed upon for the Underwriter by its counsel, Nixon Peabody LLP, New York, New York. It is expected that the Series 2006 Bonds will be available for delivery in book–entry form only through the facilities of The Depository Trust Company, New York, New York on or about April 12, 2006. Citigroup Date: April 7, 2006 MATURITY SCHEDULE $7,290,008.85 Tobacco Settlement Financing Corporation Tobacco Settlement Asset–Backed Bonds, Subordinate Series 2006 Dated: Date of Delivery $4,764,709.50 Subordinate Series 2006A Turbo Capital Appreciation Bonds Due May 15, 2035, Yield 6.250% Projected Final Turbo Redemption Date: May 15, 2023† Projected Weighted Average Life: 13.1 years† CUSIP No. 88880RAK6* Initial Principal Amount Accreted Value at Maturity Initial Amount per $5,000 Accreted Value at Maturity $4,764,709.50 $28,550,000.00 $834.45 $512,471.35 Subordinate Series 2006B Turbo Capital Appreciation Bonds‡ Due May 15, 2035, Yield 6.500% Projected Final Turbo Redemption Date: May 15, 2024† Projected Weighted Average Life: 17.2 years† CUSIP No. 88880RAL4* Initial Principal Amount Accreted Value at Maturity Initial Amount per $5,000 Accreted Value at Maturity $512,471.35 $3,295,000.00 $777.65 $867,690.00 Subordinate Series 2006C Turbo Capital Appreciation Bonds** Due May 15, 2035, Yield 6.875% Projected Final Turbo Redemption Date: May 15, 2026† Projected Weighted Average Life: 18.8 years† CUSIP No. 88880RAM2* Initial Principal Amount Accreted Value at Maturity Initial Amount per $100,000 Accreted Value at Maturity $867,690.00 $6,200,000.00 $13,995.00 $1,145,138.00 Subordinate Series 2006D Turbo Capital Appreciation Bonds††† Due May 15, 2035, Yield 7.625% Projected Final Turbo Redemption Date: May 15, 2029† Projected Weighted Average Life: 21.7 years† CUSIP No. 88880RAN0* Initial Principal Amount Accreted Value at Maturity Initial Amount per $100,000 Accreted Value at Maturity $1,145,138.00 $10,100,000.00 $11,338.00 _______________________________ † Assumes payment of all Turbo Redemption payments in accordance with the Global Insight Base Case Consumption Forecast and other assumptions described in this Offering Circular. No assurance is given that these assumptions will be realized. Projections of Turbo Redemption payments of the Series 2006 Bonds have not been rated by the Rating Agency. See “METHODOLOGY AND BOND STRUCTURING ASSUMPTIONS.” * Copyright 2006, American Bankers Association. CUSIP data herein are provided by Standard & Poor’s, CUSIP Service Bureau, a division of The McGraw–Hill Companies, Inc. The CUSIP numbers listed above are being provided solely for the convenience of Bondholders only at the time of issuance of the Series 2006 Bonds and the Corporation, the Virgin Islands and the Underwriter do not make any representation with respect to such numbers or undertake any responsibility for their accuracy now or at any time in the future. The CUSIP number for a specific maturity is subject to being changed after the issuance of the Series 2006 Bonds as a result of various subsequent actions including, but not limited to, a refunding in whole or in part of such maturity or as a result of the procurement of secondary market portfolio insurance or other similar enhancement by investors that is applicable to all or a portion of certain maturities of the Series 2006 Bonds. ‡ The Series 2006B Bonds are subordinate to the Series 2006A Bonds, and Holders of the Series 2006B Bonds are not entitled to receive any payment, including any Extraordinary Prepayment, until all Holders of Series 2006A Bonds and any other Bonds senior to the Series 2006B Bonds issued under the Indenture have been fully paid, regardless of the occurrence of an Event of Default. ** The Series 2006C Bonds are subordinate to the Series 2006B Bonds, and Holders of the Series 2006C Bonds are not entitled to receive any payment, including any Extraordinary Prepayment, until Holders of all Series 2006B Bonds and any other Bonds senior to the Series 2006C Bonds issued under the Indenture have been fully paid, regardless of the occurrence of an Event of Default. ††† The Series 2006D Bonds are subordinate to the Series 2006C Bonds, and Holders of the Series 2006D Bonds are not entitled to receive any payment, including any Extraordinary Prepayment, until Holders of all Series 2006C Bonds and any other Bonds senior to the Series 2006D Bonds issued under the Indenture have been fully paid, regardless of the occurrence of an Event of Default. (i) THE UNDERWRITER PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT STABILIZE OR MAINTAIN THE PRICE OF THE SECURITIES AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET OR OTHERWISE AFFECT THE PRICE OF THE SECURITIES OFFERED HEREBY, INCLUDING OVER–ALLOTMENT AND STABILIZING TRANSACTIONS. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. NO DEALER, BROKER, SALESPERSON OR OTHER PERSON IS AUTHORIZED IN CONNECTION WITH ANY OFFERING MADE HEREBY TO GIVE ANY INFORMATION OR MAKE ANY REPRESENTATION OTHER THAN AS CONTAINED HEREIN, AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE CORPORATION, THE VIRGIN ISLANDS OR THE UNDERWRITER. THIS OFFERING CIRCULAR DOES NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, ANY OF THE SECURITIES OFFERED HEREBY BY ANY PERSON IN ANY JURISDICTION IN WHICH IT IS UNLAWFUL FOR SUCH PERSON TO MAKE SUCH AN OFFER OR SOLICITATION. THERE CAN BE NO ASSURANCE THAT A SECONDARY MARKET FOR THE SERIES 2006 BONDS WILL DEVELOP OR, IF ONE DEVELOPS, THAT IT WILL CONTINUE FOR THE LIFE OF THE SERIES 2006 BONDS. The information set forth herein has been furnished by the Corporation, Global Insight (as defined herein) and other sources and includes information obtained from other sources, all of which are believed to be reliable. Information concerning the tobacco industry and industry participants has been obtained from certain publicly available information provided by certain participants and certain other sources. See “TOBACCO INDUSTRY.” The tobacco industry participants have not provided any information to the Corporation for use in connection with this offering. In certain cases, tobacco industry information provided herein (such as market share data) may be derived from sources that are inconsistent or in conflict with each other. The Corporation has not independently verified the information under the caption “TOBACCO INDUSTRY”; the Corporation cannot and does not warrant the accuracy or completeness of this information. The information contained under the captions “GLOBAL INSIGHT CONSUMPTION REPORT” and in the Consumption Report attached hereto as Appendix A hereto have been included in reliance upon Global Insight as an expert in econometric forecasting, and has not been independently verified by the Corporation. The information and expressions of opinion contained herein are subject to change without notice and neither the delivery of this Offering Circular nor any sale made hereunder shall, under any circumstances, create any implication that there has been no change in the affairs of the Corporation, in the matters covered by the report of Global Insight attached hereto as Appendix A to this Offering Circular, or tobacco industry information, since the date hereof, or that the information contained in this Offering Circular is correct as of any date subsequent to the date hereof. Such information and expressions of opinion are made for the purpose of providing information to prospective investors and are not to be used for any other purpose or relied on by any other person. This Offering Circular contains forecasts, projections and estimates that are based on current expectations or assumptions. In light of the factors that may materially affect the amount of Collections (see “RISK FACTORS,” “LEGAL CONSIDERATIONS,” and “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT”), the inclusion in this Offering Circular of such forecasts, projections and estimates should not be regarded as a representation by the Corporation, the Virgin Islands, Global Insight or the Underwriter that such forecasts, projections and estimates will occur. Such forecasts, projections and estimates are not intended as representations of fact or guarantees of results. If and when included in this Offering Circular, the words “expects,” “forecasts,” “projects,” “intends,” “anticipates,” “estimates,” “assumes” and analogous expressions are intended to identify forward–looking statements and any such statements inherently are subject to a variety of risks and (ii) uncertainties that could cause actual results to differ materially from those that have been projected. Such risks and uncertainties include, among others, general economic and business conditions, changes in political, social and economic conditions, regulatory initiatives and compliance with governmental regulations, litigation and various other events, conditions and circumstances, many of which are beyond the control of the Corporation. These forward–looking statements speak only as of the date of this Offering Circular. The Corporation disclaims any obligation or undertaking to release publicly any updates or revisions to any forward–looking statement contained herein to reflect any changes in the Corporation’s expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based. THE SERIES 2006 BONDS HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE UNITED STATES SECURITIES AND EXCHANGE COMMISSION, ANY STATE SECURITIES COMMISSION OR ANY OTHER REGULATORY AGENCY, NOR HAS ANY OF THE FOREGOING PASSED UPON THE ACCURACY OR ADEQUACY OF THIS OFFERING CIRCULAR. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. The Underwriter has provided the following sentence for inclusion in this Offering Circular: The Underwriter has reviewed the information in this Offering Circular in accordance with, and as part of, their responsibilities to investors under the federal securities laws as applied to the facts and circumstances of this transaction, but the Underwriter does not guarantee the accuracy or completeness of such information. TABLE OF CONTENTS Page Page (iii) SUMMARY STATEMENT ..................................S-1 RISK FACTORS....................................................... 1 Litigation Challenging the MSA, the Qualifying Statutes and Related Legislation....................... 1 Litigation Seeking Monetary Relief from Tobacco Industry Participants ....................................... 10 Decline in Cigarette Consumption Materially Beyond Forecasted Levels May Adversely Affect Payments.............................................. 11 Other Potential Payment Decreases Under the Terms of the MSA........................................... 14 Other Risks Relative to the MSA and Related Statutes............................................................ 22 Bankruptcy of PMs May Delay, Reduce or Eliminate Payments......................................... 22 Uncertainty as to Timing of Turbo Redemptions 23 Subordinate Nature of the Series 2006 Bonds .... 23 No Current Interest.............................................. 24 Limited Obligations of the Corporation.............. 24 Limited Remedies ............................................... 25 Limited Liquidity of the Series 2006 Bonds; Price Volatility ......................................................... 25 Limited Nature of Ratings; Reduction, Suspension or Withdrawal of a Rating............................... 25 LEGAL CONSIDERATIONS................................ 26 Bankruptcy of a PM May Delay or Reduce Payments......................................................... 26 MSA Enforceability ............................................ 27 Qualifying Statute Constitutionality ................... 27 Limitations on Opinions of Counsel; No Assurance as to Outcome of Litigation........... 28 Enforcement of Rights to TSRs .......................... 28 No Assurance as to the Outcome of Litigation ... 29 THE SERIES 2006 BONDS................................... 29 Book–Entry Only ................................................ 29 Payments On The Series 2006 Bonds ................. 30 Turbo Redemption .............................................. 30 Lump Sum Prepayment....................................... 31 Extraordinary Prepayment .................................. 31 Optional Redemption .......................................... 31 Notice of Redemption ......................................... 31 SECURITY FOR THE BONDS............................. 31 General................................................................ 31 Debt Service Reserve Account............................ 32 Limited Obligations ............................................ 33 Flow of Funds ..................................................... 33 Non–Impairment Pledge of the Virgin Islands ... 35 Events of Default.................................................35 Event of Default Remedies..................................36 Additional Bonds.................................................37 THE SERIES 2001 BONDS....................................38 Interest Payments.................................................38 Accreted Value of Convertible CABs .................38 Principal Outstanding ..........................................39 Turbo Redemption...............................................40 Lump Sum Prepayment .......................................40 Extraordinary Prepayment...................................40 Optional Redemption...........................................40 Mandatory Clean–Up Redemption......................40 ESTIMATED SOURCES AND USES OF PROCEEDS.........................................................41 SUMMARY OF THE MASTER SETTLEMENT AGREEMENT.....................................................41 General.................................................................41 Parties to the MSA...............................................42 Scope of Release..................................................43 Overview of Payments by the Participating Manufacturers; MSA Escrow Agent ...............44 Initial Payments ...................................................44 Annual Payments.................................................45 Strategic Contribution Payments .........................46 Adjustments to Payments ....................................46 Subsequent Participating Manufacturers .............49 Payments Made to Date.......................................50 “Most Favored Nation” Provisions......................51 State–Specific Finality and Final Approval.........51 Disbursement of Funds from Escrow Account....51 Advertising and Marketing Restrictions; Educational Programs......................................52 Remedies upon the Failure of a PM to Make a Payment ...........................................................52 Termination of Agreement ..................................53 Severability..........................................................53 Amendments and Waivers...................................53 MSA Provisions Relating to Model/Qualifying Statutes.............................................................53 TOBACCO INDUSTRY.........................................56 Industry Overview ...............................................56 Shipment Trends..................................................58 Consumption Trends............................................59 Distribution, Competition and Raw Materials.....59 Grey Market.........................................................60 Regulatory Issues.................................................60 Civil Litigation ....................................................64 TABLE OF CONTENTS (Continued) Page Page (iv) THE GLOBAL INSIGHT CONSUMPTION REPORT ............................................................. 81 General................................................................ 81 Comparison with Prior Forecasts........................ 83 Historical Cigarette Consumption....................... 83 Factors Affecting Cigarette Consumption .......... 84 METHODOLOGY AND BOND STRUCTURING ASSUMPTIONS................................................. 84 Collection Methodology and Assumptions......... 85 Annual Payments ................................................ 85 Strategic Contribution Payments......................... 88 Interest Earnings ................................................. 91 Structuring Assumptions – Series 2001 Bonds... 91 Structuring Assumptions – Series 2006 Bonds... 92 Effect of Changes in Consumption Level on Turbo Redemptions......................................... 92 Effect of Changes in Consumption Level ........... 93 Explanation of Alternative Global Insight Forecasts.......................................................... 99 THE CORPORATION ......................................... 100 CONTINUING DISCLOSURE............................ 100 LITIGATION........................................................ 101 TAX MATTERS................................................... 101 Federal Income Taxes ....................................... 101 Virgin Islands Taxes ......................................... 102 Original Issue Discount..................................... 102 Ancillary Tax Matters ....................................... 102 Changes in Federal Tax Law and Post Issuance Events............................................................ 102 Form of Transaction Counsel Opinion.............. 102 RATINGS ............................................................. 103 UNDERWRITING................................................ 103 LEGAL MATTERS.............................................. 103 OTHER PARTIES ................................................ 104 Global Insight.................................................... 104 Banc of America Securities LLC ...................... 104 APPENDIX A – GLOBAL INSIGHT CONSUMPTION REPORT..................................A–1 APPENDIX B – MASTER SETTLEMENT AGREEMENT.......................................................B–1 APPENDIX C – PROPOSED FORM OF OPINION OF TRANSACTION COUNSEL ........C–1 APPENDIX D – SUMMARY OF PRINCIPAL LEGAL DOCUMENTS ........................................D–1 APPENDIX E –BOOK–ENTRY ONLY SYSTEM ...............................................................E–1 APPENDIX F – TABLE OF ACCRETED VALUES ............................................................... F–1 APPENDIX G – DEFEASANCE TURBO SCHEDULES........................................................G–1 APPENDIX H – INDEX OF DEFINED TERMS.H–1 S-1 SUMMARY STATEMENT This Summary Statement is subject in all respects to more complete information contained in this Offering Circular and should not be considered a complete statement of the facts material to making an investment decision. The offering of the Series 2006 Bonds to potential investors is made only by means of the entire Offering Circular. Capitalized terms used in this Summary Statement and not otherwise defined shall have the meanings given such terms in the Indenture or Sale Agreement, as applicable. See Appendix D – “SUMMARY OF PRINCIPAL LEGAL DOCUMENTS – Definitions” attached hereto. Overview........................................ The Tobacco Settlement Financing Corporation (the “Corporation”) is issuing $7,290,008.85 in initial principal amount of its Tobacco Settlement Asset–Backed Bonds, Subordinate Series 2006A Turbo Capital Appreciation Bonds (the “Series 2006A Bonds”), Subordinate Series 2006B Turbo Capital Appreciation Bonds (the “Series 2006B Bonds”), Subordinate Series 2006C Turbo Capital Appreciation Bonds (the “Series 2006C Bonds”), and Subordinate Series 2006D Turbo Capital Appreciation Bonds (the “Series 2006D Bonds” and together with the Series 2006A Bonds, the Series 2006B Bonds and the Series 2006C Bonds, the “Series 2006 Bonds”). Pursuant to the Purchase Agreement (defined below), the Corporation will make $6,459,573.96 of the proceeds of the Series 2006 Bonds available to the Government of the Virgin Islands for the financing of several capital hospital and health department projects, for the benefit of the Virgin Islands and its residents including (i) the completion of the construction of the Charlotte Kimelman Cancer Institute at the Schneider Regional Medical Center on the island of St. Thomas, (ii) the construction of the Virgin Islands Cardiac Center at Juan F. Luis Hospital on the island of St. Croix, and (iii) the construction for the United States Virgin Islands Department of Health of a new long term care facility for the Eldra Shulterbrandt Facility on the island of St. Thomas and the renovation of a United States Virgin Islands Department of Health facility in Fredericksted on the island of St. Croix (collectively, the “Capital Projects”). The balance of the proceeds will be applied to (i) pay certain costs of issuance relating to the Series 2006 Bonds, and (ii) fund operating costs. The United States Virgin Islands (the “Virgin Islands”) previously sold its right, title and interest in, to and under the Master Settlement Agreement (the “MSA”), including the Virgin Islands’ share of Initial Payments, Annual Payments and Strategic Contribution Payments (each as defined herein) received from and after February 1, 2002 (collectively, the “TSRs”) to the Corporation pursuant to a Purchase and Sale Agreement dated as of November 1, 2001, by and between the Virgin Islands and the Corporation (the “Purchase Agreement”). The Corporation previously issued $21,709,861.90 initial aggregate principal amount of its Tobacco Settlement Asset-Backed Bonds, Series 2001 (the “Series 2001 Bonds, and together with any Additional Bonds (as hereinafter defined) issued under the Indenture which may be issued on a senior basis to the Series 2006 Bonds, the “Senior S-2 Bonds”; the Senior Bonds together with the Series 2006 Bonds and any other Additional Bonds issued under the Indenture, the “Bonds”). The Series 2006 Bonds are to be issued pursuant to an Amended and Restated Indenture, dated as of November 1, 2001, as amended and restated as of March 15, 2006, as supplemented by the Series 2006 Supplement, dated as of March 15, 2006 (collectively, the “Indenture”), each by and between the Corporation and The Bank of New York Trust Company, N.A., as trustee (the “Indenture Trustee”). The Series 2006 Bonds are subordinate in right of payment and in lien priority to the prior payment in full of all the indebtedness of the Senior Bonds, as provided in the Indenture. So long as any Senior Bonds remain outstanding, (i) no payments will be made on the Series 2006 Bonds, (ii) the Indenture Trustee, the Bondholders, and the Beneficial Owners cannot exercise any rights or remedies with respect to the Series 2006 Bonds, and (iii) no default or event of default can exist or be declared with respect to the Series 2006 Bonds. If the Senior Bonds are not paid in accordance with their terms or there is a default or event of default with respect to the Senior Bonds, Bondholders and Beneficial Owners may suffer a complete loss of their investment and have no remedy for the loss. In accordance with the Payment Priorities (defined below), the Series 2006B Bonds are subordinate to the Series 2006A Bonds, and the Holders of the Series 2006B Bonds are not entitled to receive any payment, including any extraordinary prepayment, until all Holders of Series 2006A Bonds and any other Bonds (herein defined) senior to the Series 2006B Bonds issued under the Indenture have been fully paid, regardless of the occurrence of an Event of Default. The Series 2006C Bonds are subordinate to the Series 2006B Bonds, and Holders of the Series 2006C Bonds are not entitled to receive any payment, including any extraordinary prepayment, until Holders of all Series 2006B Bonds and any other Bonds senior to the Series 2006C Bonds issued under the Indenture have been fully paid, regardless of the occurrence of an Event of Default. The Series 2006D Bonds are subordinate to the Series 2006C Bonds, and Holders of the Series 2006D Bonds are not entitled to receive any payment, including any extraordinary prepayment, until Holders of all Series 2006C Bonds and any other Bonds senior to the Series 2006D Bonds issued under the Indenture have been fully paid, regardless of the occurrence of an Event of Default. S-3 Master Settlement Agreement........ The MSA was entered into on November 23, 1998, among the attorneys general of 46 states, the Virgin Islands, the District of Columbia, the Commonwealth of Puerto Rico, Guam, American Samoa and the Commonwealth of the Northern Mariana Islands (collectively, the “Settling States”) and the then four largest United States tobacco manufacturers: Philip Morris Incorporated (“Philip Morris”), R.J. Reynolds Tobacco Company (“Reynolds Tobacco”), Brown & Williamson Tobacco Corporation (“B&W”) and Lorillard Tobacco Company (“Lorillard”). Philip Morris, Reynolds Tobacco, B&W and Lorillard are collectively referred to as the “Original Participating Manufacturers” or the “OPMs”). On January 5, 2004, Reynolds American Inc. (“Reynolds American”) was incorporated as a holding company to facilitate the combination of the U.S. assets, liabilities and operations of B&W with those of Reynolds Tobacco. References herein to the “Original Participating Manufacturers” or “OPMs” means, for the period prior to June 30, 2004, collectively, Philip Morris, Reynolds Tobacco, B&W and Lorillard and for the period on and after June 30, 2004, means collectively Philip Morris, Reynolds American and Lorillard. As reported by the OPMs, the OPMs accounted for approximately 86.1%† of the United States domestic cigarette market in 2005, based upon shipments. The MSA resolved cigarette smoking–related litigation between the Settling States and the OPMs and released the OPMs from past and present smoking–related claims and provides for a continuing release of future smoking–related claims, in exchange for certain payments to be made to the Settling States (including Initial Payments, Annual Payments and Strategic Contribution Payments as defined herein), and imposed certain tobacco advertising and marketing restrictions on the OPMs, among other things. The MSA represents the resolution of a large potential financial liability of the OPMs for smoking–related injuries, the costs of which have been borne and will likely continue to be borne by cigarette consumers. The Corporation is not a party to the MSA. The MSA provides for tobacco companies other than the OPMs to become parties to the MSA. Tobacco companies that become parties to the MSA after the OPMs are referred to herein as “Subsequent Participating Manufacturers” or “SPMs” and the SPMs, together with the OPMs, are referred to herein as the “Participating Manufacturers” or “PMs.” Tobacco companies † Market share information for the OPMs based on domestic industry shipments may be materially different from Relative Market Share for purposes of the MSA and the respective obligations of the OPMs to contribute to Annual Payments and Strategic Contribution Payments. See “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT – Annual Reports” and “–Strategic Contribution Payments” herein. Additionally, aggregate market share information as reported by Loews Corporation is different from that utilized in the bond structuring assumptions and may differ from the market share information reported by the OPMs for purposes of their filings with the Securities and Exchange Commission. See “METHODOLOGY AND BOND STRUCTURING ASSUMPTIONS” and “TOBACCO INDUSTRY” herein. The aggregate market share information used in the Collection Methodology and Assumptions may differ materially from the market share information used by MSA Auditor in calculating adjustments to Annual Payments and Strategic Contribution Payments. See “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT – Adjustment to Payments” herein. S-4 that do not become parties to the MSA are referred to herein as “Non–Participating Manufacturers” or “NPMs.” Under the MSA, the Virgin Islands are entitled to 0.0173593% of the Initial Payments and Annual Payments and 0.1800232% of the Strategic Contribution Payments made by PMs under the MSA and distributed through the National Escrow Agreement, entered into on December 23, 1998 (the “MSA Escrow Agreement”), among the Settling States, the OPMs and Citibank, N.A., as escrow agent thereunder (the “MSA Escrow Agent”). Litigation Regarding MSA and Related Statutes................................ Numerous lawsuits have been filed challenging the MSA and related statutes, including two cases (Grand River and Freedom Holdings, discussed in “RISK FACTORS” herein), that are pending in the U.S. District Court for the Southern District of New York. The plaintiffs in both cases seek, inter alia, a determination that state statutes enacted pursuant to the MSA conflict with and are preempted by the federal antitrust laws. The plaintiffs in the Grand River and Freedom Holdings cases also seek a determination that state statutes enacted pursuant to the MSA violate the Commerce Clause of the U.S. Constitution. A final determination in any pending or future lawsuit that the MSA or state legislation enacted pursuant to the MSA is void or unenforceable could have a materially adverse effect on the payments by PMs under the MSA and the amount or the timing of receipt of TSRs available to the Corporation to pay the Accreted Value of the Series 2006 Bonds and redeem the Series 2006 Bonds prior to their stated maturity dates, and could result in the complete loss of a Bondholder’s investment. See “RISK FACTORS” and “LEGAL CONSIDERATIONS” herein. Payments Pursuant to the MSA ..... Under the MSA, the OPMs are required to make the following payments to the Settling States: (i) five initial payments, all of which have been made (the “Initial Payments”), (ii) annual payments (the “Annual Payments”) which are required to be made annually on each April 15, having commenced April 15, 2000, and continuing in perpetuity, and (iii) ten annual payments in the amount of $861 million each, each of which is subject to adjustment (the “Strategic Contribution Payments”), required to be made on each April 15 commencing April 15, 2008 and ending April 15, 2017. See “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT – Initial Payment,” “–Annual Payments” and “– Strategic Contribution Payments” herein. S-5 The Annual Payments and Strategic Contribution Payments due under the MSA are subject to numerous adjustments, some of which may be material. Such adjustments include, among others, reductions for decreased domestic cigarette shipments and to account for those states that settle or have settled their claims against the PMs independently of the MSA and increases related to inflation in an amount of not less than 3% per year in the case of the Annual Payments and the Strategic Contribution Payments. Final Approval of the MSA occurred on November 12, 1999. Upon Final Approval, the MSA Escrow Agent distributed the up-front Initial Payment, and since then has distributed the remaining Initial Payments and the Annual Payments due on or before April 15, 2005 to the Settling States that achieved State Specific Finality. The Virgin Islands or the Corporation has already received its share of these payments, none of which are available as security for the payment of the Series 2006 Bonds. Under the MSA, each OPM is required to pay an allocable portion of each remaining Initial Payment and each Annual Payment and Strategic Contribution Payment based on its respective market share of the United States cigarette market during the preceding calendar year, in each case, subject to certain adjustments as described herein. Each SPM has Annual Payment and Strategic Contribution Payment obligations under the MSA (separate from the payment obligations of the OPMs) according to its market share only if its market share exceeds the higher of its 1998 market share or 125% of its 1997 market share. The SPMs have no payment obligation with respect to the Initial Payments under the MSA. The payment obligations under the MSA follow tobacco product brands if they are transferred by any of the PMs. Payments by the PMs under the MSA are required to be made to the MSA Escrow Agent, which is required, in turn, pursuant to the instructions of the MSA Escrow Agreement, to remit an allocable share of such payments to the parties entitled thereto. [Remainder of page intentionally left blank] S-6 * Flow of TSR Payments .................. When the TSRs were sold to the Corporation in connection with the issuance of the Series 2001 Bonds, the MSA Escrow Agent was irrevocably instructed to disburse the TSRs from the Escrow Account directly to the Indenture Trustee. The following diagram depicts the flow of TSRs to the Indenture Trustee: MSA Payment Flow After Crossover Date Industry Overview ......................... The three OPMs (Philip Morris, Reynolds American and Lorillard) are the largest manufacturers of cigarettes in the United States, based on 2004 domestic market share. The market for cigarettes is highly competitive and is characterized by brand recognition and loyalty. See “TOBACCO INDUSTRY” herein. Cigarette Consumption .................. As described in the Global Insight Consumption Report described below, domestic cigarette consumption grew dramatically in the OPMs and SPMs United States Virgin Islands State-Specific Account Series 2001 Bondholders Indenture Trustee MSA Escrow Agent Other State- Specifications under the MSA Series 2006 Bondholders S-7 20th century, reaching a peak of 640 billion cigarettes in 1981. Consumption declined in the 1980’s and 1990’s, falling to less than 400 billion cigarettes in 2004. A number of factors affect consumption, including, but not limited to, pricing, industry advertising, expenditures, health warnings, restrictions on smoking in public places, nicotine dependence, youth consumption, general population trends and disposable income. See “GLOBAL INSIGHT CONSUMPTION REPORT” herein. Global Insight Consumption Report............................................. Global Insight (USA), Inc. (“Global Insight”), an international econometric and consulting firm, was retained on behalf of the Corporation to forecast cigarette consumption in the United States from 2004 through 2034. Global Insight’s report, entitled “A Forecast of U.S. Cigarette Consumption (2004–2034) for Tobacco Settlement Financing Corporation” dated March 30, 2006 (the “Global Insight Consumption Report”) is attached hereto as Appendix A and should be read in its entirety for an understanding of the assumptions on which it is based and the conclusions contained therein. The Global Insight Consumption Report is subject to certain disclaimers and qualifications as described therein. See Appendix A attached hereto. Global Insight considered the impact of demographics, cigarette prices, disposable income, employment and unemployment, industry advertising expenditures, the future effects of the incidence of smoking among underage youth and qualitative variables that captured the impact of anti–smoking regulations, legislation and health warnings. Global Insight found the following variables to be effective in building an empirical model of adult per capita cigarette consumption: real cigarette prices, real per capita disposable personal income, the impact of restrictions on smoking in public places and the trend over time in individual behavior and preferences. Using data from 1965 to 2003 and an analysis of the variables, Global Insight constructed an empirical model of adult per capita cigarette consumption (“CPC”) for the United States. Using standard multivariate regression analysis to determine the relationship between such variables and CPC along with Global Insight’s standard adult population growth statistics and adjustments for non–adult smoking, Global Insight projected adult cigarette consumption through 2034. While the Global Insight Consumption Report is based on United States cigarette consumption, Initial Payments, Annual Payments and Strategic Contribution Payments are computed based in part on shipments in or to the fifty United States, the District of Columbia and Puerto Rico. The Global Insight Consumption Report states that the quantities of cigarettes shipped and cigarettes consumed within the United States may not match at any given point in time as a result of various factors, such as inventory adjustments, but are substantially the same when compared over a period of time. See “GLOBAL INSIGHT CONSUMPTION REPORT” herein. The S-8 projections and forecasts regarding future cigarette consumption included in the Global Insight Consumption Report are estimates which have been prepared on the basis of certain assumptions and hypotheses. No representation or warranty of any kind is or can be made with respect to the accuracy or completeness of, and no representation or warranty should be inferred from, these projections and forecasts. Collateral........................................ The Series 2006 Bonds will be secured by and are payable solely from (i) the TSRs, (ii) investment earnings on certain accounts pledged under the Indenture (which earnings, together with the TSRs, are referred to herein as the “Collections”), (iii) amounts held in the other accounts established under the Indenture (except the Rebated Account), and (iv) the Corporation’s rights under the Purchase Agreement (the “Collateral”). Prior to the Crossover Date, none of the Collateral will be available for the payment of the Series 2006 Bonds. “Crossover Date” means the first date on which no Senior Bonds are outstanding. The Corporation............................. The Corporation is a special purpose, independent instrumentality of the Virgin Islands created by Bill No. 24-0078 of the Twenty- Fourth Legislature of the United States Virgin Islands, Tobacco Settlement Financing Act of 2001 (the “Act”). Book–Entry Only System .............. The Series 2006 Bonds will be delivered in book–entry form through the facilities of The Depository Trust Company, New York, New York (“DTC”), on or about April 5, 2006 (the “Closing Date”). Individual purchases of beneficial ownership interests may be made in denominations of $5,000 of Accreted Value at maturity or any integral multiple thereof in the case of the Series 2006A Bonds and the Series 2006B Bonds, and $100,000 of Accreted Value at maturity or any integral multiple thereof in the case of the Series 2006C Bonds and the Series 2006D Bonds (each an “Authorized Denomination”). Beneficial owners of the Series 2006 Bonds will not receive physical delivery of a certificate. See Appendix E – “BOOK–ENTRY ONLY SYSTEM” attached hereto. S-9 Subordination of the Series 2006 Bonds .................................... The Series 2006 Bonds are subordinate in right of payment and in lien priority to the prior payment in full of all the indebtedness of the Senior Bonds, as provided in the Indenture. So long as any Senior Bonds remain outstanding, (i) no payments will be made on the Series 2006 Bonds, (ii) the Indenture Trustee, the Bondholders, and the Beneficial Owners cannot exercise any rights or remedies with respect to the Series 2006 Bonds, and (iii) no default or event of default can exist or be declared with respect to the Series 2006 Bonds. See “Risk Factors – Subordinate Nature of the Series 2006 Bonds” herein. Subordination of the Series 2006B Bonds ............................................ The Series 2006B Bonds are subordinate to the Series 2006A Bonds, and Holders of the Series 2006B Bonds are not entitled to receive any payment, including any Extraordinary Prepayment, until all Holders of Series 2006A Bonds and any other Bonds senior to the Series 2006B Bonds issued under the Indenture have been fully paid, regardless of the occurrence of an Event of Default. Subordination of the Series 2006C Bonds ............................................ The Series 2006C Bonds are subordinate to the Series 2006B Bonds, and Holders of the Series 2006C Bonds are not entitled to receive any payment, including any Extraordinary Prepayment, until Holders of all Series 2006B Bonds and any other Bonds senior to the Series 2006C Bonds issued under the Indenture have been fully paid, regardless of the occurrence of an Event of Default. Subordination of the Series 2006D Bonds ............................................ The Series 2006D Bonds are subordinate to the Series 2006C Bonds, and Holders of the Series 2006D Bonds are not entitled to receive any payment, including any Extraordinary Prepayment, until Holders of all Series 2006C Bonds and any other Bonds senior to the Series 2006D Bonds issued under the Indenture have been fully paid, regardless of the occurrence of an Event of Default. No Current Interest ........................ Interest on the Series 2006 Bonds is not paid currently but accretes at the yield set forth on the inside cover page from the Date of Delivery, which interest shall be compounded every May 15 and November 15, commencing May 15, 2006. See Appendix F – “TABLE OF ACCRETED VALUES” attached hereto. Principal Payments......................... The Series 2006 Bonds will mature on the date as described on the inside cover page of this Offering Circular. A failure by the Corporation to pay when due, after the Crossover Date, the Accreted Value at maturity on any Bonds will constitute an Event of Default under the Indenture. See “SECURITY FOR THE SERIES 2006 BONDS–Flow of Funds” herein. S-10 Turbo Redemption ......................... The Series 2006 Bonds are subject to mandatory redemption in whole or in part prior to their stated maturity from amounts on deposit in the Turbo Redemption Account on any Distribution Date (defined herein) on or after the Crossover Date for which notice can be given pursuant to the Indenture, at the redemption price of 100% of the Accreted Value thereof without premium. A failure by the Corporation to make Turbo Redemption payments on the Series 2006 Bonds will not constitute an Event of Default under the Indenture. The Series 2006 Bonds are subject to Turbo Redemption in accordance with the Payment Priorities (hereinafter defined) and pro rata within each Series of Series 2006 Bonds. Monies in the Turbo Redemption Account may not be applied to purchase the Series 2006 Bonds on the open market. “Payment Priorities” means, subject to the issuance of Additional Bonds which may be payable prior to the Series described herein, payment of the Series 2006 Bonds in the following order of priority: (1) first, the Series 2006A Bonds until they are fully paid and no longer Outstanding; (2) second, the Series 2006B Bonds until they are fully paid and no longer Outstanding; (3) third, the Series 2006C Bonds until they are fully paid and no longer Outstanding and (4) fourth, the Series 2006D Bonds until they are fully paid and no longer Outstanding. Actual Payments of Principal........... Due to a number of factors, including actual shipments of cigarettes in the United States and the actual level of payments received by the Settling States (including the Virgin Islands) under the MSA, the amount available to pay the Series 2006 Bonds may fluctuate from year to year. As a result, Collections received by the Corporation may be insufficient to pay the Accreted Value of the Series 2006 Bonds or sufficient to pay the Accreted Value of the Series 2006 Bonds but insufficient for Turbo Redemptions. In either event, the Corporation will have no obligation to make Turbo Redemptions thereof. A failure by the Corporation to pay the Accreted Value of a Bond on its applicable Maturity Date will constitute an Event of Default under the Indenture. Lump Sum Prepayment.................. The Series 2006 Bonds are subject to mandatory prepayment, in whole or in part prior to their stated maturity from amounts on deposit in the Lump Sum Prepayment Account on any date on or after the Crossover Date at the prepayment price of 100% of the Accreted Value thereof without premium. Any prepayments of Series 2006 Bonds from Lump Sum Prepayments pursuant to the Indenture will be by Series in accordance with the Payment Priorities and within each Series pro rata. “Lump Sum Payment” means a lump sum payment received by the Indenture Trustee as a payment from a PM that results in a release of that PM from all or any portion of its future obligations under the MSA. S-11 Optional Redemption..................... The Series 2006 Bonds are subject to redemption at the Corporation’s option on any date, in whole or in part, on and after May 15, 2016 at a redemption price of 100% of the Accreted Value thereof, without premium. The Series 2006 Bonds to be redeemed shall be selected by the Corporation in its discretion by Series and within each Series by lot. Extraordinary Prepayment ............. If an Event of Default has occurred and is continuing on or after the Crossover Date, amounts on deposit in the Extraordinary Prepayment Account will be applied on each May 15 and November 15, commencing on the first May 15 or November 15 to occur on or after the Crossover Date (each a “Distribution Date”) to prepay the Series 2006 Bonds by Series in accordance with the Payment Priorities and within each Series pro rata, at a price of the Accreted Value thereof without premium. Bond Structuring Assumptions and Methodology ......................... The Series 2006 Bonds were structured on the basis of forecasts, which themselves are based on assumptions, as described herein. Among these are a forecast of United States cigarette consumption contained in the Global Insight Consumption Report, and the application of certain adjustments and offsets to payments to be made by the PMs pursuant to the MSA, and a forecast of the Accounts and all earnings on amounts on deposit in the Accounts established under the Indenture. In addition, such forecasts were used to project amounts expected to be available for redemption of the Series 2006 Bonds from Turbo Redemptions and the resulting expected average lives of the Series 2006 Bonds. No assurance can be given, however, that events will occur in accordance with such assumptions and forecasts. Any deviations from such assumptions and forecasts could materially and adversely affect the payment of the Series 2006 Bonds. See “METHODOLOGY AND BOND STRUCTURING ASSUMPTIONS” herein. Distributions and Priorities ............ No TSRs will be available to make payment on the Series 2006 Bonds prior to the Crossover Date. On and after the Crossover Date, any TSRs received by the Corporation will be promptly (and in no event later than two Business Days after receipt) deposited by the Indenture Trustee in the Collection Account. Unless otherwise specified in the Indenture, the Indenture Trustee will deposit all Collections received by it in the Collection Account. As soon as possible, but in any event not later than five Business Days) following each deposit of TSRs to the Collection Account and after setting aside an amount sufficient to pay the Indenture Trustee’s fees and expenses (in an amount not to exceed the applicable Operating Cap) pursuant to the Indenture, the Indenture Trustee will withdraw remaining Collections on deposit in the Collection Account and transfer such amounts in priority as follows: S-12 (i) to the Operating Account, an amount specified in an Officer’s Certificate, taking into account the payment of the Indenture Trustee’s fees and expense payments from the Collection Account for the next twelve months or until the next scheduled Deposit Date, whichever is the longer period, but not exceeding, when taken together with other applicable transfers, the Operating Cap for the then current Fiscal Year; (ii) to the Debt Service Account, an amount sufficient to cause the amount therein to equal interest on Outstanding Bonds due on the next succeeding Distribution Date, and, in the case of Parity Payments, to deposit in separate subaccounts within the Debt Service Account, interest and Parity Payments due during the semiannual period including such Distribution Date, together with any unpaid interest on Outstanding Bonds from prior Distribution Dates (including interest on overdue interest, if any, to the extent legally permissible); (iii) unless an Event of Default has occurred and is continuing, to the Debt Service Account, an amount sufficient to cause the amount therein (without regard to amounts on deposit therein pursuant to (ii) above) to equal the Principal of Outstanding Bonds due during the current Fiscal Year; (iv) unless an Event of Default has occurred and is continuing, to the Debt Service Reserve Account, an amount sufficient to cause the amounts therein to equal the Debt Service Reserve Requirement; (v) unless an Event of Default has occurred and is continuing, to the Debt Service Account an amount which, together with the amount on deposit therein pursuant to clause (ii) above but exclusive of the amounts on deposit therein pursuant to clause (iii) above, will be sufficient to cause the amount on deposit therein to equal interest (including interest at the stated rate on the principal of Outstanding Bonds and on overdue interest, if any) and Parity Payments, in each case, due (a) during the current Fiscal Year and (b) if the Deposit Date is during the period from January 1 through September 30 of any year, during the first half of the next Fiscal Year (or, in the case of Parity Payments, during the last complete Semiannual Period in such next Fiscal Year), assuming that Principal of the Bonds will be paid in the amounts deposited pursuant to clause (iii) above and Turbo Redemptions will be paid pursuant to clause (x) below; (vi) unless an Event of Default has occurred and is continuing, if a Lump Sum Payment has been received to the Debt Service Account, the amount of such Lump Sum Payment; S-13 (vii) if an Event of Default has occurred and is continuing, to the Extraordinary Prepayment Account all amounts remaining in the Collection Account; (viii) in the amounts and to the accounts established by the Series Supplement for payments thereon in excess of the applicable maximum rate, principal payable under term-out provisions of Ancillary Contracts (as defined in the Indenture, including, without limitation, credit enhancement), other amounts under Ancillary Contracts and not payable as Priority Payments (as defined under the Indenture) or debt service and any other junior payments specified as such by the Indenture (collectively, the “Junior Payments”); (ix) to the Corporation, an amount specified by an Officer’s Certificate to pay for any Operating Expenses in excess of the Operating Cap; and (x) unless and Event of Default has occurred and is continuing, to the Turbo Redemption Account, all amounts remaining in the Collection Account. “Fiscal Year” means the twelve (12) month period commencing October 1 of each year and ending on September 30 of the succeeding year. “Operating Cap” means $59,702.61 in the 2006 Fiscal Year, adjusted for inflation in each following Fiscal Year, plus arbitrage rebate and penalties specified in an Officer’s Certificate relating to the Series 2006 Bonds. “Operating Expenses” means all expenses incurred by the Corporation in connection with the Series 2006 Bonds, including but not limited to, the cost of preparation of accounting and other reports, costs of maintenance of ratings on the Series 2006 Bonds, arbitrage rebate and penalties, salaries, administrative expenses, insurance premiums, auditing and legal expenses, fees and expenses incurred for the Indenture Trustee, any Paying Agents, professional consultants and fiduciaries, costs incurred to preserve the tax-exempt status of any Bonds, costs related to the Corporation's or the Trustee's enforcement rights with respect to the Indenture or the Series 2006 Bonds and all Operating Expenses so identified in the Indenture. S-14 “Deposit Date” means the date of actual receipt by the Indenture Trustee of any Collections, provided that any payment received prior to January 1 of the year in which due, will be deemed to have been received on January 1 of such year. After making the deposits set forth above, (A) the Indenture Trustee shall compare (i) the amount on deposit in the Debt Service Reserve Account to (ii) the principal amount of Bonds that will remain Outstanding after giving effect to the application of amounts described below on the related Distribution Date, and if the amount in clause (i) is greater than the amount in clause (ii), the Indenture Trustee shall withdraw from the Debt Service Reserve Account an amount sufficient to, and shall, retire the Bonds in full on such Distribution Date, and (B) any amounts remaining in the Collection Account in excess of amounts required to be applied to make payments from the Collection Account pursuant to the distributions described below, after all the Bonds have been retired, will be paid to the Corporation, free and clear of the lien of the Indenture. Notwithstanding the foregoing, all amounts remaining in the Debt Service Reserve Account on the Crossover Date will be transferred to the Collection Account. On each Distribution Date, the Indenture Trustee will apply amounts in the various Accounts in the following order of priority: (i) from the Operating Account, to the parties entitled thereto, upon the Corporation’s written request, to pay Operating Expenses; (ii) from the Debt Service Account and the Debt Service Reserve Account, in that order, to pay interest on Outstanding Bonds and Parity Payments due on such Distribution Date, plus any such unpaid interest on Outstanding Bonds and Parity Payments from prior Distribution Dates (including interest on overdue interest, if any, to the extent legally permissible); (iii) unless an Event of Default has occurred and is continuing, from the Debt Service Account and the Debt Service Reserve Account, in that order, to pay in order of Maturity Dates, the principal of Outstanding Bonds due on such Distribution Date; (iv) unless an Event of Default has occurred and is continuing, from the Debt Service Reserve Account, any amount remaining in excess of the Debt Service Reserve Requirement, to the Collection Account and from these immediately to the Debt Service Account; (v) if an Event of Default has occurred and is continuing, from the Debt Service Reserve Account and the Extraordinary Prepayment Account to pay Extraordinary Prepayments; S-15 (vi) unless an Event of Default has occurred and is continuing, if a Lump Sum Payment has been received, from the Debt Service Account to pay Lump Sum Prepayments; and (vii) from the Funds and Accounts therefore, to make Junior Payments; and (viii) from the Turbo Redemption Account, to any amounts remaining therein to make Turbo Redemptions. All amounts on deposit in the various accounts will be transferred to the Collection Account on the Crossover Date, and applied as described above. Events of Default ........................... The occurrence of any of the following events will constitute an “Event of Default” under the Indenture: (i) failure to pay when due principal of, interest on or Accreted Value on any Bond when due; (ii) failure of the Corporation to observe or perform any other provision of the Indenture that is not remedied within 60 days after written notice thereof has been given to the Corporation by the Indenture Trustee or to the Corporation and the Indenture Trustee by the Bondholders of at least 25% in principal amount or Accreted Value of the Bonds then Outstanding; (iii) bankruptcy, reorganization, arrangement or insolvency proceedings, or other proceedings for relief under any bankruptcy or similar law or laws for the relief of debtors, are instituted by or against the Corporation and, if instituted against the Corporation, are not dismissed within 60 days after such institution; or (iv) the Virgin Islands fails to observe or perform its covenant included in the Indenture for the benefit of the Holders, which failure is not remedied within 60 days after written notice thereof is given to the Corporation and the Virgin Islands by the Indenture Trustee or to the Corporation and the Indenture Trustee by the Holders of at least 25% in principal amount or Accreted Value of the Bonds then Outstanding; or (v) the Virgin Islands fails to pay promptly to the Corporation or the Indenture Trustee any TSRs received by it; or (v) the Virgin Islands consents to or acquiesces in an amendment or modification of the MSA, or the Consent Decree is amended or modified, in each case, so as materially to reduce the amount of TSRs payable to the Virgin Islands under the MSA or to materially delay any date of payment of a material amount thereof. S-16 Additional Bonds ........................... Subsequent to the issuance of the Series 2006 Bonds, additional series of bonds (“Additional Bonds”) may be issued on a parity with one or more series of the Series 2006 Bonds, or on a senior or subordinate basis to one or more series of Series 2006 Bonds, for any lawful purpose, including refunding of outstanding Series 2006 Bonds, from time to time in such principal amounts and Accreted Value at maturity as the Corporation shall determine, provided, however, none of such Additional Bonds will receive payments of principal, premium or interest, or be deemed Outstanding for purposes of the Indenture, until the Crossover Date. Additional Bonds may be issued only upon receipt by the Indenture Trustee of (i) a written confirmation from each Rating Agency then rating the Outstanding Series 2006 Bonds that such issuance shall not cause such Rating Agency to lower, suspend or withdraw the rating then assigned by such Rating Agency to any Outstanding Series 2006 Bonds (a “Rating Confirmation”) and (ii) a certificate of the Corporation that (x) no Event of Default has occurred under the Indenture, and (y) as a result of the issuance of such Additional Bonds, the weighted average life of each Series 2006 Bond then Outstanding, projected in years from its date of issuance, will not exceed the sum of (i) the weighted average life of each such Outstanding Series 2006 Bond and (ii) one. In calculating the weighted average life of each of the Outstanding Series 2006 Bonds for the purpose of the certificate required by clause (y) of the preceding sentence, the Corporation shall take into consideration (1) the amount of Turbo Redemptions of Series 2006 Bonds that have been paid prior to and including the date of issuance of the Additional Bonds and (2) the amount of Turbo Redemptions projected by the Corporation to be paid on each May 15 and November 15 subsequent to the issuance of such Additional Bonds based upon the amount of TSRs then expected to be received by the Corporation and available for payment of Turbo Redemptions of the Outstanding Series 2006 Bonds. Refunding Bonds ........................... Subsequent to the issuance of the Series 2006 Bonds, Additional Bonds may be issued from time to time in such principal amounts as the Corporation shall determine, but only to renew or refund Outstanding Bonds (“Refunding Bonds”). Refunding Bonds may be issued to refund Series 2001 Bonds only upon receipt by the Indenture Trustee of (i) a Rating Confirmation from each Rating Agency then rating the Outstanding Series 2001 Bonds and Series 2006 Bonds, and any other Series of Bonds, and (ii) a certificate of the Corporation that (x) no Event of Default has occurred under the Indenture, and (y) as a result of the issuance of such Refunding Bonds, the weighted average life of each Series 2006 Bond then Outstanding, projected in years from its date of issuance, will not exceed the sum of (i) the weighted average life of each such Outstanding Series 2006 Bond and (ii) one. In calculating the weighted average life of each of the Outstanding S-17 Series 2006 Bonds for the purpose of the certificate required by clause (y) of the preceding sentence, the Corporation shall take into consideration (1) the amount of Turbo Redemptions of such Series 2006 Bonds that have been paid prior to the and including the date of issuance of the Refunding Bonds and (2) the amount of Turbo Redemptions projected by the Corporation to be paid on each May 15 and November 15 subsequent to the issuance of such Refunding Bonds based upon the amount of TSRs then expected to be received by the Corporation and available for payment of Turbo Redemptions of the Outstanding Series 2006 Bonds. Covenants....................................... The Corporation and the Virgin Islands have made certain covenants for the benefit of the Bondholders. See Appendix D – “SUMMARY OF PRINCIPAL LEGAL DOCUMENTS–THE INDENTURE” attached hereto for a summary of the covenants made by the Corporation, and “SUMMARY OF PRINCIPAL LEGAL DOCUMENTS–THE PURCHASE AND SALE AGREEMENT” attached hereto for a summary of the covenants made by the Virgin Islands. Continuing Disclosure Certificate....................................... Pursuant to the Continuing Disclosure Certificate by and between the Corporation and the Indenture Trustee, as dissemination agent, dated the date of issuance and delivery of the Series 2006 Bonds (the “Continuing Disclosure Certificate”), the Corporation has agreed to provide, or cause to be provided, to each nationally recognized municipal securities information repository and any State information repository for purposes of Rule 15c2–12(b)(5) adopted by the Securities and Exchange Commission (each, a “Repository”) certain annual financial information and operating data and, in a timely manner, notice of certain material events. See “CONTINUING DISCLOSURE” herein. Ratings ........................................... The ratings for the Series 2006A Bonds, the Series 2006B Bonds and the Series 2006C Bonds address only the ability of the Corporation to pay the Accreted Value of such Series 2006 Bonds on the respective Maturity Dates therefor, when due, as set forth on the inside cover page of this Offering Circular. Turbo Redemption payments on such Series 2006 Bonds have not been rated by the Rating Agencies. A rating is not a recommendation to buy, sell or hold securities, and such ratings are subject to revision or withdrawal at any time. No rating has been sought for or assigned to the Series 2006D Bonds. See “RATINGS” herein. Legal Considerations ..................... Reference is made to “LEGAL CONSIDERATIONS” herein for a description of certain legal issues relevant to an investment in the Series 2006 Bonds. Risk Factors ................................... Reference is made to “RISK FACTORS” herein for a description of certain considerations relevant to an investment in the Series 2006 Bonds. S-18 Tax Matters.................................... In the opinion of Transaction Counsel, under existing law and assuming compliance with the tax covenants described herein, interest on the Series 2006 Bonds is excluded from gross income for federal income tax purposes under Section 103 of the Internal Revenue Code of 1986, as amended (the “Code”). Transaction Counsel is also of the opinion that such interest is not treated as a preference item in calculating the alternative minimum tax imposed under the Code with respect to individuals and corporations. Interest on the Series 2006 Bonds is, however, included in the adjusted current earnings of certain corporations for purposes of computing the alternative minimum tax imposed on such corporations. Transaction Counsel is further of the opinion that the Series 2006 Bonds and the interest thereon are exempt from personal income tax imposed by the United States Virgin Islands, any state, other territory or possession of the United States or any political subdivision thereof, or by the District of Columbia. See “TAX MATTERS” herein regarding certain other tax considerations. See “TAX MATTERS” herein. Availability of Documents............. Included herein are brief summaries of certain documents and reports, which summaries do not purport to be complete or definitive, and reference is made to such documents and reports for full and complete statements of the contents thereof. Copies of the Indenture and the Continuing Disclosure Certificate may be obtained by written request from the Indenture Trustee at The Bank of New York Trust Company, N.A., 10161 Centurion Parkway, Jacksonville, Florida 32256. Any statements in this Offering Circular involving matters of opinion, whether or not expressly so stated, are intended as such and not as representations of fact. This Offering Circular is not to be construed as a contract or agreement among the Corporation, the Virgin Islands and the purchasers or Bondholders. 1 $7,290,008.85 Tobacco Settlement Financing Corporation Tobacco Settlement Asset–Backed Bonds, Subordinate Series 2006 $4,764,709.50 $512,471.35 $867,690.00 $1,145,138.00 Subordinate Series 2006A Turbo Capital Appreciation Bonds Subordinate Series 2006B Turbo Capital Appreciation Bonds Subordinate Series 2006C Turbo Capital Appreciation Bonds Subordinate Series 2006D Turbo Capital Appreciation Bonds RISK FACTORS Prospective investors should carefully consider the factors set forth below regarding an investment in the Series 2006 Bonds as well as other information contained in this Offering Circular. The following discussion of risks is not meant to be a complete list of the risks associated with the purchase of the Series 2006 Bonds and does not necessarily reflect the relative importance of the various risks. Potential purchasers of the Series 2006 Bonds are advised to consider the following factors, among others, and to review the other information in this Offering Circular in evaluating the Series 2006 Bonds. Any one or more of the risks discussed, and others, could lead to a decrease in the market value or the liquidity of the Series 2006 Bonds or, in certain circumstances, could result in a complete loss of a Bondholder’s investment. There can be no assurance that other risk factors will not become material in the future. Litigation Challenging the MSA, the Qualifying Statutes and Related Legislation General Overview. Certain smokers, consumer groups, cigarette importers, cigarette wholesalers, cigarette distributors, cigarette manufacturers, Native American tribes, taxpayers, taxpayers’ groups and other parties have instituted lawsuits against various PMs, certain of the Settling States and other public entities challenging the MSA and/or the Qualifying Statutes and related legislation. One or more of the lawsuits, several of which remain pending, allege, among other things, that the MSA and/or the Qualifying Statutes and related legislation are void or unenforceable under the Commerce Clause and certain other provisions of the U.S. Constitution and the federal antitrust laws, as described below under “—Grand River, Freedom Holdings and Related Cases” and “—Other Litigation Challenging the MSA, Qualifying Statutes and Related Legislation” in this subsection. In addition, some of the lawsuits allege that the MSA and/or related state legislation are void or unenforceable under the federal civil rights laws, state constitutions, consumer protection laws and unfair competition laws. Certain of these lawsuits seek, and, if ultimately successful, could result in, a determination that the MSA and/or the Qualifying Statutes and related legislation are void or unenforceable. Certain of the lawsuits further seek, among other things, an injunction against one or more of the Settling States from collecting any moneys under the MSA and barring the PMs from collecting cigarette price increases related to the MSA. In addition, class action lawsuits have been filed in several federal and state courts, and one such lawsuit remains pending, alleging that under the federal Medicaid law, any amount of tobacco settlement funds that the Settling States receive in excess of what they paid through the Medicaid program to treat tobacco–related diseases should be paid directly to Medicaid recipients. To date, challenges to the MSA or related state legislation have not been ultimately successful, although two challenges in a federal district court in the Second Circuit have survived appellate review of motions to dismiss and have proceeded to a stage of litigation where the ultimate outcome may be determined by, among other things, findings of fact based on extrinsic evidence as to the operation and impact of the MSA and the related statutes. In these cases, certain decisions by the U.S. Court of Appeals for the Second Circuit have created heightened uncertainty as a result of that court’s interpretation of federal antitrust immunity and Commerce Clause doctrines as 2 applied to the MSA and related statutes, which interpretation appears to conflict with interpretations by other courts, which have rejected challenges to the MSA and related statutes. Prior decisions rejecting such challenges have concluded that the MSA and related statutes do not violate the Commerce Clause of the U.S. Constitution and are protected from antitrust challenges based on established antitrust immunity doctrines. In addition, appeals are still possible in certain other cases. See “–Grand River, Freedom Holdings and Related Cases” in this subsection. The MSA and related state legislation may also continue to be challenged in the future. A final determination in any of the pending cases or in future lawsuits that the MSA or related state legislation is void or unenforceable could have a material adverse effect on the payments by the PMs under the MSA and the amount or the timing of receipt of TSRs available to the Corporation to make Turbo Redemptions and pay the Accreted Value of the Series 2006 Bonds and could result in the complete loss of a Bondholder’s investment. See “LEGAL CONSIDERATIONS” herein. Qualifying Statute and Related Legislation. Under the MSA’s NPM Adjustment, downward adjustments may be made to the Annual Payments and Strategic Contribution Payments payable by a PM if the PM experiences a loss of market share in the United States to NPMs as a result of the PM’s participation in the MSA. See “í Other Potential Payment Decreases Under the Terms of the MSA í NPM Adjustment” herein and “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT í MSA Provisions Relating to Model/Qualifying Statutes” herein. A Settling State may avoid the effect of this adjustment by adopting and diligently enforcing a Qualifying Statute, as hereinafter described. The Virgin Islands has adopted the Model Statute, which by definition is a Qualifying Statute under the MSA. The Model Statute, in its original form, required an NPM to make escrow deposits approximately in the amount that the NPM would have had to pay had it been a PM and further authorized the NPM to obtain from the applicable Settling State the release of the amount by which the escrow deposit in that state exceeded that state’s allocable share of the total payments that the NPM would have made as a PM. Legislation has been enacted in at least 44 of the Settling States amending the Qualifying Statutes in those states by eliminating the reference to the allocable share and limiting the possible release an NPM may obtain under the statute to the excess above the total payment that the NPM would have paid had it been a PM (each an “Allocable Share Release Amendment”). A majority of the PMs, including all OPMs, have indicated in writing that such jurisdiction’s Model Statute, as amended, will continue to constitute a Qualifying Statute within the meaning of the MSA. In addition, at least 44 Settling States have passed, and various states are considering, legislation (often termed “Complementary Legislation”) to further ensure that NPMs are making required escrow payments under the states’ respective Qualifying Statutes. Pursuant to a jurisdiction’s Complementary Legislation, every tobacco product manufacturer whose cigarettes are sold directly or indirectly in the jurisdiction is required to certify annually that it is either (a) a PM and is in full compliance with the terms of the MSA or (b) an NPM and is in full compliance with the jurisdiction’s Qualifying Statute. Legislation to enact the Complementary Legislation and the Allocable Share Release Legislation is being prepared for introduction by the Governor to the Virgin Islands Legislature, but has not been adopted. No assurance can be made that such legislation will be introduced, or if introduced, that it will be adopted. According to the Virgin Islands Bureau of Internal Revenue, no NPMs currently sell cigarettes in the Virgin Islands. The Bureau of Internal Revenue receives and reviews monthly filings listing the brands of cigarettes sold by the two cigarette wholesalers in the Virgin Islands, as well as excise invoices filed by excise agents in the Virgin Islands listing the brands of cigarettes on which excise taxes are collected at the port of entry into the Virgin Islands. None of the cigarette brands listed on such reports and invoices are manufactured by NPMs. As long as no NPMs sell cigarettes in the Virgin Islands, such legislation is not necessary to ensure that NPMs make the required escrow payments under the Virgin Islands’ Qualifying Statute. The Qualifying Statutes and related legislation of some of the Settling States, like the MSA, have also been the subject of litigation in cases alleging that those Qualifying Statutes and related legislation 3 violate certain provisions of the U.S. Constitution and/or state constitutions and are preempted by federal antitrust laws. The lawsuits seek, among other things, injunctions against the enforcement of the Qualifying Statutes and related legislation. To date such challenges have not been ultimately successful, although the enforcement of Allocable Share Release Amendments has been preliminarily enjoined in New York and certain other states. Appeals are also possible in certain cases. The Qualifying Statutes and related legislation may also continue to be challenged in the future. Pending challenges to the Qualifying Statutes and related legislation are described below under “–Grand River, Freedom Holdings and Related Cases” and “Other Litigation Challenging the MSA, Qualifying Statutes and Related Legislation” in this subsection. The Qualifying Statute adopted by the Virgin Islands is not the subject of any pending litigation. A determination that a Qualifying Statute is unconstitutional would have no effect on the enforceability of the MSA itself; such a determination could, however, have an adverse effect on payments to be made under the MSA if one or more NPMs were to gain market share. See “í Other Potential Payment Decreases Under the Terms of the MSA – NPM Adjustment” herein, “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT – MSA Provisions Relating to Model/Qualifying Statutes,” and “LEGAL CONSIDERATIONS” herein. A determination that an Allocable Share Release Amendment is unenforceable would not constitute a breach of the MSA but could permit NPMs to exploit differences among states, target sales in states without Allocable Share Release Amendments, and thereby potentially increase their market share at the expense of the PMs. See “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT – MSA Provisions Relating to Model/Qualifying Statutes” herein. A determination that the Virgin Islands Complementary Legislation, if enacted, is unenforceable would not constitute a breach of the MSA or affect the enforceability of the Virgin Islands’ Qualifying Statute; such a determination could, however, make enforcement of the Virgin Islands’ Qualifying Statute against NPMs more difficult for the Virgin Islands. See “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT í MSA Provisions Relating to Model/Qualifying Statutes” herein. Grand River, Freedom Holdings and Related Cases. Among the pending challenges to the MSA and/or related state legislation are two lawsuits referred to herein as Grand River and Freedom Holdings, both of which are pending in the U.S. District Court for the Southern District of New York. The Grand River case is pending against the attorneys general of 31 states (but not the Virgin Islands) and alleges, among other things, that (a) the MSA and related statutes create an unlawful output cartel under federal antitrust law and are thus preempted by federal law and that (b) the MSA and related statutes are invalid or unenforceable under the Commerce Clause and other provisions of the U.S. Constitution. The plaintiffs in Grand River seek to enjoin the enforcement of the Qualifying Statutes and Complementary Legislation by the Grand River Challenged States (defined below). The Virgin Islands’ Qualifying Statute is not at issue in Grand River and the Virgin Islands is not a party in that case. The Freedom Holdings case is pending against the attorney general and the commissioner of taxation and finance of the State of New York and alleges that, among other things, (a) the MSA creates an unlawful output cartel under federal antitrust law and New York state legislation enacted pursuant to the MSA mandates or authorizes such cartel and are thus preempted by federal law, and (b) the MSA and related statutes are invalid or unenforceable under the Commerce Clause of the U.S. Constitution. The plaintiffs in Freedom Holdings seek to enjoin the enforcement of New York’s Qualifying Statute and Complementary Legislation. These suits have survived appellate review of motions to dismiss for failure to state a claim upon which relief can be granted and are in the discovery phase of litigation in preparation for the development of a factual record to support possible findings of fact that may be used by the court in its decision as to the pending claims. To date, Grand River and Freedom Holdings, along with Xcaliber v. Ieyoub (discussed below), are the only cases challenging the MSA or related legislation that have survived initial appellate review of 4 motions to dismiss. Moreover, Grand River and Freedom Holdings are the only cases challenging the MSA or related legislation that have proceeded to a stage of litigation where the ultimate outcome may be determined by, among other things, findings of fact based on extrinsic evidence as to the operation and impact of the MSA and the related state legislation. On July 1, 2002, Grand River Enterprises Six Nations Ltd. v. Pryor was filed in the U.S. District Court of the Southern District of New York by certain NPMs against current and former attorneys general of 31 states (the “Grand River Challenged States”)∗. The Virgin Islands is not a defendant in the case. The plaintiffs seek to enjoin the enforcement of the Grand River Challenged States’ Qualifying Statutes and Complementary Legislation, alleging that such Qualifying Statutes and Complementary Legislation violate the plaintiffs’ constitutional rights under the Commerce Clause and other provisions of the U.S. Constitution and also that such Qualifying Statutes and Complementary Legislation conflict with and are therefore preempted by the federal antitrust laws. In September 2003, the District Court held that it lacked personal jurisdiction over the non–New York attorneys general and dismissed the plaintiffs’ complaint against them. In addition, the District Court dismissed the plaintiffs’ complaint against the New York Attorney General, finding that the plaintiffs had failed to state a claim. After the Second Circuit’s decision in Freedom Holdings (discussed below), however, the District Court granted the plaintiffs’ motion in Grand River to reinstate, against the New York Attorney General only, that portion of the complaint alleging that New York’s Qualifying Statute and New York’s Complementary Legislation conflict with antitrust laws and are preempted by federal law. The plaintiffs appealed the dismissal of their other claims to the Second Circuit. On September 28, 2005, the Second Circuit reinstated the Commerce Clause challenge and reinstated the non–New York attorneys general as defendants as to all claims, finding that a federal court in New York could exercise personal jurisdiction over them. The Second Circuit also affirmed the dismissal of certain remaining claims, including the claim that the Qualifying Statute and related legislation at issue violated the Indian Commerce Clause of the U.S. Constitution. The case was remanded to the District Court for further proceedings. On October 12, 2005, the defendants filed a petition with the Second Circuit for rehearing with regard to the Second Circuit’s ruling on the issue of personal jurisdiction. The plaintiffs then filed a petition with the Second Circuit for rehearing on the Indian Commerce Clause ruling. On January 3, 2006, the Second Circuit denied all parties’ petition for rehearing. With regard to the Commerce Clause challenge, the Second Circuit in Grand River noted that because it was reviewing a motion to dismiss, that it was required to accept as true the material facts alleged in the complaint and to draw all reasonable inferences in the plaintiffs’ favor. The Second Circuit held that although each state’s Qualifying Statute and Complementary Legislation apply to cigarette sales within that state, the plaintiffs sufficiently stated a possible claim that these statutes together create a national or “interstate” regulatory policy and thereby exert “extraterritorial control” over out–of–state transactions in contravention of the Commerce Clause. To date, Grand River is the only case in which a Commerce Clause challenge to the MSA and related statutes has survived a motion to dismiss. An adverse ruling on Commerce Clause grounds could potentially lead to invalidation of the MSA and the Qualifying Statutes at issue in their entirety and could result in the complete loss of a Bondholder’s outstanding investment. Grand River remains pending in the Southern District and the parties have engaged in discovery with respect to the antitrust and Commerce Clause claims. A final decision in this case by the District ∗ The Grand River Defendant States are: Alabama, Alaska, Arizona, California, Colorado, Delaware, Georgia, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Missouri, Montana, Nebraska, New York, North Carolina, Ohio, Oregon, South Carolina, South Dakota, Tennessee, Washington, Wisconsin and Wyoming. 5 Court would be subject to appeal as of right to the Second Circuit. However, any decision by the Second Circuit in this case would not be subject to appeal as of right to the U.S. Supreme Court. No assurance can be given that the Supreme Court would choose to hear and determine any appeal relating to the validity or enforceability of the MSA and/or related legislation in this or any other case. Even if appealed, a decision adverse to the defendants in Grand River could, unless stayed pending appeal at the discretion of the court, result in the complete cessation of the TSRs available to make payments on the Series 2006 Bonds during the pendency of the appeal. On April 16, 2002, in Freedom Holdings, Inc. v. Spitzer, certain cigarette importers filed an action against the Attorney General and the Commissioner of Taxation and Finance of the State of New York (the “New York State Defendants”), challenging New York’s Complementary Legislation, alleging in their initial complaint that New York’s Complementary Legislation enforces a market–sharing and price–fixing cartel, and allows the OPMs to charge supra–competitive prices for their cigarettes. Plaintiffs also alleged that New York’s Complementary Legislation violates the Commerce Clause of the U.S. Constitution and establishes an output cartel in violation of federal antitrust law. The initial complaint also alleged that the legislation is selectively enforced in violation of the Equal Protection Clause of the U.S. Constitution. The Southern District dismissed the action on May 14, 2002. In its decision, the Southern District applied two U.S. Supreme Court doctrines known as the “state action” immunity doctrine (based on a Supreme Court case known as “Parker”) and the First Amendment based immunity doctrine (based on two Supreme Court cases known collectively as Noerr– Pennington (“NP”)). The applicability of the Parker immunity doctrine requires two levels of analysis. Where a state confers authority on private parties to engage in conduct that would otherwise be per se violative of antitrust laws, cases subsequent to Parker (most notably a U.S. Supreme Court case known as “MidCal”) have required both a clear articulation of state policy and active supervision by the state of the otherwise anticompetitive conduct for Parker immunity to apply. When a state is acting unilaterally, in its capacity as the sovereign, however, no MidCal analysis is required and Parker immunity applies directly. NP immunity applies to conduct that is protected by the First Amendment, most particularly conduct that constitutes petitioning activity directed at courts or governmental bodies. The Southern District held, among other things, that New York’s Complementary Legislation was protected from antitrust challenge by both direct Parker immunity and NP immunity. The plaintiffs appealed and on January 6, 2004, the Second Circuit partially reversed the decision of the Southern District. In its reversal, the Second Circuit in Freedom Holdings noted, because it was reviewing a motion to dismiss, that it was required to accept as true the material facts alleged in the complaint and to draw all reasonable inferences in the plaintiffs’ favor. The Second Circuit affirmed the Southern District’s dismissal of that portion of the complaint that alleged a Commerce Clause violation. The Second Circuit reversed the dismissal of the plaintiffs’ Equal Protection claim, based on allegations that the Complementary Legislation is not applied to the sale of cigarettes by wholesalers or importers located on Native American Reservations located in New York, and allowed the plaintiffs to amend their complaint to correct deficiencies in the pleadings. The Second Circuit held, however, that the plaintiffs had alleged facts sufficient to state a claim that New York’s Complementary Legislation conflicts with federal antitrust law, and that based on the facts alleged, the legislation was not protected from an antitrust challenge based on either of the Parker or NP immunity doctrines. The Second Circuit determined, on the record before it, that a MidCal analysis was required and, on that record and solely for the purpose of reviewing the Southern District’s dismissal of the complaint, found insufficient active supervision and insufficient articulation of state policy to support a conclusion that there was antitrust immunity under Parker and MidCal. On March 25, 2004, the Second Circuit denied the New York State Defendants’ petition for a rehearing. 6 In April 2004, the plaintiffs in Freedom Holdings filed an amended complaint, which was supplemented in November 2004. The plaintiffs now seek (1) a declaratory judgment that the operation of the MSA, New York’s Qualifying Statute and New York’s Complementary Legislation implements an illegal per se output cartel in violation of the federal antitrust laws and is thus preempted by federal antitrust law and (2) an injunction permanently enjoining the enforcement of New York’s Qualifying Statute and New York’s Complementary Legislation. The amended complaint did not seek an injunction enjoining the enforcement or administration of the MSA. The amended complaint was limited only to claims under the federal antitrust laws and did not allege that the MSA, New York’s Qualifying Statute or New York’s Complementary Legislation violate the Commerce Clause or the Equal Protection Clause of the U.S. Constitution. On September 14, 2004, the Southern District denied the plaintiffs’ motion for a preliminary injunction enjoining New York, during the pendency of the action, from enforcing the MSA, New York’s Qualifying Statute and New York’s Complementary Legislation. The Southern District held that, based on the evidence presented by the parties, the plaintiffs had failed to establish a likelihood of success on the merits of their claims (1) that New York’s Qualifying Statute and New York’s Complementary Legislation authorized or mandated a per se violation of the federal antitrust laws or (2) that the MSA, New York’s Qualifying Statute and New York’s Complementary Legislation would not be entitled to Parker antitrust immunity under a MidCal analysis. The Southern District also determined that the plaintiffs had failed to make a showing of irreparable harm sufficient to justify preliminary injunctive relief. The Southern District, however, granted the plaintiffs’ motion to enjoin New York from enforcing its Allocable Share Release Amendment, holding that the plaintiffs had established a likelihood of success on their claim that New York’s Allocable Share Release Amendment conflicts with the federal antitrust laws and that its enforcement would cause plaintiffs and other NPMs irreparable harm. The plaintiffs appealed the Southern District’s denial of their motion for a preliminary injunction as to New York’s Qualifying Statute and New York’s Complementary Legislation. The plaintiffs did not appeal the denial of their motion for a preliminary injunction to enjoin the enforcement of the MSA and supplemented their amended complaint to state that they do not seek a permanent injunction to enjoin the enforcement of the MSA. The New York State Defendants did not appeal the granting of the plaintiffs’ motion to enjoin enforcement of New York’s Allocable Share Release Amendment. On May 18, 2005, the Second Circuit affirmed the Southern District’s denial of the plaintiffs’ request for a preliminary injunction. The Second Circuit held that the plaintiffs failed to satisfy the irreparable harm requirement for a preliminary injunction. The Second Circuit made no determination as to the likelihood of the plaintiffs’ ultimate success on the merits. On November 1, 2005, the Southern District denied, without prejudice and upon agreement of the parties, plaintiffs’ motion for partial summary judgment which sought a determination that the state’s Allocable Share Release Amendment violates federal antitrust law. On December 28, 2005, the Southern District denied the plaintiffs’ motion to file an amended complaint to add a Commerce Clause claim similar to the plaintiffs’ claims in Grand River, as described above. In its decision, however, the Southern District granted the plaintiffs leave to renew their motion to amend upon the condition that the plaintiffs show what additional discovery would be required to support such additional claims. On February 6, 2006, the Southern District granted plaintiffs’ renewed motion for leave to assert a claim under the Commerce Clause. On February 10, 2006, plaintiffs filed a Second Supplemental and Amended Complaint in which they added a Commerce Clause claim and requested injunctive and declaratory relief. Freedom Holdings remains pending and the Southern District has ordered the parties to complete discovery with respect to the claims. Uncertainty; Possibility of Conflict Among Federal Courts. Certain decisions by the U.S. Court of Appeals for the Second Circuit in Freedom Holdings and Grand River have created uncertainty as a result of the court’s interpretation of federal antitrust law immunity doctrines, as applied to the MSA and related statutes, which interpretation appears to conflict with interpretations by other courts which have rejected challenges to the MSA and related statutes. Prior decisions rejecting such challenges have 7 concluded that the MSA and related statutes are protected from an antitrust challenge based on the Parker or NP doctrines. An adverse decision by the Second Circuit in Grand River regarding the enforceability of the MSA and/or related statutes under federal antitrust law or the Commerce Clause of the U.S. Constitution would not be controlling law in the Virgin Islands. However, if a final decision by the Second Circuit regarding the enforceability of the MSA and/or related statutes is appealed, and the U.S. Supreme Court chooses to hear and determines the appeal on the substantive merits, the U.S. Supreme Court’s decision would be binding everywhere in the United States, including the Virgin Islands. In addition, a decision by the Second Circuit in Freedom Holdings that is adverse to defendants regarding the enforceability of the MSA and/or related statutes under federal antitrust law would be controlling law only within the Second Circuit from which no appeal as of right to the U.S. Supreme Court would exist. If, however, the Second Circuit were to make a final determination in Freedom Holdings that the MSA constitutes a per se federal antitrust violation, not immunized by the NP or Parker doctrines, or that New York’s Qualifying Statute and Complementary Legislation authorize or mandate such a per se violation, such determination could be considered to be in conflict with decisions rendered by other federal courts, which have come to different conclusions on these issues. The existence of a conflict as to the rulings of different federal courts on these issues, especially between Circuit Courts of Appeals, is one factor that the Supreme Court may take into account when deciding whether to exercise its discretion in agreeing to hear an appeal. No assurance can be given that the Supreme Court would choose to hear and determine any appeal relating to the substantive merits of Freedom Holdings. Any decision by the U.S. Supreme Court on the substantive merits of Freedom Holdings would be binding everywhere in the United States, including in the Virgin Islands. Any decision by the U.S. Supreme Court that is adverse to defendants on the substantive merits of Freedom Holdings could have a material adverse effect on the amount of TSRs available to the Corporation to make Turbo Redemptions and pay the Accreted Value of the Series 2006 Bonds and could result in the complete loss of a Bondholder’s investment. Other Litigation Challenging the MSA, Qualifying Statutes and Related Legislation. In addition to Freedom Holdings and Grand River, other cases remain pending in federal courts that challenge the MSA, the Qualifying Statute, the Complementary Legislation and/or the Allocable Share Release Amendment in California, Louisiana, Oklahoma, Kansas, Kentucky, Tennessee and Arkansas. Most of these cases, as briefly described below, by way of example only, and not as an exclusive or complete list, raise essentially the same issues as those raised in Freedom Holdings or Grand River. On March 28, 2005, the U.S. District Court for the Northern District of California in the California case, Sanders v. Lockyer, dismissed an antitrust challenge to the MSA and California’s Qualifying Statute and Complementary Legislation brought by a class of California consumers against the State of California and the OPMs. The District Court, expressly unpersuaded by Freedom Holdings, found the MSA to be the sovereign act of the State of California and further found California’s Qualifying Statute and Complementary Legislation to be direct legislative activity entitled to Parker immunity without the need for any additional MidCal analysis. The District Court also found the MSA and California’s Qualifying Statute and Complementary Legislation to be entitled to NP immunity. The plaintiffs have appealed the dismissal to the Ninth Circuit Court of Appeals. The plaintiff’s opening appellate brief was filed on August 19, 2005, and the defendant’s brief was filed on October 20, 2005. On August 13, 1999, in PTI, Inc v. Philip Morris Inc., certain cigarette importers and cigarette distributors filed an action in the U.S. District Court for the Central District of California against the PMs and all of the state officials involved in the negotiation of the MSA and those charged with the enforcement of the Qualifying Statute and Complementary Legislation as enacted by the respective states 8 (collectively, the “State Defendants”). The plaintiffs therein sought to enjoin the passage or enforcement, as the case may be, of the Qualifying Statute and Complementary Legislation. The complaint alleged, among other things, that the passage, implementation and/or enforcement of the Qualifying Statute would be preempted by federal antitrust laws and violate certain provisions of the federal constitution, including the Interstate Compact Clause, the prohibition on Bills of Attainder, the Commerce Clause, the Import–Export Clause, the Supremacy Clause, the First Amendment, the Equal Protection Clause, and the Due Process Clause. On May 25, 2000, the District Court found that jurisdiction did not exist over the non–California State Defendants, and dismissed with prejudice all federal antitrust and constitutional claims against the PMs and the California State Defendants based on the merits. Like the Sanders Court, the PTI Court found antitrust immunity under both the NP and Parker doctrines. With respect to the Commerce Clause challenge, the Court found that neither the Qualifying Statute nor the Complementary Legislation was discriminatory on its face and applied equally to in–state, out–of–state and foreign manufacturers. In addition, the Court found that the alleged burden imposed on interstate commerce by the Qualifying Statute did not clearly exceed the putative local benefits of discouraging cigarette consumption. Two cases are currently pending in Louisiana that challenge the MSA, Qualifying Statutes and related legislation. In Xcaliber International Limited, LLC v. Foti, certain NPMs have challenged Louisiana’s Allocable Share Release Amendment on both federal and state constitutional grounds (plaintiffs do not challenge the legality of the MSA or the Qualifying Statute). This action was dismissed by the District Court in February 2005 for failure to state a proper claim. The plaintiffs then appealed the dismissal to the Fifth Circuit Court of Appeals. On March 1, 2006, the Fifth Circuit reversed and vacated the trial court’s order of dismissal and remanded the case for further proceedings. In Coker v. Foti, filed in August 2005, certain NPMs and cigarette distributors brought an action in a federal district court in Louisiana, seeking, among other relief, (i) a declaration that the MSA and Louisiana’s Qualifying Statute and Complementary Legislation are invalid under the Interstate Compact Clause of the U.S. Constitution and that Louisiana’s Qualifying Statute and Complementary Legislation are preempted by the federal antitrust laws; and (ii) an injunction barring the enforcement of the MSA and Louisiana’s Qualifying Statute and Complementary Legislation. On November 2, 2005 the state defendants filed a motion to dismiss the complaint. In the Oklahoma case, Xcaliber International Limited, LLC v. Edmondson, certain NPMs have challenged Oklahoma’s enforcement of its Allocable Share Release Amendment under federal antitrust laws. On May 20, 2005, the District Court granted summary judgment in favor of defendant, holding that the Oklahoma Allocable Share Release Amendment constituted unilateral state action that is directly protected from preemption by the Parker immunity doctrine. The plaintiffs have requested that the District Court reconsider its summary judgment order and appealed the order to the U.S. Court of Appeals for the Tenth Circuit. On August 31, 2005, the District Court denied the motion to reconsider. On October 28, 2005, the Tenth Circuit referred the case for mediation conferencing. Mediation conferencing was subsequently terminated and appellate briefing was completed in February 2006. In the Kentucky case, Tritent International Corp. v. Commonwealth of Kentucky, the plaintiffs seek a declaratory judgment that Kentucky’s Qualifying Statute and Complementary Legislation conflict with federal antitrust laws and certain provisions of the U.S. Constitution. On September 8, 2005, the District Court granted Kentucky’s motion to dismiss the complaint and on October 24, 2005, the District Court denied the plaintiffs’ subsequent motion for reconsideration. The plaintiffs have appealed the dismissal to the Sixth Circuit Court of Appeals. Similarly, in the Tennessee case, S&M Brands, Inc. v. Summers, the plaintiffs seek a declaratory judgment that Tennessee Qualifying Statute (including the Allocable Share Release Amendment) and Complementary Legislation also conflict with federal antitrust laws and certain provisions of the U.S. 9 Constitution. On June 1, 2005, the Sixth Circuit affirmed the District Court’s denial of plaintiffs’ motion for a preliminary injunction with respect to the enforcement of Tennessee’s Allocable Share Release Amendment. On October 6, 2005, the District Court granted Tennessee’s motion to dismiss the complaint except that portion of the complaint that alleges that the state’s retroactive enforcement of the state’s Allocable Share Release Provision violates plaintiff’s constitutional rights, which issue was not raised by the state in its original motion and was therefore not addressed by the court. In its opinion, the District Court expressly rejected the Second Circuit’s reasoning in sustaining antitrust challenges in the Freedom Holdings case and the Third Circuit’s rationale for denying state action immunity in the Bedell and Mariana cases. Instead, the District Court in S&M Brands followed the Sanders and PTI line of cases and held that the Qualifying Statute and Complementary Legislation are direct state action, and are entitled to Parker immunity without the need for MidCal analysis. By decision filed November 28, 2005, the District Court held that the state’s retroactive application of its Allocable Share Release Amendment, which was effective as of April 20, 2004, to 2003 cigarette sales was unconstitutional. On December 12, 2005, the District Court entered a final judgment dismissing the claims seeking a declaration that the Tennessee Qualifying Statute violated federal antitrust laws and certain provisions of the U.S. Constitution. On January 3, 2006, plaintiffs filed a notice of appeal of that judgment. Similar cases are pending in Arkansas. In three cases pending in the U.S. District Court for the Western District of Arkansas (Grand River Enterprises Six Nations Ltd. v. Beebe, International Tobacco Partners Ltd. v. Beebe, and Dos Santos v. Beebe), the plaintiffs seek to enjoin preliminarily and permanently Arkansas’ enforcement of its Allocable Share Release Amendment as preempted by the federal antitrust laws and certain provisions of the U.S. Constitution and the Arkansas Constitution. In International Tobacco Partners Ltd, .the plaintiffs also seek a declaratory judgment that the MSA and Arkansas’ Qualifying Statute and Complementary Legislation are preempted by federal antitrust laws and certain provisions of the U.S. Constitution. The District Court preliminarily enjoined, as against the plaintiffs only, the enforcement of Arkansas’ Allocable Share Release Amendment. On August 8, 2005, the court ordered Arkansas to reimburse certain amounts it withheld pursuant to the Allocable Share Release Amendment to International Tobacco Partners Ltd. On March 6, 2006, the District Court issued orders in all three cases (1) denying Arkansas’ motion to dismiss the complaint with respect to the plaintiffs’ claim that the retroactive application of the Allocable Share Release Amendment violates the plaintiffs’ right to due process of law under the Fourteenth Amendment of the U.S. Constitution and (2) granting Arkansas’ motion to dismiss the complaint in all other respects. On March 14, 2006, the District Court in Grand River v. Beebe denied the plaintiffs’ motion to preliminarily enjoin the Allocable Share Release Amendment. Two cases are currently pending in Kansas. In the first case filed, Xcaliber International Limited, LLC v. Kline, the plaintiffs seek to enjoin preliminarily and permanently Kansas’ enforcement of its Allocable Share Release Amendment as preempted by the federal antitrust laws, expressly based on the same facts that were before the District Court in the Freedom Holdings case in New York. The complaint challenges only the Allocable Share Amendment but purports to reserve the right to challenge the Kansas Qualifying Statute in its entirety. The plaintiff’s motion for preliminary injunction and Kansas’ motion to dismiss the complaint were denied on July 29, 2005. Subsequently, Kansas moved for summary judgment, which was granted on February 7, 2006. In its order the District Court held that the Allocable Share Release Amendment was neither a “per se” violation of the Sherman Act, nor a “hybrid restraint”. In the second case, International Tobacco Partners Ltd. v. Kline, the plaintiffs seek a declaratory judgment that the Allocable Share Release Amendment is preempted by federal antitrust laws and certain provisions of the U.S. Constitution and preliminary and permanent injunctions against the enforcement of the Allocable Share Release Amendment. Although the complaint asserts that the MSA and Kansas’ Qualifying Statute are also preempted by federal antitrust laws and certain provisions of the U.S. Constitution, it does not specifically seek to enjoin the enforcement thereof. The Kansas Attorney general has filed a motion to dismiss the Second Amended Complaint in this case, which motion is still pending. 10 The plaintiffs in Freedom Holdings filed a motion with the federal Judicial Panel on Multidistrict Litigation (the “MDL Panel”) requesting that the Tennessee, Kentucky and Oklahoma cases described above, together with Grand River, be transferred to the Southern District of New York for coordinated and consolidated pretrial proceedings with Freedom Holdings. On June 16, 2005, the MDL Panel denied this motion. The MDL Panel’s denial of this motion is not subject to appeal. If there is a ruling in one or more of the cases discussed above that is adverse to defendants regarding the enforceability of the MSA and/or related statutes, it could have a material adverse effect on the amount of TSRs available to the Corporation to make Turbo Redemptions and pay the Accreted Value of the Series 2006 Bonds and could result in the complete loss of a Bondholder’s investment. For a description of the opinions of Buchanan Ingersoll PC addressing such matters, see “LEGAL CONSIDERATIONS í MSA Enforceability” and “LEGAL CONSIDERATIONS – Qualifying Statute Constitutionality” herein. Litigation Seeking Monetary Relief from Tobacco Industry Participants The tobacco industry has been the target of litigation for many years. Both individual and class action lawsuits have been brought by or on behalf of smokers alleging that smoking has been injurious to their health, and by non–smokers alleging harm from environmental tobacco smoke (“ETS”), also known as “secondhand smoke.” Plaintiffs in these actions seek compensatory and punitive damages aggregating billions of dollars. Philip Morris, for example, has reported that, as of September 30, 2005, there were 13 cases on appeal in which verdicts were returned against Philip Morris, including a compensatory and punitive damages verdict totaling approximately $10.1 billion in the Price case in Illinois. On December 15, 2005, however, the Illinois Supreme Court reversed the judgment against Philip Morris in Price and remanded the case to the trial court with instructions to dismiss the case in its entirety. In its decision, the court held that the defendant’s conduct alleged by the plaintiffs to be fraudulent under the Illinois Consumer Fraud Act was specifically authorized by the Federal Trade Commission and that the Illinois Consumer Fraud Act specifically exempts conduct so authorized by a regulatory body acting under the authority of the United States. The court declined to review the case on the merits, concluding that the action was barred entirely by the Illinois Consumer Fraud Act. It has been reported that the plaintiffs have filed a motion asking the court to reconsider its decision in Price. It is possible that the plaintiffs will seek further appeals and/or rehearings. No assurance can be given that that such appeals and/or rehearings will not be granted or that they will not be decided in the plaintiffs’ favor. The MSA does not release PMs from liability in either individual or class action cases. However, certain PMs have taken the position that the entry into the MSA by the Settling States settled and therefore prevents all punitive damages claims in smoking and health cases brought by individuals residing in the Settling States. Healthcare cost recovery cases have also been brought by governmental and non–governmental healthcare providers seeking, among other things, reimbursement for healthcare expenditures incurred in connection with the treatment of medical conditions allegedly caused by smoking. The PMs are also exposed to liability in these cases because the MSA only settled healthcare cost recovery claims of the Settling States. Litigation has also been brought against certain PMs and their affiliates in foreign countries. Pending claims related to tobacco products generally fall within four categories: (i) smoking and health cases alleging personal injury and purporting to be brought on behalf of a class of individual plaintiffs, including cases brought pursuant to a 1997 settlement agreement involving claims by flight attendants alleging injury from exposure to ETS in aircraft cabins, (ii) smoking and health cases alleging personal injury brought on behalf of individual plaintiffs, (iii) healthcare cost recovery cases brought by governmental (both domestic and foreign) and non–governmental plaintiffs seeking reimbursement for healthcare expenditures allegedly caused by cigarette smoking and/or disgorgement of profits, and 11 (iv) other tobacco–related litigation, including class action suits alleging that the use of the terms “Lights” and “Ultra Lights” constitute deceptive and unfair trade practices, suits by former asbestos manufacturers seeking contribution or reimbursement for amounts expended in connection with the defense and payment of asbestos claims that were allegedly caused in whole or in part by cigarette smoking, and various antitrust suits and suits by foreign governments seeking to recover damages for taxes lost as a result of the allegedly illegal importation of cigarettes into their jurisdictions. Plaintiffs seek various forms of relief, including compensatory and punitive damages, treble/multiple damages and other statutory damages and penalties, creation of medical monitoring and smoking cessation funds, disgorgement of profits, legal fees, and injunctive and equitable relief. Defenses raised in these cases include lack of proximate cause, statutes of limitation and preemption by the Federal Cigarette Labeling and Advertising Act. The ultimate outcome of these and any other pending or future lawsuits is uncertain. Verdicts of substantial magnitude that are enforceable as to one or more PMs, if they occur, could encourage commencement of additional litigation, or could negatively affect perceptions of potential triers of fact with respect to the tobacco industry, possibly to the detriment of pending litigation. An unfavorable outcome or settlement, or one or more adverse judgments could result in a decision by the affected PMs to substantially increase cigarette prices, thereby reducing cigarette consumption beyond what is forecast in the Global Insight Consumption Report. In addition, the financial condition of any or all of the PM defendants could be materially and adversely affected by the ultimate outcome of pending litigation, including bonding and litigation costs and/or a verdict or verdicts awarding substantial compensatory or punitive damages. Depending upon the magnitude of any such negative financial impact (and irrespective of whether the PM is thereby rendered insolvent), an adverse outcome in one or more of the lawsuits could substantially impair the affected PM’s ability to make payments under the MSA, and have a material adverse effect on the amount of TSRs available to the Corporation to pay Turbo Redemptions or Accreted Value of the Series 2006 Bonds. See “TOBACCO INDUSTRY–Civil Litigation” and “LEGAL CONSIDERATIONS.” Decline in Cigarette Consumption Materially Beyond Forecasted Levels May Adversely Affect Payments Smoking Trends. As discussed in the Global Insight Consumption Report, cigarette consumption in the United States has declined since its peak in 1981 of 640 billion cigarettes to an estimated 381 billion cigarettes in 2005. Adult per capita cigarette consumption (total consumption divided by the number of people 18 years and older) has been declining since 1964. The Global Insight Consumption Report forecasts a continued decline in total cigarette consumption at an average annual rate of 1.82% to 226 billion cigarettes in 2034 under its Base Case Forecast (as defined herein), which represents a decline in per capita consumption at an average rate of 2.62% per year. These consumption declines are based on historical trends which may not be indicative of future trends, as well as other factors which may vary significantly from those assumed or forecasted by Global Insight. On March 8, 2006, the National Association of Attorneys General and the American Legacy Foundation jointly announced that cigarette consumption in 2005 had fallen to 378 billion cigarettes. The Global Insight 2005 estimate of 381 billion cigarettes is slightly higher. For a more detailed discussion of the Global Insight methodology, see “THE GLOBAL INSIGHT CONSUMPTION REPORT” and “APPENDIX A – GLOBAL INSIGHT CONSUMPTION REPORT.” According to the Global Insight Consumption Report, the pharmaceutical industry is seeking approval from the U.S. Food and Drug Administration (the “FDA”) for two new smoking cessation products possibly more effective than those now in existence such as gum and patch nicotine replacement products, and other smoking cessation products such as NicoBloc or Zyban. The FDA has granted priority review, implying an approval decision within six months, to Pfizer and its product Varenicline, 12 which is a smoking cessation pill containing a product that binds to brain nicotine receptors and is intended to satisfy nicotine cravings without being pleasurable or addictive, and Acomplia, a Sanofi– Synthelabo product, is mainly a weight reduction pill, but also contributes to smoking cessation. Three companies are also seeking FDA approval for vaccines to prevent and treat nicotine addiction. One of these companies, Cytos Biotechnology AG, announced on May 14, 2005 that it had successfully completed Phase II testing of a virus–based vaccine, which is genetically engineered to cause an immune system response from nicotine. The company now plans to begin Phase III trials. Nabi Biopharmaceuticals has been in Phase II clinical trials for NicVAX, a vaccine to prevent and treat nicotine addiction. It triggers antibodies that bind with Nicotine molecules. On March 9, 2006, NicVAX received Fast Track Designation from the FDA, which is intended to expedite its review process. The Xenova Group is set to begin Phase II testing of its similar vaccine, Ta-Nic. One NPM has also introduced a cigarette with reportedly little or no nicotine. Future FDA regulation could also include regulation of nicotine content in cigarettes to non–addictive levels. Such new products or similar products, if successful, or such FDA regulation, if enacted, could have a material adverse effect on cigarette consumption. A decline in the overall consumption of cigarettes beyond the levels forecasted in the Global Insight Consumption Report could have a material adverse effect on the payments by PMs under the MSA and the amounts of TSRs available to the Corporation to make Turbo Redemptions and pay the Accreted Value of the Series 2006 Bonds due thereon. Regulatory Restrictions and Legislative Initiatives. The tobacco industry is subject to a wide range of laws and regulations regarding the marketing, sale, taxation and use of tobacco products imposed by local, state, federal and foreign governments. Various state governments have adopted or are considering, among other things, legislation and regulations that would increase their excise taxes on cigarettes, restrict displays and advertising of tobacco products, establish ignition propensity standards for cigarettes, raise the minimum age to possess or purchase tobacco products, ban the sale of “flavored” cigarette brands, require the disclosure of ingredients used in the manufacture of tobacco products, impose restrictions on smoking in public and private areas, restrict the sale of tobacco products directly to consumers or other unlicensed recipients, including over the Internet and charging state employees who smoke higher health insurance premiums than non-smoking state employees. For example, on January 26, 2006, the California Environmental Protection Agency Air Resources Board declared environmental tobacco smoke as a toxic air contaminant. Five states, Alabama, Georgia, Idaho, Kentucky and West Virginia, charge higher health insurance premiums to smokers than non-smokers, and a number of states have implemented legislation that allows employers to provide incentives to employees who do not smoke. In addition, the U.S. Congress may consider legislation further increasing the federal excise tax, regulation of cigarette manufacturing and sale by the FDA, amendments to the Federal Cigarette Labeling and Advertising Act to require additional warnings, reduction or elimination of the tax deductibility of advertising expenses, implementation of a national standard for “fire–safe” cigarettes, regulation of the retail sale of cigarettes over the Internet and in other non–face–to–face retail transactions, such as by mail order and telephone, and banning the delivery of cigarettes by the U.S. Postal Service. In March 2005, for example, bipartisan legislation was reintroduced in the U.S. Congress which would provide the FDA with broad authority to regulate tobacco products. Philip Morris has indicated its strong support for this legislation. FDA regulation could also include regulation of nicotine content in cigarettes to non– addictive levels. Cigarettes are also currently subject to substantial excise taxes in the United States. The federal excise tax per pack of 20 cigarettes is currently $0.39. All states, the District of Columbia and the Commonwealth of Puerto Rico currently impose taxes at levels ranging from $0.07 per pack in South Carolina to $2.46 per pack in Rhode Island. In addition, certain municipalities also impose an excise tax on cigarettes ranging up to $1.50 per pack in New York City and $2.00 per pack in Cook County, Illinois, 13 which includes Chicago. According to the Global Insight Consumption Report, excise tax increases were enacted in 20 states and in New York City in 2002, in 13 states in 2003, in 11 states in 2004, and in 8 states in 2005. The average state excise tax as of February 10, 2006 was $0.917 per pack. Currently, at least ten states are considering proposed excise tax increases, including a $1.00 per pack increase outside of New York City and a $0.50 per pack increase within New York City in a budget proposal by the Governor of the State of New York. An additional $2.60 per pack tax on cigarettes is being proposed for the November 2006 ballot in California. If such proposed increase becomes effective, California would have the nation’s highest cigarette tax. According to the Global Insight Consumption Report, all of the states and the District of Columbia now require smoke–free indoor air to some degree or in some public places. The most comprehensive bans have been enacted since 1998 in ten states and a few large cities. On March 26, 2003, New York State enacted legislation banning smoking in indoor workplaces, including restaurants and bars. Delaware had banned smoking in all indoor public areas in 2002. California imposed a comprehensive statewide smoking ban in 1998. Also in 2003, Connecticut, Maine, and Florida passed laws which ban smoking in restaurants and bars. Similarly comprehensive bans took effect in March 2003 in New York City and Dallas and in Boston in May 2003. Since then Massachusetts, Montana, Rhode Island, and Vermont have established similar bans. Effective July 1, 2005, California banned smoking in its prisons. Voters in Washington State passed a ballot initiative in November 2005 which bans smoking in all public places effective January 2006. The restrictions are stronger than those in other states as they include a ban on outdoor smoking within 25 feet of the entrances of restaurants and other public places. In January 2006, New Jersey adopted a comprehensive ban which will go into effect in April 2006. At the same time New Jersey increased the minimum legal age to purchase cigarettes from 18 to 19 years. Three states, Alabama, Alaska, and Utah, also set the minimum age at 19. In December 2005 Chicago passed a smoking ban which also applies within 15 feet of entrances to restaurants and public places. It went into effect in January 2006, with an exemption for bars until July 2008. In January 2006, the District of Columbia enacted an extensive ban which will be fully in effect in January 2007. In March 2006, Colorado, Utah and Puerto Rico enacted similar legislation. On March 17, 2006, Calabasas, California became the first city in the United States to ban smoking in virtually all public places, including outdoor spaces. It is expected that these restrictions will continue to proliferate. Currently, at least four states, Alabama, Arkansas, Iowa, and New Hampshire, are considering comprehensive bans. On January 26, 2006, the California Environmental Protection Agency Air Resources Board declared environmental tobacco smoke to be a toxic air contaminant. The American Nonsmokers’ Rights Foundation documents clean indoor air ordinances by local governments throughout the U.S. As of January 3, 2006, there were 2,129 municipalities in the U.S. with indoor smoking restrictions. The attorneys general of the Settling States recently obtained agreements from Philip Morris, Reynolds Tobacco and B&W that they will remove product advertisements from various magazines that are circulated in schools for educational purposes. No assurance can be given that future federal or state legislation or administrative regulations will not seek to further regulate, restrict or discourage the manufacture, sale and use of cigarettes. Excise tax increases and other legislative or regulatory measures could severely increase the cost of cigarettes, limit or prohibit the sale of cigarettes, make cigarettes less appealing to smokers or reduce the addictive qualities of cigarettes. As a result of these types of initiatives and other measures, the overall consumption of cigarettes nationwide may decrease materially more than forecasted in the Global Insight Consumption Report and thereby have a material adverse effect on the amounts available to pay the Accreted Value of the Series 2006 Bonds. See “TOBACCO INDUSTRY – Regulatory Issues” herein. 14 Other Potential Payment Decreases Under the Terms of the MSA Adjustments to MSA Payments. The MSA provides that the amounts payable by the PMs are subject to numerous adjustments, offsets and recalculations, some of which may be material. Such adjustments, offsets and recalculations could reduce the TSRs available to the Corporation below the respective amounts required to pay the Accreted Value of the Series 2006 Bonds. Both the Settling States and one or more of the PMs are disputing or have disputed the calculations of some of the Initial Payments for the years 2000 through 2003 and the Annual Payments for the years 2000 through 2005. No assurance can be given as to the magnitude of the adjustments that may result upon resolution of those disputes. Any such adjustments could trigger the Offset for Miscalculated or Disputed Payments. For additional information regarding the MSA and the payment adjustments, see “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT” herein. The assumptions used to project Collections (the source of the payments on the Series 2006 Bonds) are based on the premise that certain adjustments will occur as set forth under “METHODOLOGY AND BOND STRUCTURING ASSUMPTIONS” herein. Actual adjustments could be materially different from what has been assumed and described herein. Growth of NPM Market Share and Other Factors. The assumptions used to project Collections and structure the Series 2006 Bonds contemplate declining consumption of cigarettes in the United States combined with a static relative market share of 6.2%.*Ҙ for the NPMs. See “METHODOLOGY AND BOND STRUCTURING ASSUMPTIONS” herein. Should the forecasted decline in consumption occur, but be accompanied by a material increase in the relative aggregate market share of the NPMs, shipments by PMs would decline at a rate greater than the decline in consumption. This would result in greater reductions of Annual Payments and Strategic Contribution Payments by the PMs due to application of the Volume Adjustment, even for Settling States (including the Virgin Islands) that have adopted enforceable Qualifying Statutes and are diligently enforcing such statutes and are thus exempt from the NPM Adjustment. One NPM has introduced a cigarette with reportedly no nicotine. Sales of this NPM’s product could capture market share, causing a reduction in Annual Payments and Strategic Contribution Payments. In addition, if consumers used the product to quit smoking, it could reduce the size of the cigarette market. The capital costs required to establish a profitable cigarette manufacturing facility are relatively low and new cigarette manufacturers, whether SPMs or NPMs, are less likely than OPMs to be subject to frequent litigation. The Model Statute in its original form had required each NPM to make escrow deposits approximately in the amount that the NPM would have had to pay had it been a PM, but entitled the NPM to a release, from each Settling State in which the NPM had made an escrow deposit, of the amount by which the escrow deposit exceeds that Settling State’s allocable share of the total payments that the NPM would have been required to make had it been a PM. At least 44 Settling States have enacted, and other states are considering, legislation that amends this provision in their Model/Qualifying Statutes, by eliminating the reference to the allocable share and limiting the possible release an NPM may obtain to the excess above the total payment that the NPM would have paid had it been a PM (so called “Allocable Share Release Legislation”). The National Association of Attorneys General (“NAAG”) has endorsed these legislative efforts. A majority of the PMs, including all OPMs, have indicated their agreement in writing that in the event a Settling State enacts legislation substantially in the form of the Allocable Share Release Legislation, such Settling State’s previously enacted Model Statute or Qualifying Statute will continue to constitute a Model Statute or Qualifying Statute within the meaning of the MSA. Legislation * The aggregate market share of NPMs utilized in the Collection Methodology and Assumptions may differ materially from the market share information utilized by the MSA Auditor when calculating the NPM adjustments. 15 to enact the Complementary Legislation and the Allocable Share Release Legislation is being prepared for introduction by the Governor to the Virgin Islands Legislature, but has not been adopted. No assurance can be made that such legislation will be introduced, or if introduced, that it will be adopted. According to the Virgin Islands Bureau of Internal Revenue, no NPMs currently sell cigarettes in the Virgin Islands. The Bureau of Internal Revenue receives and reviews monthly filings listing the brands of cigarettes sold by the two cigarette wholesalers in the Virgin Islands, as well as excise invoices filed by excise agents in the Virgin Islands listing the brands of cigarettes on which excise taxes are collected at the port of entry into the Virgin Islands. None of the cigarette brands listed on such reports and invoices are manufactured by NPMs. As long as no NPMs sell cigarettes in the Virgin Islands, such legislation is not necessary to ensure that NPMs make the required escrow payments under the Virgin Islands’ Qualifying Statute. Following the challenge by NPMs in Freedom Holdings, the U.S. District Court for the Southern District of New York in September 2004 enjoined New York from enforcing its Allocable Share Release Legislation. NPMs are also currently challenging Allocable Share Release Legislation in Arkansas, California, Kansas, Kentucky, Louisiana, Oklahoma and Tennessee. It is possible that NPMs will challenge such legislation in other jurisdictions. See “ –Litigation Challenging the MSA, the Qualifying Statutes and Related Legislation” herein. To the extent either that (i) other jurisdictions do not enact or enforce Allocable Share Release Legislation or (ii) a jurisdiction’s Allocable Share Release Legislation is invalidated, NPMs could concentrate sales in such jurisdictions to take advantage of the absence of Allocable Share Release Legislation by limiting the amount of its escrow payment obligations to only a fraction of the payment it would have been required to make had it been a PM. Because the price of cigarettes affects consumption, NPM cost advantage is one of the factors that has resulted and could continue to result in increases in market share for the NPMs. A significant loss of market share by PMs to NPMs could have a material adverse effect on the payments by PMs under the MSA and the amounts of TSRs available to pay principal and Accreted Value of, as applicable, on the Series 2006 Bonds. See “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT – Adjustments to Payments” and “GLOBAL INSIGHT CONSUMPTION REPORT” herein. NPM Adjustment. The NPM Adjustment, measured by domestic sales of cigarettes by NPMs, operates to reduce the payments of the PMs under the MSA in the event that the PMs incur losses in market share to NPMs during a calendar year as a result of the MSA. Three conditions must be met in order to trigger an NPM Adjustment for one or more Settling States: (1) the aggregate market share of the PMs in any year must fall more than 2% below the aggregate market share held by those same PMs in 1997 (a condition that has existed for every year since 2000), (2) a nationally recognized firm of economic consultants must determine that the disadvantages experienced as a result of the provisions of the MSA were a significant factor contributing to the market share loss for the year in question, and (3) the Settling States in question must be proven to not have diligently enforced their Model Statutes.* In May 2004 the Settling States and the PMs selected The Brattle Group as the firm of economic consultants that will be responsible for making the “significant factor” determination. The NPM Adjustment is applied to the subsequent year’s Annual Payment and Strategic Contribution Payment and the decrease in total funds available as a result of the NPM Adjustment is then allocated on a Pro Rata basis among those Settling States that have been found (i) to have not diligently enforced their Model Statutes, or (ii) to have enacted a Model Statute or Qualifying Statute that is * The NPM Adjustment does not apply at all if the number of cigarettes shipped in or to the U.S. in the year prior to the year in which the payment is due by all manufacturers that were PMs prior to December 7, 1998 exceeds the number of cigarettes shipped in or to the U.S. by all such PMs in 1997. 16 declared invalid or unenforceable by a court of competent jurisdiction. The 1997 market share percentage for the PMs, less 2%, is defined in the MSA as the “Base Aggregate Participating Manufacturer Market Share.” If the PMs’ actual aggregate market share is between 0% and 16Ҁ% less than the Base Aggregate Participating Manufacturer Market Share, the amounts paid by the PMs would be decreased by three times the percentage decrease in the PMs’ actual aggregate market share. If, however, the aggregate market share loss from the Base Aggregate Participating Manufacturer Market Share is greater than 16Ҁ%, the NPM Adjustment will be calculated as follows: NPM Adjustment = 50% + [50%/(Base Aggregate Participating Manufacturer Market Share – 16Ҁ%)] x [market share loss – 16Ҁ%] The MSA further provides however, that in no event shall the amount of an NPM Adjustment applied to any Settling State in any given year exceed the amount of Annual and Strategic Contribution Payments to be received by such Settling State in such year. For a more detailed description of the NPM Adjustment, including limitations on the amount of adjustment in certain cases, see “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT – Adjustments to Payments – Non-Participating Manufacturers Adjustment” herein. In June 2003, the OPMs and the Settling States settled all NPM Adjustment claims for the years 1999 through 2002, subject, however, under limited circumstances, to the reinstatement of an OPM’s right to an NPM Adjustment for the years 2001 and 2002. In connection therewith, the OPMs and the Settling States agreed prospectively that OPMs claiming an NPM Adjustment for any year after 2002 will not make a Disputed Payments Account deposit or withholding unless and until the selected economic consultants, The Brattle Group, determine that the disadvantages of the MSA were a significant factor contributing to the market share loss giving rise to the alleged NPM Adjustment. (The SPMs did not agree to await such a determination.) If any SPM alleges, in any given year, that (1) the aggregate market share of the PMs in such year fell more than 2% below its aggregate market in 1997, (2) disadvantages experienced as a result of the provisions of the MSA were significant factors contributing to such market share loss and (3) one or more of the Settling States did not diligently enforce the Qualifying Statute, such SPM may claim the NPM Adjustment for such year and either make an appropriate deposit into the Disputed Payments Account or withhold payment. The Virgin Islands has indicated that the 2005 Annual Payments by the OPMs were made without the diversion of any portion thereof into the Disputed Payments Account for the Settling States. According to the Virgin Islands, however, eleven SPMs did pay approximately $84 million of their 2005 Annual Payments into the Disputed Payments Account for the Settling States as a result of alleged disputes, including disputes related to NPM Adjustments. Of this $84 million, approximately $44 million represented payments by six SPMs related to 2003 Annual Payments that were made by such SPMs. Following litigation alleging that such actions were improper, the six SPMs released such $44 million to the Settling States. Such release of money, however, does not represent final settlement of any alleged disputes. In addition, more than $18 million due from various SPMs was not paid on April 15, 2005. The Virgin Islands has not reported having received any indication from the PMs whether or not they currently plan to pay or not pay future Annual Payments into the Disputed Payments Account or whether or not they expect to withhold payment. However, on March 17, 2006, Vector Group Ltd., the parent of Liggett, filed its Form 10-K for the year ended December 31, 2005. In the filing, Liggett stated that it intends to withhold $1.6 million from its April 2006 MSA payment as a claimed NPM Adjustment to its 2005 payment obligation. In March 2006, the Brattle Group issued its preliminary finding that the MSA was a significant factor contributing to the Market Share Loss of the PMs for calendar year 2003. The preliminary 17 determination was challenged by the Settling States and additional arguments and information, including the decision of the Supreme Court of New York described below, were submitted to The Brattle Group for consideration in connection with its final decision. The Settling States contended that the disadvantages experienced as a result of the provisions of the MSA were not a “significant factor” contributing to the Market Share Loss for calendar year 2003. On March 6, 2006, the State of New York filed a Motion in the Supreme Court of New York, New York County, for Declaratory Order Construing Terms of the MSA. The motion asserted that The Brattle Group’s initial determination was legally incorrect because it applied its “significant factor” analysis to the OPMs’ total market share loss from 1997 through 2003 (7.95%), rather than to the “Market Share Loss”, which, the State of New York maintains, is defined for the purposes of the MSA as the decline in market share for the applicable period minus 2 percent (i.e., 5.95%). The New York court, exercising continuing jurisdiction over the MSA in the state, issued its order on March 13, 2006, directing that The Brattle Group undertake its significant factor determination only after considering the extent of the impact of MSA-related loss on market share loss after first excluding two percent from any MSA- related loss, if found. On March 27, 2006, the Brattle Group announced its final determination that the MSA was a significant factor contributing to the Market Share Loss of the PMs for calendar year 2003. If the OPMs claim an NPM Adjustment for 2003, such OPMs may either make an appropriate deposit into the Disputed Payments Account or withhold payment reflecting the claimed NPM Adjustment. Prior to the announcement of the Brattle Group’s final determination, each of the three OPMs notified the Settling States that, in connection with the market share loss for calendar year 2003, it is seeking an NPM Adjustment. The OPMs are requesting the Independent Auditor for the MSA to reduce its calculation of the expected 2006 payment by $1.14 billion plus interest to account for the NPM Adjustment for calendar year 2003. There can be no assurance as to the amount of any NPM Adjustment or the corresponding reduction in TSRs payable to the Settling States. On March 31, 2006, Philip Morris made its full 2006 Annual Payment of $3.4 billion. Philip Morris has stated that it intends to continue to negotiate with the Settling States’ Attorneys General for a reduction in its payment to reflect its market share loss due to its participation in the MSA. Also on March 31, 2006, Reynolds American paid a portion of its 2006 Annual Payment. Neither Reynolds American nor Lorillard have announced whether or not they will pay the full amount of their respective shares of the 2006 Annual Payment. In the event the OPMs and/or the SPMs make a deposit to the Disputed Payments Account or claim a NPM Adjustment and withhold a portion of the 2006 payment, such actions could have a materially adverse impact on the available amount of TSRs. The Settling States have reserved the right to commence an enforcement action for compliance with the MSA. It has been reported that a majority of the Settling States have sent a notice to the PMs of their intent to commence such an action, including an action seeking a declaratory order that regardless of the “significant factor” determination, the PMs are not entitled to an NPM adjustment because they have been diligently enforcing their Qualifying Statute. The Virgin Islands has not decided whether or not to send such a notice, but reserves its right to commence an enforcement action for compliance with the MSA. Even if commenced prior to April 17, 2006, no such actions could be resolved with finality before then. The next payment due, assuming no NPM adjustment, has been reported to be approximately $6.5 billion and is due on April 17, 2006. 18 The MSA provides that the NPM Adjustment is to be applied against those Settling States that (i) have not diligently enforced their Model Statutes or (ii) have enacted a Model Statute that is declared invalid or unenforceable by a court of competent jurisdiction.* The Virgin Islands Bureau of Internal Revenue requires each cigarette wholesaler located within the Virgin Islands to make a monthly filing listing the brands of cigarettes being sold by such wholesalers in the territory. According to such filings there are no NPMs selling cigarettes in the Virgin Islands. The Virgin Islands has adopted the Model Statute (which is a Qualifying Statute under the MSA). No provision of the MSA attempts to define what activities, if undertaken by a Settling State, would constitute diligent enforcement. Furthermore, the MSA does not explicitly state which party bears the burden of proving or disproving whether a Settling State has diligently enforced its Qualifying Statute or whether any diligent enforcement dispute would be resolved in state courts or through arbitration. On August 3, 2005, a Connecticut state court ruled that certain issues relating to the calculation of an NPM Adjustment are subject to arbitration pursuant to the terms of the MSA. See State of Connecticut v. Philip Morris, Inc. The case involved a claim by certain SPMs that the MSA Auditor, selected by the parties to the MSA to determine payments under the MSA, miscalculated their Annual Payments for shipment year 2003 by refusing to reduce the amounts by applying the NPM Adjustment. In the decision, the court held that a challenge to the MSA Auditor’s determination that the MSA forbids the application of the NPM Adjustment to payments owed by PMs for any year in which all Settling States had Qualifying Statutes in full force and effect is subject to arbitration. The MSA provides that the arbitration shall be governed by the U.S. Federal Arbitration Act. The decision of an arbitration panel under the Federal Arbitration Act may only be overturned under limited circumstances, including a showing of a manifest disregard of the law by the panel. The Connecticut court’s determination is contrary to the determination by a New York State trial court that concluded that such issues were not subject to arbitration under the MSA. See The State of New York v. Philip Morris Incorporated. The Connecticut court’s decision has been appealed by the State of Connecticut. The New York Court’s decision was reversed on April 6, 2006, by the Appellate Division, First Department, of the Supreme Court of New York (the “Appellate Division)”. The Appellate Division ruled that the MSA Auditor’s decision not to apply the NPM adjustment, and the dispute over whether that adjustment should have been applied, is “a proper subject for arbitration pursuant to the plain terms of the MSA.” The Appellate Division then ordered that the motion to compel arbitration be granted. It has been reported that the defendants in the New York case are considering an appeal of the Appellate Division’s decision. Neither decision ruled on whether or not a diligent enforcement dispute itself would be resolved in state courts or through arbitration. Regardless of the forum in which a diligent enforcement dispute is heard, however, no assurance can be given as to how long it will take to resolve such a dispute with finality. The Attorneys General of the Settling States, including the Virgin Islands, believe that the court in each Settling State that retains continuing jurisdiction over the MSA should make the determination as to diligent enforcement of such state’s Qualifying Statute. In January 2002, B&W disputed the recalculation of the Annual Payments due in 2000 and 2001, claiming that the MSA Auditor relied upon inappropriate data in calculating B&W’s market share and that a larger NPM Adjustment should have been applied to the 2001 payment because a majority of the Settling States were not diligently enforcing their Qualifying Statutes in 2000. Although this dispute was resolved in April 2002, other disputes regarding the diligent enforcement of Qualifying Statutes by the Settling States may be expected in the future if the market share of the NPMs is sufficiently large so that, absent the protection of the Qualifying Statutes, the NPM Adjustment could apply. * If a court of competent jurisdiction declares a Settling State’s Model Statute to be invalid or unenforceable, then the NPM Adjustment for such state is limited to no more, on an annual basis, than 65% of the amount of such state’s allocated payment. 19 In February 2002, B&W sent a letter addressed to the Settling States requesting information relating to the enforcement of their applicable Qualifying Statute. In November 2003, six SPMs sent a letter to NAAG and the Attorneys General of the Settling States, which is intended to provide notice that such SPMs may initiate litigation or arbitration proceedings relating to the MSA. The MSA requires a party to provide at least 30 days’ prior written notice to the other parties before initiating a proceeding to enforce the MSA or alleging breaches of the MSA. Among other things, such SPMs alleged that the NPM Adjustment is not working as designed to ensure that SPMs are not penalized by becoming signatories to the MSA. They also alleged that the Market Share Loss recorded by the MSA Auditor is significantly smaller than the Market Share Loss that actually exists and that the Model Statute has not been diligently enforced or that, in states where it is diligently enforced, does not contain efficient and effective enforcement mechanisms. The SPMs specifically request in their letter to continue to discuss possible resolution of these issues with the other parties to the MSA. The letter does not specify what type of relief would be sought in any litigation or arbitration proceedings. It has been reported that in March 2005, the OPMs filed a Freedom of Information Act request with a number of the Settling States seeking information pertaining to their efforts to identify NPMs and to enforce their Qualifying Statutes. The Virgin Islands has not reported receiving a similar request. In addition, at least 44 Settling States have passed, and various Settling States are considering, legislation (often termed “Complementary Legislation”) to further ensure that NPMs are making required escrow payments under the Qualifying Statutes. Under the Complementary Legislation, every tobacco product manufacturer whose cigarettes are sold, directly or indirectly, in a jurisdiction is required to certify annually that it is either a PM or NPM that it is in full compliance with the jurisdiction’s Qualifying Statute. The Attorney General is required to maintain a directory listing all tobacco product manufacturers that have filed current and accurate certifications. No person may sell, offer or possess for sale in the jurisdiction cigarettes of a tobacco product manufacturer not included in the then current directory. Any cigarettes that have been sold, offered for sale or possessed in the jurisdiction in violation of the jurisdiction’s Complementary Legislation shall be deemed contraband and subject to confiscation and forfeiture. Legislation to enact the Complementary Legislation and the Allocable Share Release Legislation is being prepared for introduction by the Governor to the Virgin Islands Legislature, but has not been adopted. No assurance can be made that such legislation will be introduced, or if introduced, that it will be adopted. According to the Virgin Islands Bureau of Internal Revenue, no NPMs currently sell cigarettes in the Virgin Islands. The Bureau of Internal Revenue receives and reviews monthly filings listing the brands of cigarettes sold by the two cigarette wholesalers in the Virgin Islands, as well as excise invoices filed by excise agents in the Virgin Islands listing the brands of cigarettes on which excise taxes are collected at the port of entry into the Virgin Islands. None of the cigarette brands listed on such reports and invoices are manufactured by NPMs. As long as no NPMs sell cigarettes in the Virgin Islands, such legislation is not necessary to ensure that NPMs make the required escrow payments under the Virgin Islands’ Qualifying Statute. All of the OPMs and other PMs have provided written assurances that the Settling States have no duty to enact Complementary Legislation, that the failure to enact such a legislation will not be used in determining whether a state has diligently enforced its Qualifying Statute pursuant to the terms of the MSA, and that the diligent enforcement obligations under the MSA shall not apply to the Complementary Legislation. In addition, the written assurances contain an agreement that the Complementary Legislation shall not constitute an amendment to a Settling State’s Qualifying Statute. However, a determination that a state’s Complementary Legislation is invalid may make enforcement of its Qualifying Statute more difficult, which could lead to an increase in the market share of NPMs, resulting in a reduction of Annual Payments under the MSA. The Qualifying Statute and Complementary Legislation has been challenged in a federal district court in New York by certain NPMs on constitutional grounds (including allegations that the Complementary Legislation is preempted by federal antitrust laws). See “íLitigation Challenging the MSA, Qualifying Statutes and Related Legislation í Grand River, Freedom Holdings and Related Cases” 20 herein. See “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT – MSA Provisions Related to Model/Qualifying Statutes” and “SUMMARIES OF CERTAIN PROVISIONS OF THE TRANSACTION DOCUMENTS—The Indenture—Affirmative Covenants” herein. Future NPM Adjustment claims remain possible for calendar years 2004, 2005 and all future years. The Brattle Group has not made any preliminary or final “significant factor” determination for any year other than 2003. In addition, the “diligent enforcement” exemption afforded a Settling State is based on actual enforcement efforts for the calendar year preceding each Annual Payment, and could be disputed by a PM even after the final resolution of a diligent enforcement dispute related to a prior year. If the other preconditions to an NPM Adjustment exist for a given year, disputes regarding diligent enforcement for such year may be expected if the market share of the NPMs results in an NPM Adjustment that, absent the protection of the Qualifying Statutes, would apply. Although a Settling State that diligently enforces its Qualifying Statute is exempt from the NPM Adjustment, many procedural uncertainties, as described above, still remain regarding the resolution of a dispute regarding diligent enforcement. In addition, the resolution of the substance of such a dispute could take years. A decision by the PMs to pay the amount of a claimed NPM Adjustment into the Disputed Payments Account or to withhold payments of such an amount pending the resolution of the dispute could have a material adverse effect on the amounts of TSRs available to the Corporation to make Turbo Redemptions and pay the Accreted Value of the Series 2006 Bonds. Should a PM be determined with finality to be entitled to an NPM Adjustment in a future year due to non-diligent enforcement of the Qualifying Statute by the Virgin Islands, the NPM Adjustment could reduce the payments by the PMs under the MSA and the amounts of TSRs available to the Corporation to make Turbo Redemptions on the Series 2001 Bonds and the Series 2006 Bonds, and pay the Accreted Value of the Series 2006 Bonds. In such a situation the estimated redemption schedule for the Series 2001 Bonds described herein under “METHODOLOGY AND BOND STRUCTURING ASSUMPTIONS” and the estimated redemption schedules set forth under Appendix G—“DEFEASANCE TURBO SCHEDULES” attached hereto may not be realized. See “Disputed or Recalculated Payments” below. The structuring assumptions for the Series 2006 Bonds do not include any NPM Adjustments. See “METHODOLOGY AND BOND STRUCTURING ASSUMPTIONS” herein. Disputed or Recalculated Payments. Miscalculations or recalculations by the MSA Auditor or disputed calculations by any of the parties to the MSA, such as those described above under “–NPM Adjustment”, have resulted and could in the future result in offsets to, or delays in disbursements of, payments to the Settling States pending resolution of the disputed item in accordance with the provisions of the MSA. By way of example, on August 30, 2004, one of the SPMs announced that it had notified the attorneys general of 46 states that it intends to initiate proceedings against the attorneys general for violating the terms of the MSA. It alleges that the attorneys general violated its rights and the MSA by extending unauthorized favorable financial terms to Miami–based Vibo Corporation d/b/a General Tobacco when, on August 19, 2004, the attorneys general entered into an agreement with General Tobacco allowing it to become an SPM. General Tobacco imports discount cigarettes manufactured in Colombia, South America. In the notice sent to the attorneys general, the SPM indicated that it will seek to enforce the terms of the MSA, void the General Tobacco Agreement and enjoin the Settling States and NAAG from listing General Tobacco as a PM on their websites. On August 18, 2005, the SPM that sent the notice and an additional four SPMs filed a motion to enforce the MSA in Kentucky. The Commonwealth of Kentucky filed its opposition and the SPMs replied. General Tobacco intervened in the case and filed its opposition to the other SPMs’ motion. The SPMs replied and a hearing was held on the issue on November 8, 2005. It was reported on January 31, 2006 that the court upheld the agreement by which General Tobacco became an SPM. 21 Disputes concerning payments and their calculations may be raised up to four years after the respective Payment Due Date (as defined in the MSA). The resolution of disputed payments may result in the application of an offset against subsequent Annual Payments or Strategic Contribution Payments. Both the diversion of disputed payments to the Disputed Payments Account and the application of offsets against future payments could materially impair the flow of TSRs available to the Corporation to make Turbo Redemptions and pay the Accreted Value on the Series 2006 Bonds. The structuring assumptions for the Series 2006 Bonds do not factor in an offset for miscalculated or disputed payments. The structuring assumptions for the Series 2006 Bonds do not factor in an offset for miscalculated or disputed payments. In such a situation the estimated redemption schedule for the Series 2001 Bonds set forth herein under “METHODOLOGY AND BOND STRUCTURING ASSUMPTIONS” and the estimated redemption schedules set forth under Appendix G—“DEFEASANCE TURBO SCHEDULES” attached hereto may not be realized. See “Disputed or Recalculated Payments” above. The structuring assumptions for the Series 2006 Bonds do not include any NPM Adjustments. See “METHODOLOGY AND BOND STRUCTURING ASSUMPTIONS” herein and “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT – Adjustments to Payments – Offset for Miscalculated or Disputed Payments” herein. Other Disputes Arising Under the MSA. On June 3, 2005, California filed an application in San Diego County Superior Court for an enforcement order against Bekenton USA, Inc. (“Bekenton”), to compel Bekenton to comply with its full payment obligations under the MSA. On June 29, 2005, Bekenton filed a motion to file a suit against California, alleging that California breached the Most Favored Nation (“MFN”) provisions of the MSA by allowing three other SPMs (Farmer’s Tobacco Co., General Tobacco, and Premier Manufacturing Incorporated) to join the MSA under more favorable terms. In a tentative ruling dated November 1, 2005, the Superior Court granted Bekenton’s motion to file suit based on this allegation. In its initial complaint, Bekenton had further alleged that (a) California’s agreements with Farmer’s Tobacco, General Tobacco and Premier (the “Three Agreements”), which required these companies to make certain back payments (as required by the MSA) as a precondition to joining the MSA, permitted such back payments to be made on an extended time frame and (b) this time frame effectively “relieved” Farmer’s Tobacco, General Tobacco and Premier of certain payment obligations as PMs. Bekenton claimed that it was entitled to a similar relief under another clause of the MFN (the “Relief Clause”), which requires that if any PM is relieved of a payment obligation, such relief becomes applicable to all of the PMs. In the November 1, 2005, tentative ruling, the Superior Court denied Bekenton’s motion to file suit under the Relief Clause, ruling that (1) because the Three Agreements were preconditions to allowing Farmer’s Tobacco, General Tobacco and Premier to become PMs, these companies were not “PMs” for purposes of the Relief Clause and (2) even if Farmer’s Tobacco, General Tobacco and Premier are PMs for purposes of the Relief Clause, the payment schedules in the Three Agreements did not relieve them of any obligations. Bekenton is involved in a similar dispute in Iowa. In that case, the State of Iowa sought to de–list Bekenton as a PM for failing to comply with the MSA payment provisions and to prohibit Bekenton from doing business in Iowa for failing to comply with the escrow payment provisions of the Iowa Qualifying Statute. On August 11, 2005 an Iowa state court, finding that the MSA itself provides procedures for the resolution of disputes regarding MSA payments and that such procedures should be followed in this case, enjoined Iowa from “de–listing” Bekenton, permitting Bekenton to continue selling cigarettes in Iowa. In 2005, Bekenton filed for bankruptcy relief. “Nicotine–Free” Cigarettes. The MSA contemplates that the manufacturers of cigarettes will be either a PM or an NPM. The term “cigarette” is defined in the MSA to mean any product that contains tobacco and nicotine, is intended to be burned and is likely to be offered to, or purchased by, consumers as a cigarette and includes “roll–your–own” tobacco. Should a manufacturer develop a “nicotine–free” 22 tobacco product (intended to be burned and is likely to be offered to, or purchased by, consumers as a cigarette), such manufacturer would not be a manufacturer for purposes of the MSA. Sales of such a product could cause a reduction in Annual Payments and Strategic Contribution Payments. In addition, if consumers used the product to quit smoking, it could reduce the size of the cigarette market. The capital costs required to establish a profitable cigarette manufacturing facility are relatively low and new cigarette manufacturers are less likely to be subject to frequent litigation than OPMs. Furthermore, the Qualifying Statutes would not cover a manufacturer of such “nicotine–free” products and such manufacturer would not be required to make escrow deposits in the same manner as the NPMs are so required. Vector Group has introduced QUEST, a tobacco product that is reportedly nicotine–free. Other Risks Relative to the MSA and Related Statutes Severability. Most of the major provisions of the MSA are not severable. If a court materially modifies, renders unenforceable or finds unlawful any nonseverable provision, the attorneys general of the Settling States and the OPMs are required by the MSA to attempt to negotiate substitute terms. However, if any OPM does not agree to the substitute terms, the MSA will terminate in all Settling States affected by the court’s ruling. See “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT– Severability.” Amendments, Waivers and Termination. As a settlement agreement between the PMs and the Settling States, the MSA is subject to amendment in accordance with its terms, and may be terminated upon consent of the parties thereto. Parties to the MSA, including the Virgin Islands, may waive the performance provisions of the MSA. The Corporation is not a party to the MSA; accordingly, the Corporation does not have the right to challenge any such amendment, waiver or termination of the MSA. While the economic interests of the Virgin Islands and the Bondholders will presumably be the same in many circumstances, no assurance can be given that such an amendment, waiver or termination of the MSA would not have a material adverse effect on the Bondholders. See “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT–Amendments and Waivers.” Reliance on State Enforcement of the MSA and State Impairment. The Virgin Islands may not convey and has not conveyed to the Corporation or the Bondholders any right to enforce the terms of the MSA. Pursuant to its terms, the MSA, as it relates to the Virgin Islands, can only be enforced by the Virgin Islands. Pursuant to the Purchase Agreement, the Virgin Islands has covenanted to enforce the MSA; however, no assurance can be given that the Virgin Islands will enforce any particular provision of the MSA. Failure to do so may have a material adverse effect on the Bondholders. Pursuant to the Act, the Purchase Agreement and the Indenture, the Corporation has, in the opinion of Transaction Counsel, validly included the pledge and agreement of the Virgin Islands not to limit or alter the rights of the Corporation to fulfill the terms of the Purchase Agreement and the Indenture or impair the rights and remedies of the Bondholders. See “LEGAL CONSIDERATIONS.” Bankruptcy of PMs May Delay, Reduce or Eliminate Payments The only source of payment for the Series 2006 Bonds is the TSRs that are paid by the PMs. Therefore, if one or more PMs were to become a debtor in a case under Title 11 of the United States Code (the “Bankruptcy Code”), there could be delays in or reductions or elimination of payments on the Series 2006 Bonds, and Bondholders and Beneficial Owners of the Series 2006 Bonds could incur losses on their investments. Philip Morris, by way of example, prior to the resolution of the dispute in the Price case in Illinois in the spring of 2003 over the size of the required appeal bond, had publicly stated that it would not have been possible for it to post the $12 billion bond initially ordered by the trial judge. Philip Morris also publicly stated at that time that there was a risk that immediate enforcement of the judgment would force a bankruptcy. In addition, on May 13, 2003, Alliance Tobacco Corporation, one of the 23 SPMs, filed for bankruptcy in the Western District of Kentucky and, in September 2004, its plan of reorganization was confirmed. As part of the confirmed plan, Alliance Tobacco Corporation effectively ceased its operations in September 2004. Bekenton has filed for bankruptcy relief. In the event of the bankruptcy of a PM, unless approval of the bankruptcy court is obtained, the automatic stay provisions of the Bankruptcy Code could prevent any action by the Virgin Islands, the Corporation, the Indenture Trustee, the Bondholders, or the Beneficial Owners of the Series 2006 Bonds to collect any TSRs or any other amounts owing by the bankrupt PM. In addition, even if the bankrupt PM wanted to continue paying TSRs, it could be prohibited as a matter of law from making such payments. In particular, if it were to be determined that the MSA was not an “executory contract” under the Bankruptcy Code, then the PM may be unable to make further payments of TSRs. If the MSA is determined in a bankruptcy case to be an “executory contract” under the Bankruptcy Code, the bankrupt PM may be able to repudiate the MSA and stop making payments under it. Furthermore, payments previously made to the Bondholders or the Beneficial Owners of the Series 2006 Bonds could be avoided as preferential payments, so that the Bondholders and the Beneficial Owners of the Series 2006 Bonds would be required to return such payments to the bankrupt PM. Also, the bankrupt PM may have the power to alter the terms of its payment obligations under the MSA without the consent, and even over the objection of the Virgin Islands, the Corporation, the Indenture Trustee, the Bondholders, or the Beneficial Owners of the Series 2006 Bonds. Finally, while there are provisions of the MSA that purport to deal with the situation when a PM goes into bankruptcy, such provisions may be unenforceable. There may be other possible effects of a bankruptcy of a PM that could result in delays or reductions or elimination of payments to the Bondholders or the Beneficial Owners of the Series 2006 Bonds. For a further discussion of certain bankruptcy issues, see “LEGAL CONSIDERATIONS” herein. Uncertainty as to Timing of Turbo Redemptions No assurance can be given as to the timing of amortization of the Series 2006 Bonds. A certain level of payments due under the MSA has been forecast based on various assumptions, including among others, domestic cigarette consumption levels as set forth in the Global Insight Base Case Consumption Forecast and adjustments to the payments by the PMs as required by the terms of the MSA. These assumptions, which were used to schedule Principal and Accreted Value of the Series 2006 Bonds, as well as provide expectations of Turbo Redemptions of the Series 2006 Bonds from Collections are discussed in “METHODOLOGY AND BOND STRUCTURING ASSUMPTIONS.” Actual results could and likely will vary from such assumptions. Such variance could be material and could affect the level of payments due under the MSA. Any material reduction would impair the Collections available for Turbo Redemptions of the Series 2006 Bonds and extend the average life of the Series 2006 Bonds. On the other hand, material increases would generate more Collections for Turbo Redemptions and shorten the average life of the Series 2006 Bonds. In addition, future increases in the rate of inflation above 3% per annum could, in the absence of other factors, materially shorten the average lives of the Series 2006 Bonds. No assurance can be given that these assumptions will be realized. The ratings of the Series 2006 Bonds address the payment of the Accreted Value of the Series 2006 Bonds on their Maturity Date. Owners of the Series 2006 Bonds bear the reinvestment risk from faster than expected amortization, as well as the extension risk from slower than expected amortization of the Series 2006 Bonds. Subordinate Nature of the Series 2006 Bonds The Series 2006 Bonds are subordinated in right of payment and in lien priority to the Senior Bonds. Absolutely no payments will be made on the Series 2006 Bonds until the Crossover Date. The Crossover Date is the first date on which no Senior Bonds are outstanding. 24 The Crossover Date is not expected to occur prior to May 15, 2016*, and may occur substantially later. As a result, payments on the Series 2006 Bonds may not commence until substantially later than expected, thus potentially reducing the value of and the yield on the Series 2006 Bonds. In addition, prior to the Crossover Date, no default or event of default can exist or be declared under the Indenture or with respect to the Series 2006 Bonds, and the Indenture Trustee, the Bondholders, and the Beneficial Owners cannot exercise any right or remedy with respect to the Series 2006 Bonds or the Indenture. Thus, even if the Virgin Islands the Corporation, or any other person or entity fails to perform its obligations under the Indenture and the related documents, breaches its obligations under the Indenture or the related documents, or violates the law, or there is any other failure to comply with the Indenture, any related document, or any applicable law, there is absolutely nothing that the Indenture Trustee, the Bondholders, or the Beneficial Owners can do to prevent it. Prior to the Crossover Date, the Indenture Trustee and the Holders of the Senior Bonds are expressly authorized to exercise their rights under the Indenture and with respect to the Senior Bonds as if the Series 2006 Bonds did not exist. The Indenture Trustee and the Holders of the Senior Bonds are expressly authorized to exercise their rights even if their exercise of their rights adversely affects or destroys the rights of the Bondholders or the Beneficial Owners, or would otherwise be unlawful or violate the rights of the Bondholders or the Beneficial Owners. The Indenture Trustee and the Holders of the Senior Bonds are not required to give any notice to, or obtain the consent of, the Bondholders or the Beneficial Owners, before exercising any of their rights. Thus, the Indenture Trustee and the Holders of the Senior Bonds can exercise their rights under the Indenture and the Senior Bonds in a manner that adversely affects or destroys the rights of the Bondholders or the Beneficial Owners, and there is absolutely nothing that the Bondholders, or the Beneficial Owners can do to prevent it. These provisions apply even if the Corporation becomes the subject of a bankruptcy, insolvency, or similar proceeding. If the Corporation becomes the subject of this type of proceeding prior to the Crossover Date, Bondholders and Beneficial Owners may suffer a complete loss of their investment. The effect of these provisions is that prior to the Crossover Date, the Bondholders and the Beneficial Owners have absolutely no rights or remedies whatsoever, and have absolutely no ability to protect or exercise the rights, remedies, and benefits that would otherwise be provided by the Indenture or applicable law. As a result, if the Senior Bonds are not paid in accordance with their terms or there is a default or event of default with respect to the Senior Bonds, Bondholders and Beneficial Owners may suffer a complete loss of their investment and have no remedy for the loss. No Current Interest The Series 2006 Bonds do not pay any current interest. All interest accretes until both principal and accreted interest are paid. The lack of current interest payments may affect liquidity or cause price volatility. See Appendix F – “TABLE OF ACCRETED VALUES” attached hereto. Limited Obligations of the Corporation The Series 2006 Bonds are neither general nor moral obligations of the Virgin Islands and are not secured by a pledge of the full faith and credit of the Virgin Islands and Bondholders may not require the levy or imposition of taxes. The assets of the Corporation (other than the TSRs) are not pledged to the * Based on the Global Insight Base Case Consumption Forecast and assuming the values of all other structuring variables. See “METHODOLOGY AND BOND STRUCTURING ASSUMPTIONS” herein. 25 payment of, nor are they security for, the Series 2006 Bonds. The Corporation’s only source of funds for payments on the Series 2006 Bonds are the Collections and amounts on deposit in pledged funds and accounts pursuant to the Indenture. The proceeds of the Series 2006 Bonds will not be available to pay debt service on the Series 2006 Bonds. The Corporation has no taxing power and no assets other than the assets acquired pursuant to the Purchase Agreement. Limited Remedies The Indenture Trustee is limited under the terms of the Purchase Agreement and the Indenture to enforcing the terms of such agreements and to receiving the TSRs and applying them in accordance with the Indenture. If an Event of Default occurs, the Indenture Trustee cannot sell its rights under the Purchase Agreement or the Indenture. The Corporation is not a party to the MSA, and neither the Virgin Islands nor the Corporation has made any representation or warranty that the MSA is enforceable. Remedies under the Purchase Agreement do not include the repurchase of the TSRs under any circumstances, including unenforceability of the MSA or breach of any representation of warranty. Limited Liquidity of the Series 2006 Bonds; Price Volatility There is currently a limited secondary market for securities such as the Series 2006 Bonds. The Underwriter is under no obligation to make a secondary market. There can be no assurance that a secondary market for the Series 2006 Bonds will develop, or if a secondary market does develop, that it will provide Bondholders with liquidity or that it will continue for the life of the Series 2006 Bonds. Tobacco settlement securitization bonds generally have also exhibited greater price volatility than traditional municipal bonds. Any purchaser of the Series 2006 Bonds must be prepared to hold such securities for an indefinite period of time or until final redemption of such securities. Limited Nature of Ratings; Reduction, Suspension or Withdrawal of a Rating Any rating assigned to a Series 2006A Bond, a Series 2006B Bond or a Series 2006C Bond by the Rating Agency will reflect the Rating Agency’s assessment of the likelihood that owners of such Bonds will receive payments of the Accreted Value on such Series 2006 Bonds when due. Any such rating will not address the likelihood of payments from the Turbo Redemption Account or the expected average life of such Series 2006 Bonds. A rating of such Series 2006 Bonds will not be a recommendation to purchase, hold or sell such Series 2006 Bonds and such rating will not address the marketability of such Series 2006 Bonds, any market price or suitability for a particular investor. There is no assurance that any rating will remain for any given period of time or that any rating will not be lowered, suspended or withdrawn entirely by the Rating Agency if in the Rating Agency’s judgment circumstances so warrant based on factors prevailing at the time, including, but not limited to, the evaluation by the Rating Agency of the financial outlook for the tobacco industry. Any such reduction, suspension or withdrawal of a rating, if it were to occur, could adversely affect the availability of a market or the market price of such Series 2006 Bonds. See “RATINGS.” Fitch’s view of the tobacco industry is a key factor in its ratings of tobacco settlement securitizations. Currently, Fitch indicates its outlook on the unsecured credit profile of the tobacco industry is negative. 26 LEGAL CONSIDERATIONS The following discussion summarizes some, but not all, of the possible legal problems that could affect the Series 2006 Bonds. The discussion does not address every possible legal challenge that could result in a decision that would cause the TSRs to be reduced or eliminated. References in the discussion to various opinions of Buchanan Ingersoll PC are incomplete summaries of such opinions and are qualified in their entirety by reference to the actual opinions. Bankruptcy of a PM May Delay or Reduce Payments Because the only significant source of payment for the Series 2006 Bonds is the TSRs paid by the PMs, if one or more PMs were to become a debtor in a case under the Bankruptcy Code, there could be delays or reductions in or elimination of payments on the Series 2006 Bonds. See “RISK FACTORS – Bankruptcy of PMs May Delay, Reduce, or Eliminate Payments” herein. In the bankruptcy of a PM, the automatic stay provisions of the Bankruptcy Code could prevent (unless approval of the bankruptcy court was obtained) any action by the Virgin Islands, the Corporation, the Indenture Trustee, the Bondholders, or the Beneficial Owners to collect any TSRs or any other amounts owing by the bankrupt PM. In addition, even if the bankrupt PM wanted to continue paying TSRs, it could be prohibited as a matter of law from making such payments. In particular, if it were to be determined that the MSA was not an “executory contract” under the Bankruptcy Code, then the PM may be unable to make further payments of TSRs. Buchanan Ingersoll PC will render an opinion to the Rating Agency that, subject to all the assumptions, qualifications, and limitations set forth therein, if a PM were to become the debtor in a case under the Bankruptcy Code, and the matter were properly briefed and presented to a federal court with jurisdiction over such bankruptcy case, the court, exercising reasonable judgment after full consideration of all relevant factors, would hold that the MSA is an “executory contract” under Section 365 of the Bankruptcy Code. Certain of the assumptions contained in this opinion will be assumptions that certain facts or circumstances will exist or occur, and Buchanan Ingersoll PC can provide no assurance that such facts or circumstances will exist or occur as assumed in the opinion. This opinion will be based on an analysis of existing laws and court decisions, and will cover certain matters not directly addressed by such authorities. There are no court decisions directly on point, there are court decisions that could be viewed as contrary to the conclusions expressed in the opinion, and the matter is not free from doubt. Accordingly, no assurance can be given that a particular court would not hold that the MSA is not an executory contract, thus resulting in delays or reductions in, or elimination of, payments on the Series 2006 Bonds. If the MSA is an “executory contract” under the Bankruptcy Code, the bankrupt PM may be able to repudiate the MSA and stop making payments under it, thus resulting in delays or reductions in, or elimination of, payments on the Series 2006 Bonds. Furthermore, some payments previously made to the holders of the Series 2006 Bonds or the Beneficial Owners could be avoided as preferential payments, so that the Bondholders and the Beneficial Owners would be required to return such payments to the bankrupt PM. Also, the bankrupt PM may have the power to alter the terms of its payment obligations under the MSA without the consent, and even over the objection, of the Virgin Islands, the Corporation, the Indenture Trustee, the Bondholders, and the Beneficial Owners. Finally, while there are provisions of the MSA that purport to deal with the situation when a PM goes into bankruptcy, such provisions may be unenforceable. There may be other possible effects of a bankruptcy of a PM that could result in delays or reductions in, or elimination of, payments on the Series 2006 Bonds. 27 MSA Enforceability Most of the major provisions of the MSA are not severable. If a court materially modifies, renders unenforceable or finds unlawful any nonseverable provision, the attorneys general of the Settling States and the OPMs are required by the MSA to attempt to negotiate substitute terms. However, if any OPM does not agree to the substitute terms, the MSA would terminate in all Settling States affected by the court’s ruling. Even if substitute terms are agreed upon, payments under such terms may be less than payments under the MSA and could reduce the amount available to the Corporation to pay the Accreted Value of the Series 2006 Bonds. Certain cigarette manufacturers, cigarette importers, cigarette distributors, Native American tribes and smokers’ rights organizations have filed actions against some, and in certain cases all, of the signatories to the MSA alleging, among other things, that the MSA violates provisions of the U.S. Constitution, federal antitrust laws, federal civil rights laws, state constitutions, state consumer protection laws and unfair competition laws, which actions, if ultimately successful, could result in a determination that the MSA is void or unenforceable. The lawsuits seek, among other things, an injunction against one or more of the Settling States from collecting any moneys under the MSA and barring the PMs from collecting cigarette price increases related to the MSA or a determination that the MSA is void or unenforceable. To date, such challenges have not been ultimately successful, although two cases have survived pre–trial motions and have proceeded to a stage of litigation where the ultimate outcome may be determined in part by findings of fact based on extrinsic evidence as to the operation and impact of the MSA and appeals are pending or still possible in certain other cases. The terms of the MSA are currently being challenged and may continue to be challenged in the future. A determination by a court that a nonseverable provision of the MSA is void or voidable would, in the absence of an agreement to a substitute term as described above, result in the termination of the MSA in any Settling States affected by the court’s ruling. Accordingly, in the event of an adverse court ruling, Bondholders could incur a complete loss of their investment. See “RISK FACTORS – Litigation Challenging the MSA, the Qualifying Statutes and Related Legislation” herein. In rendering the opinions described below, Buchanan Ingersoll PC considered the claims asserted in the federal and state actions described above under the caption “RISK FACTORS – Litigation Challenging the MSA, the Qualifying Statutes and Related Legislation” that it believes are representative of the legal theories that an opponent of the MSA would advance in an attempt to invalidate the MSA. Subject to the assumptions and qualifications set forth below, Buchanan Ingersoll PC will render an opinion to the Rating Agency that, subject to all the assumptions, qualifications and limitations set forth therein, and although there can be no assurances that a court applying existing legal principles would not hold otherwise, a court applying existing legal principles to the facts would find the MSA to be a valid and enforceable agreement under federal and Virgin Islands law among the Virgin Islands and the tobacco companies who are parties thereto. Qualifying Statute Constitutionality The Qualifying Statutes and related legislation, like the MSA, have also been the subject of litigation in cases alleging that the Qualifying Statutes and related legislation violate certain provisions of the federal and state constitutions or are preempted by federal antitrust laws. The lawsuits seek, among other things, injunctions against the enforcement of the Qualifying Statutes and related legislation. To date such challenges have not been ultimately successful, although the enforcement of Allocable Share Release Amendments has been preliminarily enjoined in New York and certain other states. Appeals are pending or still possible in certain cases. The Qualifying Statutes and related legislation may also continue to be challenged in the future. Although a determination that the Qualifying Statute is unconstitutional would have no effect on the enforceability of the MSA, such a determination could have 28 an adverse effect on payments to be made under the MSA if an NPM were to gain market share in the future and there occurred the requisite impact on the market share of PMs under the MSA. See “RISK FACTORS – Litigation Challenging the MSA, the Qualifying Statutes and Related Legislation” herein. In rendering the opinions described below, Buchanan Ingersoll PC considered the claims asserted in the federal and state actions described above under the caption “RISK FACTORS – Litigation Challenging the MSA, the Qualifying Statutes and Related Legislation” that it believes are representative of the legal theories that an opponent of the Qualifying Statute would advance in an attempt to invalidate the Qualifying Statute. Subject to the assumptions and qualifications set forth below, Buchanan Ingersoll PC will render an opinion to the Rating Agency that, subject to all the facts, assumptions and qualifications set forth therein, and although there can be no assurance that a court applying existing legal principles would not hold otherwise, that a court applying existing legal principles to the facts would find the Virgin Islands’ Qualifying Statute to be valid, enforceable and constitutional in all material respects under federal and Virgin Islands law. In rendering its opinion, Buchanan Ingersoll PC will rely upon a letter dated August 8, 2001, from counsel to the OPMs confirming that the OPMs would not dispute that the Virgin Islands Qualifying Statute constitutes a “model statute” under the MSA. Limitations on Opinions of Counsel; No Assurance as to Outcome of Litigation A court’s decision regarding the matters upon which a lawyer is opining would be based on such court’s own analysis and interpretation of the factual evidence before it and of applicable legal principles. Thus, if a court reached a result different from that expressed in an opinion, such as that the MSA is void or voidable or that the Virgin Islands Qualifying Statute is unenforceable, it would not necessarily constitute reversible error or be inconsistent with that opinion. An opinion of counsel is not a prediction of what a particular court (including any appellate court) that reached the issue on the merits would hold, but, instead, is the opinion of such counsel as to the proper result to be reached by a court applying existing legal rules to the facts as properly found after appropriate briefing and argument and, in addition, is not a guarantee, warranty or representation, but rather reflects the informed professional judgment of such counsel as to specific questions of law. Opinions of counsel are not binding on any court or party to a court proceeding. The descriptions of the opinions set forth herein are summaries, do not purport to be complete and are qualified in their entirely by the opinions themselves. Enforcement of Rights to TSRs It is possible that the Virgin Islands could in the future attempt to claim some or all of the TSRs for itself, or otherwise interfere with the security for the Series 2006 Bonds. In that event, the Bondholders, the Indenture Trustee or the Corporation may assert claims based on contractual, fiduciary, or constitutional rights, but no prediction can be made as to the disposition of such claims. Contractual Remedies. Pursuant to the Act, the Virgin Islands has covenanted, and the Corporation has included in the Indenture for the benefit of the Bondholders, the Virgin Islands pledge and agreement with the Holders of the Outstanding Bonds that the Virgin Islands (i) shall defend the rights of the Corporation to receive the TSRs up to the maximum allowed by the MSA; (ii) shall ensure that the Model Statute (as defined in the MSA) be diligently complied with; (iii) shall not amend the MSA in a way that may materially alter the rights of the Holders or of those persons and entities that enter into contracts with the Corporation; (iv) will not limit or alter the rights of the Corporation to fulfill the terms of its agreements with such Bondholders; or (v) in any way impair the rights and remedies of such Bondholders or the security for such Bonds until such Bonds, together with the interest thereon and all costs and expenses in connection with any action or proceeding by or on behalf of such Bondholders are fully paid and discharged. 29 Constitutional Claims. The Bondholders are further entitled to the benefit of the prohibitions in the U.S. Constitution’s Contract Clause against any state’s impairment of the obligation of contracts. This prohibition, although not absolute, is particularly strong when applied to a jurisdiction’s attempt to evade its own obligations. Based on the U.S. Supreme Court’s standard of review for Contract Clause challenges in Energy Reserves Group, Inc. v. Kansas Power & Light Co., 459 U.S. 400 (1983), the Virgin Islands must justify the exercise of its inherent police power to safeguard the vital interests of its people before the Virgin Islands may alter the MSA, the Decree or the financing arrangements in a manner that would substantially impair the rights of the Bondholders to be paid from the TSRs. However, to justify the enactment by the Virgin Islands of legislation that substantially impairs the contractual rights of the Bondholders to be paid from the TSRs, the Virgin Islands must demonstrate a significant and legitimate public purpose, such as the remedying of a broad and general social or economic problem. In the event that the Virgin Islands demonstrates a significant and legitimate public purpose for such legislation, the Virgin Islands must also show that the impairment of the Bondholders’ rights are based upon reasonable conditions and are of a character appropriate to the public purpose justifying the legislation’s adoption. Finally, the Bondholders may also have constitutional claims under the Due Process Clauses of the United States and Virgin Islands constitutions. No Assurance as to the Outcome of Litigation With respect to all matters of litigation that have been brought and may in the future be brought against the PMs, or involving the enforceability of the MSA or constitutionality of the Virgin Islands Qualifying Statute or the enforcement of the right to the TSRs or otherwise filed in connection with the tobacco industry, the outcome of such litigation, in general, cannot be determined with certainty and depends, among other things, on (i) the issues being appropriately presented and argued before the courts (including the applicable appellate courts) and (ii) on the courts, having been presented with such issues, correctly applying applicable legal principles in reaching appropriate decisions regarding the merits. In addition, the courts may, in their exercise of equitable jurisdiction, reach judgments based not upon the legal merits but upon a balancing of the equities among the parties. Accordingly, no assurance can be given as to the outcome of any such litigation and any such adverse outcome could have a material and adverse impact on the amounts available to the Corporation to make payments on the Series 2006 Bonds. THE SERIES 2006 BONDS The following summary describes certain terms of the Series 2006 Bonds. This summary does not purport to be complete and is subject to, and qualified in its entirety by reference to, the provisions of the Indenture and the Series 2006 Bonds. Copies of the Indenture may be obtained upon written request to the Indenture Trustee. Book–Entry Only The Series 2006 Bonds will initially be represented by one certificate for each maturity of the Series 2006 Bonds registered in the name of DTC, New York, New York or its nominee. DTC will act as securities depository for the Series 2006 Bonds. The Series 2006 Bonds will be available for purchase in Authorized Denominations in book–entry form only. Beneficial Owners of the Series 2006 Bonds will not receive physical delivery of the Series 2006 Bonds. See Appendix E – “BOOK–ENTRY ONLY SYSTEM” herein. 30 Payments On The Series 2006 Bonds Interest Payments. Interest on the Series 2006 Bonds is not paid currently but accretes from the Date of Delivery, compounded on each May 15 and November 15, commencing May 15, 2006 and is paid at maturity or upon prior redemption. Payments of Accreted Value. The Accreted Value of the Series 2006 Bonds will be paid on or after the Crossover Date on the maturity dates as set forth on the inside front cover of this Offering Circular or upon prior redemption. “Accreted Value” means an amount equal to the initial principal amount of the Series 2006 Bonds, plus interest accreted thereon from its date of issuance, compounded on each May 15 and November 15, commencing on May 15, 2006 through and including the Maturity Date or earlier redemption date of such Bond at the interest rate for such Bond, as set forth in the Subordinate Series 2006 Supplement and in accordance with the Accreted Value Table attached thereto; provided, however, that the Corporation shall calculate or cause to be calculated the Accreted Value on any date other than each May 15 and November 15 by straight line interpolation of the Accreted Values as of the immediately preceding and succeeding May 15 and November 15. See Appendix F – “TABLE OF ACCRETED VALUES” attached hereto. Before the Crossover Date, failure by the Corporation to pay the Accreted Value at maturity will not constitute an Event of Default under the Indenture. After the Crossover Date, failure by the Corporation to pay the Accreted Value at maturity on any Series 2006 Bonds will constitute an Event of Default under the Indenture. Failure to make Turbo Redemption payments on the Series 2006 Bonds will not constitute an Event of Default. See “SECURITY FOR THE SERIES 2006 BONDS – Flow of Funds” herein. Turbo Redemption The Series 2006 Bonds are subject to mandatory redemption in whole or in part prior to their stated maturity, from amounts on deposit in the Turbo Redemption Account on any Distribution Date on or after the Crossover Date for which notice can be given pursuant to the Indenture, at the redemption price of 100% of the Accreted Value thereof and without premium. Any redemption of the Series 2006 Bonds from the Turbo Redemption Account pursuant to the Indenture shall be made by Series in accordance with the Payment Priorities and pro rata within each Series of Bonds. For purposes of defeasance, such Bonds shall have the assumed redemptions schedule set forth under Appendix G— “DEFEASANCE TURBO SCHEDULES” attached hereto. Monies in the Turbo Redemption Account may not be applied to purchase the Series 2006 Bonds on the open market. See “METHODOLOGY AND BOND STRUCTURING ASSUMPTIONS” herein. “Payment Priorities” means, subject to the issuance of Additional Bonds which may be payable prior to the Series described herein, payment of the Series 2006 Bonds in the following order of priority: (1) first, the Series 2006A Bonds until they are fully paid and no longer Outstanding; (2) second, the Series 2006B Bonds until they are fully paid and no longer Outstanding; (3) third, the Series 2006C Bonds until they are fully paid and no longer Outstanding, and (4) fourth, the Series 2006D Bonds until they are fully paid and no longer Outstanding. “Distribution Date” means each May 15 and November 15, commencing the first May 15 or November 15 to occur on or after the Crossover Date. “Crossover Date” means the first date on which no Senior Bonds are outstanding. 31 Lump Sum Prepayment The Series 2006 Bonds are subject to mandatory redemption, in whole or in part prior to their stated maturity from amounts on deposit in the Lump Sum Prepayment Account on any date on or after the Crossover Date for which notice of redemption can be given under the Indenture at the prepayment price of 100% of the Accreted Value thereof, without premium. Any redemption of Bonds from the Lump Sum Prepayment Account pursuant to the Indenture will be by Series in accordance with the Payment Priorities and within each Series pro rata. See “METHODOLOGY AND BOND STRUCTURING ASSUMPTIONS” herein. Extraordinary Prepayment If an Event of Default has occurred and is continuing on or after the Crossover Date, amounts on deposit in the Extraordinary Prepayment Account will be applied on each Distribution Date after the Crossover Date to prepay the Series 2006 Bonds by Series in accordance with the Payment Priorities and within each Series pro rata, at a price of the Accreted Value thereof without premium. Optional Redemption The Series 2006 Bonds are subject to redemption at the Corporation’s option at any time, in whole or in part, on and after May 15, 2016, at a redemption price of 100% of the Accreted Value thereof, without premium. The Series 2006 Bonds to be redeemed shall be selected by the Corporation in its sole discretion by Series and within each Series by lot. Notice of Redemption Pursuant to the Indenture, the Indenture Trustee will give at least 30 days’ notice by mail, or otherwise transmit the redemption notice in accordance with any appropriate provisions of the Indenture, to the registered owners of any Bonds that are to be redeemed, at their addresses shown on the registration books of the Corporation. Such notice may be waived by any Bondholders holding Bonds to be redeemed. Failure by a particular Bondholder to receive notice, or any defect in the notice to such Bondholder, will not affect the redemption of any Bond. Any notice of redemption given pursuant to the Indenture may be rescinded by written notice to the Indenture Trustee by the Corporation no later than 5 days prior to the date specified for redemption. The Indenture Trustee will give notice of such rescission as soon thereafter as practicable in the same manner and to the same persons, as notice of such redemption was given as described above. SECURITY FOR THE BONDS General Purchase of TSRs. Pursuant to the Act and the Purchase Agreement, in connection with the issuance of the Series 2001 Bonds, the Virgin Islands sold to the Corporation and the Corporation purchased from the Virgin Islands, all of the Virgin Islands’ right, title and interest in certain amounts payable to the Virgin Islands under the MSA, including the Virgin Islands’ right to receive its allocable share of (i) future Initial Payments made by the OPMs under the MSA which were required to be made on January 10, 2002 and January 10, 2003, (ii) future Annual Payments made by the PMs under the MSA, which are required to be made annually on each April 15 in perpetuity, (iii) Strategic Contribution Payments made by the PMs under the MSA, which are required to be made annually on each April 15, commencing April 15, 2008 through April 15, 2017 (collectively, the “Tobacco Settlement Revenues” or “TSRs”). The MSA Escrow Agent was irrevocably instructed to disburse all of the TSRs from the 32 Escrow Account to the Indenture Trustee. See Appendix D—“SUMMARY OF PRINCIPAL LEGAL DOCUMENTS—THE PURCHASE AGREEMENT” attached hereto. The Series 2006 Bonds are subordinated to the Senior Bonds and so long as any Senior Bond remains outstanding, no payment on the Series 2006 Bonds may be made, the Indenture Trustee, the Bondholders, and the Beneficial Owners cannot exercise any rights or remedies with respect to the Series 2006 Bonds, and no default or event of default can exist or be declared with respect to the Series 2006 Bonds. If the Senior Bonds are not paid in accordance with their terms or there is a default or event of default with respect to the Senior Bonds, Bondholders and Beneficial Owners may suffer a complete loss of their investment and have no remedy for the loss. See “Risk Factors – Subordinate Nature of the Series 2006 Bonds” herein. In accordance with the Payment Priorities, the Series 2006B Bonds are subordinate to the Series 2006A Bonds, and the Holders of the Series 2006B Bonds are not entitled to receive any payment, including any extraordinary prepayment, until all Holders of Series 2006A Bonds and any other Bonds (herein defined) senior to the Series 2006B Bonds issued under the Indenture have been fully paid, regardless of the occurrence of an Event of Default. The Series 2006C Bonds are subordinate to the Series 2006B Bonds, and Holders of the Series 2006C Bonds are not entitled to receive any payment, including any extraordinary prepayment, until Holders of all Series 2006B Bonds and any other Bonds senior to the Series 2006C Bonds issued under the Indenture have been fully paid, regardless of the occurrence of an Event of Default. The Series 2006D Bonds are subordinate to the Series 2006C Bonds, and Holders of the Series 2006D Bonds are not entitled to receive any payment, including any extraordinary prepayment, until Holders of all Series 2006C Bonds and any other Bonds senior to the Series 2006D Bonds issued under the Indenture have been fully paid, regardless of the occurrence of an Event of Default. Indenture. The Series 2006 Bonds are to be issued pursuant to the Indenture and are secured by all the Corporation’s right, title and interest, whether now owned or hereafter acquired in the following: (a) Collections, including all TSRs to be received by the Corporation, (b) except for the Rebate Account and the Construction Account, all amounts held in the Funds and Accounts established under the Indenture, and (c) the Corporation’s rights under the Purchase Agreement. The Series 2001 Bonds were issued pursuant to the Indenture and are secured by all the Corporation’s right, title and interest, whether now owned or hereafter acquired, in the following: (a) Collections, including all TSRs to be received by the Corporation, (b) amounts held in the Debt Service Reserve Account (the “Debt Service Reserve Account”) and the NPM Adjustment Reserve Account (the “NPM Adjustment Reserve Account”) established under the Indenture, (c) except for the Rebate Account, all amounts held in the other Funds and Accounts established under the Indenture, and (d) the Corporation’s rights under the Purchase Agreement. See Appendix D – “SUMMARY OF PRINCIPAL LEGAL DOCUMENTS–THE INDENTURE” attached hereto. Debt Service Reserve Account Under the Indenture, the Indenture Trustee has established and holds the Debt Service Reserve Account. Until the Crossover Date, except after the occurrence and continuance of an Event of Default, the balance in the Debt Service Reserve Account must be maintained, to the extent of available funds, at the least of (i) the initial deposit therein plus any retained earnings thereon, (ii) the amount of $2,352,750, and (iii) the principal amount of Senior Bonds Outstanding on the date of calculation (the “Debt Service Reserve Requirement”). All earnings on amounts in the Debt Service Reserve Account will be retained until the amount therein is equal to $2,352,750. There is currently $2,089,993 in the Debt Service Reserve Account. 33 The Debt Service Reserve Account established by the Indenture will not secure the Series 2006 Bonds. The Debt Service Reserve Account Requirement will be zero on and after the Crossover Date, unless otherwise adjusted in connection with the issuance of Additional Bonds. Limited Obligations The Bonds are limited obligations of the Corporation, payable solely from the Collections, which constitute the only asset of the Corporation. The Bonds shall not constitute an indebtedness of the Virgin Islands. The Bonds are neither general nor moral obligations of the Virgin Islands and are not secured by a pledge of the full faith and credit of the Virgin Islands and the holders of the Bonds may not require the levy or imposition of taxes. The Corporation has no taxing power. The Indenture Trustee will establish and maintain the following segregated trust accounts in the Indenture Trustee’s name: the Collection Account, the Operating Account, the Debt Service Account, the Debt Service Reserve Account, the Extraordinary Prepayment Account, the Turbo Redemption Account, the Costs of Issuance Account, the NPM Adjustment Reserve Account and the Rebate Account. Flow of Funds No TSRs will be available to make payment on the Series 2006 Bonds prior to the Crossover Date. Any TSRs received by the Corporation will be promptly (and in no event later than two Business Days after receipt) deposited by the Indenture Trustee in the Collection Account. Unless otherwise specified in the Indenture, the Indenture Trustee will deposit all Collections received by it in the Collection Account. (A) As soon as possible, but in any event not later than five Business Days) following each deposit of TSRs to the Collection Account and after setting aside an amount sufficient to pay the Indenture Trustee’s fees and expenses (in an amount not to exceed the applicable Operating Cap) pursuant to the Indenture, the Indenture Trustee will withdraw remaining Collections on deposit in the Collection Account and transfer such amounts in priority as follows: (i) to the Operating Account, an amount specified in an Officer’s Certificate, taking into account the payment of the Indenture Trustee’s fees and expense payments from the Collection Account for the next twelve months or until the next scheduled Deposit Date, whichever is the longer period, but not exceeding, when taken together with other applicable transfers, the Operating Cap for the then current Fiscal Year; (ii) to the Debt Service Account, an amount sufficient to cause the amount therein to equal interest on Outstanding Bonds due on the next succeeding Distribution Date, and, in the case of Parity Payments, to deposit in separate subaccounts within the Debt Service Account, interest and Parity Payments due during the semiannual period including such Distribution Date, together with any unpaid interest on Outstanding Bonds from prior Distribution Dates (including interest on overdue interest, if any, to the extent legally permissible); (iii) unless an Event of Default has occurred and is continuing, to the Debt Service Account, an amount sufficient to cause the amount therein (without regard to amounts on deposit therein pursuant to (ii) above) to equal the Principal of Outstanding Bonds due during the current Fiscal Year; (iv) unless an Event of Default has occurred and is continuing, to the Debt Service Reserve Account, an amount sufficient to cause the amounts therein to equal the Debt Service Reserve Requirement; 34 (v) unless an Event of Default has occurred and is continuing, to the Debt Service Account an amount which, together with the amount on deposit therein pursuant to clause (ii) above but exclusive of the amounts on deposit therein pursuant to clause (iii) above, will be sufficient to cause the amount on deposit therein to equal interest (including interest at the stated rate on the principal of Outstanding Bonds and on overdue interest, if any) and Parity Payments, in each case, due (a) during the current Fiscal Year and (b) if the Deposit Date is during the period from January 1 through September 30 of any year, during the first half of the next Fiscal Year (or, in the case of Parity Payments, during the last complete Semiannual Period in such next Fiscal Year), assuming that Principal of the Bonds will be paid in the amounts deposited pursuant to clause (iii) above and Turbo Redemptions will be paid pursuant to clause (x) below; (vi) unless an Event of Default has occurred and is continuing, if a Lump Sum Payment has been received, to the Debt Service Account the amount of such Lump Sum Payment; (vii) if an Event of Default has occurred and is continuing, to the Extraordinary Prepayment Account all amounts remaining in the Collection Account; (viii) in the amounts and to the accounts established by the Series Supplement for payments thereon in excess of the applicable maximum rate, principal payable under term-out provisions of Ancillary Contracts (as defined in the Indenture, including, without limitation, credit enhancement), other amounts under Ancillary Contracts and not payable as Priority Payments (as defined under the Indenture) or debt service and any other junior payments specified as such by the Indenture (collectively, the “Junior Payments”); (ix) to the Corporation, an amount specified by an Officer’s Certificate to pay for any Operating Expenses in excess of the Operating Cap; and (x) unless and Event of Default has occurred and is continuing, to the Turbo Redemption Account, all amount remaining in the Collection Account. Except as otherwise provided in the Indenture, investment earnings on the Accounts shall be deposited in the Collection Account. After making the deposits set forth above, (A) the Indenture Trustee shall compare (i) the amount on deposit in the Debt Service Reserve Account to (ii) the principal amount of Bonds that will remain Outstanding after giving effect to the application of amounts described below on the related Distribution Date, and if the amount in clause (i) is greater than the amount in clause (ii), the Indenture Trustee shall withdraw from the Debt Service Reserve Account an amount sufficient to, and shall, retire the Bonds in full on such Distribution Date, and (B) any amounts remaining in the Collection Account in excess of amounts required to be applied to make payments from the Collection Account pursuant to paragraph (B) below, after all the Bonds have been retired, will be paid to the Corporation, free and clear of the lien of the Indenture. Notwithstanding the foregoing, all amounts remaining in the Debt Service Reserve Account on the Crossover Date will be transferred to the Collection Account. (B) On each Distribution Date, the Indenture Trustee will apply amounts in the various Accounts in the following order of priority: (i) from the Operating Account, to the parties entitled thereto, upon the written request of the Corporation, to pay Operating Expenses; 35 (ii) from the Debt Service Account and the Debt Service Reserve Account, in that order, to pay interest on Outstanding Bonds and Parity Payments due on such Distribution Date, plus any such unpaid interest on Outstanding Bonds and Parity Payments from prior Distribution Dates (including interest on overdue interest, if any, to the extent legally permissible); (iii) unless an Event of Default has occurred and is continuing, from the Debt Service Account and the Debt Service Reserve Account, in that order, to pay in order of Maturity Dates, the principal of Outstanding Bonds due on such Distribution Date; (iv) unless an Event of Default has occurred and is continuing, from the Debt Service Reserve Account, any amount remaining in excess of the Debt Service Reserve Requirement, to the Collection Account and from these immediately to the Debt Service Account; (v) if an Event of Default has occurred and is continuing, from the Debt Service Reserve Account and the Extraordinary Prepayment Account to pay Extraordinary Prepayments; (vi) unless an Event of Default has occurred and is continuing, if a Lump Sum Payment has been received, from the Debt Service Account to pay Lump Sum Prepayments; (vii) from the Funds and Accounts therefore, to make Junior Payments; and (viii) from the Turbo Redemption Account, any amounts remaining thereon to make Turbo Redemptions. All amounts on deposit in the various accounts will be transferred to the Collection Account on the Crossover Date, and applied as described above. Non–Impairment Pledge of the Virgin Islands Pursuant to the Act, the Purchase Agreement and the Indenture, the Corporation has, in the opinion of Transaction Counsel, validly included the pledge and agreement of the Virgin Islands not to limit or alter the rights of the Corporation to fulfill the terms of the Purchase Agreement and the Indenture, or to impair the rights and remedies of the Bondholders. Events of Default The occurrence of any of the following events will constitute an “Event of Default” under the Indenture: (i) failure to pay when due principal of, interest on or Accreted Value on any Bond when due; (ii) failure of the Corporation to observe or perform any other provision of the Indenture that is not remedied within 60 days after written notice thereof has been given to the Corporation by the Indenture Trustee or to the Corporation and the Indenture Trustee by the Bondholders of at least 25% in principal amount or Accreted Value of the Bonds then Outstanding, provided that, except for payments specified in clause (i) above, failure to make a Turbo Redemption because of insufficiency of available Collections will not constitute an Event of Default. In the case of a default specified in this subsection, if the default cannot be corrected within the said 60-day period and is diligently pursued until the default is corrected, it shall not constitute an Event of Default if corrective 36 action is instituted by the Corporation within said 60-day period and diligently pursued until the default is corrected; (iii) bankruptcy, reorganization, arrangement or insolvency proceedings, or other proceedings for relief under any bankruptcy or similar law for the relief of debtors, are instituted by or against the Corporation and if instituted against the Corporation, are not dismissed within 60 days after such institution; or (iv) the Virgin Islands fails to observe or perform its covenant included in the Indenture for the benefit of the Holders, which failure is not remedied within 60 days after written notice thereof is given to the Corporation and the Virgin Islands by the Indenture Trustee or to the Corporation and the Indenture Trustee by the Holders of at least 25% in principal amount or Accreted Value of the Bonds then Outstanding; or (v) the Virgin Islands fails to pay promptly to the Corporation or the Indenture Trustee any TSRs received by it in accordance with the Purchase Agreement; or (vi) the Virgin Islands consents to or acquiesces in an amendment or modification of the MSA or the Consent Decree, so as to materially reduce the ability of the Corporation to pay the principal of, interest on or Accreted Value of the Bonds when due. Event of Default Remedies No Remedies Prior to Crossover Date. As set forth more fully in the Indenture, the Series 2006 Bondholders, the Beneficial Owners of the Series 2006 Bonds and the Indenture Trustee have waived all rights and remedies prior to the Crossover Date, and no rights or remedies shall be available under the Indenture or under any other provision of the Series 2006 Bonds, the Indenture or applicable law until the Crossover Date has occurred. Remedies of the Indenture Trustee. If an Event of Default occurs and is continuing: The Indenture Trustee may, and upon written request of the Holders of at least 25% in principal amount or Accreted Value of the Bonds Outstanding shall, in its own name by action or proceeding in accordance with law: (a) enforce all rights of the Holders and require the Corporation or, to the extent permitted by law, the Virgin Islands, to carry out their respective agreements with the Holders and to perform its duties under the Purchase Agreement; (b) sue upon such Bonds; (c) require the Corporation to account as if it were the trustee of an express trust for such Holders; and (d) enjoin any acts or things that may be unlawful or in violation of the rights of such Holders. The Indenture Trustee shall, in addition to the other provisions of the Indenture, have and possess all of the powers necessary or appropriate for the exercise of any functions incident to the general representation of Holders in the enforcement and protection of their rights. Upon a payment default of the Corporation under the Indenture or a failure actually known to an Authorized Officer of the Indenture Trustee to make any other payment required by the Indenture within 7 days after the same becomes due and payable, the Indenture Trustee will give written notice thereof to the Corporation. The Indenture Trustee shall give Default notices of non–payment defaults under the Indenture when instructed to do so by the written direction of another Fiduciary, if any, or the Holders of at least 25% in principal amount or Accreted Value of the Outstanding Bonds. The Indenture Trustee shall proceed under the Indenture for the benefit of the Holders in accordance with the written direction of a Majority in Interest of the Holders of the Outstanding Bonds. The Indenture Trustee will not be 37 required to take any remedial action (other than the giving of notice) unless indemnity satisfactory to the Indenture Trustee is furnished for any expense or liability to be incurred therein. Upon receipt of written notice, direction and indemnity, and after making such investigation, if any, as it deems appropriate to verify the occurrence of any event of which it is notified as aforesaid, the Indenture Trustee will promptly pursue the remedies provided by the Indenture or any such remedies (not contrary to any such direction) as it deems appropriate for the protection of the Holders, and will act for the protection of the Holders with the same promptness and prudence as would be expected of a prudent person in the conduct of such person’s own affairs. Extraordinary Prepayment. Prior to the Crossover Date, if an Event of Default occurs, the Outstanding Bonds shall be redeemed after payment of certain expenses and all current and past due interest on the Outstanding Bonds, pro rata in authorized denominations, from all available funds in the Debt Service Reserve Account and the Extraordinary Prepayment Account, at the principal amount or Accreted Value thereof plus accrued interest to the date of redemption. If an Event of Default occurs on or after the Crossover Date, amounts on deposit in the Extraordinary Prepayment Account will be applied on each Distribution Date to prepay Series 2006 Bonds by Series in accordance with the Payment Priorities and within each Series pro rata, at a price of the Accreted Value thereof without premium. Additional Bonds Subsequent to the issuance of the Series 2006 Bonds, additional series of bonds (“Additional Bonds”) may be issued on a parity with one or more series of the Series 2006 Bonds, or on a senior or subordinate basis to one or more series of Series 2006 Bonds, for any lawful purpose, including refunding of outstanding Series 2006 Bonds, from time to time in such principal amounts and Accreted Value at maturity as the Corporation shall determine, provided, however, none of such Additional Bonds will receive payments of principal, premium or interest, or be deemed Outstanding for purposes of the Indenture, until the Crossover Date. Additional Bonds may be issued only upon receipt by the Indenture Trustee of (i) a written confirmation from each Rating Agency then rating the Outstanding Series 2006 Bonds that such issuance shall not cause such Rating Agency to lower, suspend or withdraw the rating then assigned by such Rating Agency to any Outstanding Series 2006 Bonds (a “Rating Confirmation”) and (ii) a certificate of the Corporation that (x) no Event of Default has occurred under the Indenture, and (y) as a result of the issuance of such Additional Bonds, the weighted average life of each Series 2006 Bond then Outstanding, projected in years from its date of issuance, will not exceed the sum of (i) the weighted average life of each such Outstanding Series 2006 Bond and (ii) one. In calculating the weighted average life of each of the Outstanding Series 2006 Bonds for the purpose of the certificate required by clause (y) of the preceding sentence, the Corporation shall take into consideration (1) the amount of Turbo Redemptions of Series 2006 Bonds that have been paid prior to and including the date of issuance of the Additional Bonds and (2) the amount of Turbo Redemptions projected by the Corporation to be paid on each May 15 and November 15 subsequent to the issuance of such Additional Bonds based upon the amount of TSRs then expected to be received by the Corporation and available for payment of Turbo Redemptions of the Outstanding Series 2006 Bonds. Subsequent to the issuance of the Series 2006 Bonds, Additional Bonds may be issued from time to time in such principal amounts as the Corporation shall determine, but only to renew or refund Outstanding Bonds (“Refunding Bonds”). 38 Refunding Bonds may be issued to refund Series 2001 Bonds only upon receipt by the Indenture Trustee of (i) a Rating Confirmation from each Rating Agency then rating the Outstanding Series 2001 Bonds and Series 2006 Bonds, and any other Series of Bonds, and (ii) a certificate of the Corporation that (x) no Event of Default has occurred under the Indenture, and (y) as a result of the issuance of such Refunding Bonds, the weighted average life of each Series 2006 Bond then Outstanding, projected in years from its date of issuance, will not exceed the sum of (i) the weighted average life of each such Outstanding Series 2006 Bond and (ii) one. In calculating the weighted average life of each of the Outstanding Series 2006 Bonds for the purpose of the certificate required by clause (y) of the preceding sentence, the Corporation shall take into consideration (1) the amount of Turbo Redemptions of such Series 2006 Bonds that have been paid prior to the and including the date of issuance of the Refunding Bonds and (2) the amount of Turbo Redemptions projected by the Corporation to be paid on each May 15 and November 15 subsequent to the issuance of such Refunding Bonds based upon the amount of TSRs then expected to be received by the Corporation and available for payment of Turbo Redemptions of the Outstanding Series 2006 Bonds. THE SERIES 2001 BONDS Certain amendments to the Indenture will be made, in compliance with the amendment provisions thereof, to effectuate the issuance of the Series 2006 Bonds. The following summary describes certain terms of the Series 2001 Bonds. This summary does not purport to be complete and is subject to, and qualified in its entirety by reference to, the provisions of the Indenture and the Series 2001 Bonds. Defined terms in this summary have the meanings ascribed thereto in the Indenture. Copies of the Indenture may be obtained upon written request to the Indenture Trustee. Interest Payments Interest on the outstanding principal amount of the Series 2001 Bonds (except the Convertible CABs prior to May 15, 2008) is payable on May 15 and November 15 of each year (each, a “Series 2001 Bonds Distribution Date”). Failure to pay the full amount of interest on the Series 2001 Bonds when due is an Event of Default. If on any Series 2001 Bonds Distribution Date there are insufficient funds to pay all interest then due on the Series 2001 Bonds, available amounts will be allocated pro rata among all Series 2001 Bonds based on the respective amounts of interest due thereon. See “SECURITY FOR THE BONDS – Flow of Funds” herein. For each Series 2001 Bonds Distribution Date, payments that are to be made on the Series 2001 Bonds will be made to holders of the Series 2001 Bonds of record (the “Series 2001 Bondholders”) as of the applicable Record Date. “Record Date” means the last Business Day of the calendar month preceding a Series 2001 Bonds Distribution Date, or such other date as may be specified by the Indenture or an Officer’s Certificate of the Corporation; and the Corporation or the Indenture Trustee may in its discretion establish special record dates for the determination of the Holders of Series 2001 Bonds for various purposes thereof, including giving consent or direction to the Indenture Trustee. “Business Day” means any day other than (i) a Saturday or a Sunday or (ii) a day on which banking institutions in New York, New York are required or authorized by law to be closed. Accreted Value of Convertible CABs The Series 2001 Bonds maturing on May 15, 2008 through and including May 15, 2014 (the “Convertible CABs”) will not begin accruing current interest until from and after November 15, 2007. 39 Prior to such date, interest on the Convertible CABs will accrete so that the value of each such Convertible CAB will be an amount equal to the initial principal amount thereof, plus interest accrued thereon from the date of original issuance of such Convertible CAB, compounded on May 15 and November 15 of each year, commencing on the date of issuance of the Series 2001 Bonds, at the respective original issue yield to November 15, 2007. The Accreted Value as of each May 15 and November 15 from the date of issuance of the Series 2001 Bonds through and including November 15, 2007 are set forth below. The Accreted Value on other than a May 15 or November 15 shall be calculated by straight line interpolation of the Accreted Value. For the purpose of determining the redemption price and outstanding principal amount of CABs, the value of each such CAB shall be its Accreted Value. ACCRETED VALUES TABLE Series 2001 Bonds Serial Maturities May 15, 2008 May 15, 2009 May 15, 2010 May 15, 2011 May 15, 2012 May 15, 2013 May 15, 2014 May 15, 2005 $818,181.00 $923,807.00 $ 984,181.00 $1,039,785.80 $1,124,913.90 $1,184,265.15 $1,243,326.65 Nov. 15, 2005 835,771.30 944,128.90 1,006,324.00 1,063,703.25 1,151,630.70 1,212,981.00 1,274,096.15 May 15, 2006 853,734.70 964,904.00 1,028,962.00 1,088,168.25 1,178,980.00 1,242,404.40 1,305,624.35 Nov. 15, 2006 872,089.40 986,132.30 1,052,117.00 1,113,192.45 1,206,987.10 1,272,522.00 1,337,939.35 May 15, 2007 890,844.50 1,007,824.10 1,075,789.00 1,138,799.15 1,235,652.00 1,303,387.20 1,371,055.20 Nov. 15, 2007 910,000.00 1,030,000.00 1,100,000.00 1,165,000.00 1,265,000.00 1,335,000.00 1,405,000.00 Principal Outstanding The Series 2001 Bonds mature in the amounts and on May 15 of the years set forth below. A failure by the Corporation to pay when due (i) interest or principal at maturity on any Series 2001 Bonds or (ii) interest and principal on any Series 2001 Bonds, when due, will constitute an Event of Default under the Indenture. Failure to make Turbo Redemption payments on the Series 2001 Bonds will not constitute an Event of Default. See “SECURITY FOR THE BONDS – Flow of Funds” herein. Series 2001 Bonds Maturities Principal Amount Outstanding Year of Maturity (May 15) Interest Rate or Yield $ 910,000 2008 4.30% 1,030,000 2009 4.40 1,100,000 2010 4.50 1,165,000 2011 4.60 1,265,000 2012 4.75 1,335,000 2013 4.85 1,405,000 2014 4.95 5,675,000 2021 5.00 8,045,000 2031 5.00 The Series 2001 Bonds maturing in the years 2008 through 2014 are serial Convertible CABs and the Series 2001 Bonds maturing in the years 2021 and 2031 are Term Bonds (the “Series 2001 Turbo Bonds”). 40 Turbo Redemption The Series 2001 Turbo Bonds are subject to mandatory redemption in whole or in part prior to their stated maturity, from amounts on deposit in the Turbo Redemption Account on any Distribution Date for which notice can be given pursuant to the Indenture, at the redemption price of 100% of the principal amount thereof together with interest accrued thereon to the date fixed for redemption and without premium; provided, however, that any such redemption shall be in a minimum amount of $5,000. Any redemption of Series 2001 Turbo Bonds pursuant to the Indenture shall be made in chronological order of maturity and by lot within a maturity. Amounts on deposit in the Debt Service Reserve Account will not be available to make Turbo Redemption payments on Series 2001 Turbo Bonds, except as specified in “ʊMandatory Clean–Up Redemption” described below. For purposes of defeasance, such Series 2001 Turbo Bonds shall have the assumed redemption schedule of Turbo Redemption Payments set forth in the Indenture. Monies in the Turbo Redemption Account may not be applied to purchase Series 2001 Turbo Bonds on the open market. Lump Sum Prepayment The Series 2001 Bonds are subject to prepayment at any time at par plus accrued interest to the date fixed for redemption, upon receipt by the Indenture Trustee of a lump sum payment received as a payment from a PM which results in, or is due to, a release of that PM from all or a portion of its future obligations under the MSA (a “Lump Sum Payment”) existing and available on any date chosen by the Corporation for such mandatory prepayment. Each Lump Sum Payment shall be allocated to prepay Principal pro rata among Series 2001 Bonds with accrued interest thereon to, but not including the date of redemption (except when a Convertible CAB is being redeemed on or before the end of its Accretion Period, in which case no accrued interest shall be due and payable), pro rata. Extraordinary Prepayment If an Event of Default has occurred, on each semiannual Series 2001 Bonds Distribution Date and such other Series 2001 Bonds Distribution Date selected by the Indenture Trustee or the Corporation, Series 2001 Bonds will be prepaid pro rata from available funds on deposit in the Debt Service Reserve Account and the Extraordinary Prepayment Account, without premium (any such prepayment, an “Extraordinary Prepayment”). Collections are only deposited in the Extraordinary Prepayment Account to the extent all current and past due interest (not included in Accreted Value) on the Series 2001 Bonds has been paid. Optional Redemption The Series 2001 Bonds with a stated maturity on or after May 15, 2012 are subject to redemption at the Corporation’s option at any time on or after May 15, 2011, in whole or in part, at a redemption price of 100% of the principal amount thereof together with accrued interest to the date fixed for redemption, without premium. The Series 2001 Bonds to be redeemed at the Corporation’s option shall be selected by the Corporation in its sole discretion. Mandatory Clean–Up Redemption The Series 2001 Bonds are subject to mandatory redemption in full at the principal amount thereof from moneys withdrawn from the Debt Service Reserve Account and any other accounts on any Series 2001 Bonds Distribution Date on which the amount on deposit in the Debt Service Reserve Account is greater than the sum of the principal amount of Series 2001 Bonds that would remain Outstanding after giving effect to the application of amounts described in part (B) under “SECURITY 41 FOR THE BONDS – Flow of Funds” on such Series 2001 Bonds Distribution Date and any amounts due as termination payments or otherwise under investment contracts, forward delivery agreements or swaps relating to the Series 2001 Bonds upon such mandatory redemption of the Series 2001 Bonds. ESTIMATED SOURCES AND USES OF PROCEEDS The Corporation will make available to the Government $6,459,573.96 of the proceeds of the Series 2006 Bonds for deposit to the Construction Account on behalf of the Government for the account of the Tobacco Settlement Health Care and Capital Improvement Fund to finance several capital hospital and health department projects. The Corporation will apply the balance of the proceeds to pay certain costs of issuance of the Series 2006 Bonds. The expected application of such amounts is set forth below: SOURCES OF FUNDS Initial Principal Amount of Bonds.................................................... $ 7,290,008.85 TOTAL SOURCES $ 7,290,008.85 USES OF FUNDS Construction Account....................................................................... $ 6,459,573.96 Underwriter’s Discount ................................................................... 358,434.89 Costs of Issuance .............................................................................. 472,000.00 TOTAL USES .................................................................................. $ 7,290,008.85 SUMMARY OF THE MASTER SETTLEMENT AGREEMENT The following is a brief summary of certain provisions of the MSA. This summary is not complete and is subject to, and qualified in its entirety by reference to, the copy of the MSA which is attached hereto as Appendix B. General The MSA is an industry–wide settlement of litigation between the Settling States and the OPMs and was entered into between the attorneys general of the Settling States and the OPMs on November 23, 1998. The MSA provides for other tobacco companies (the “SPMs”) to become parties to the MSA. The three OPMs together with the 44 SPMs are referred to as the “PMs.” The settlement represents the resolution of a large potential financial liability of the PMs for smoking–related injuries, the costs of which have been borne and will likely continue to be borne by cigarette consumers. Pursuant to the MSA, the Settling States agreed to settle all their past, present and future smoking–related claims against the PMs in exchange for agreements and undertakings by the PMs concerning a number of issues. These issues include, among others, making payments to the Settling States, abiding by more stringent advertising restrictions and funding educational programs, all in accordance with the terms and conditions set forth in the MSA. Distributors of PMs’ products are also covered by the settlement of such claims to the same extent as the PMs. 42 Parties to the MSA The Settling States are all of the states, territories and the District of Columbia, except for the four states (Florida, Minnesota, Mississippi and Texas) that separately settled with the OPMs prior to the adoption of the MSA (the “Previously Settled States”). According to the National Association of Attorneys General (“NAAG”), as of April 5, 2006, 47 PMs have signed the MSA. The chart below identifies each of the PMs which was a party to the MSA as of April 5, 2006: OPMs SPMs Lorillard Tobacco Company Anderson Tobacco Company, LLC Lignum–2, Inc. Philip Morris, USA (formerly Philip Morris Incorporated) Bekenton, S.A. Mac Baren Tobacco Company A/S Reynolds American, Inc. (formerly R.J. Reynolds Tobacco Company and Brown & Williamson Tobacco Corporation) Canary Islands Cigar Co. Monte Paz (Compania Industrial de Tabacos Monte Paz S.A.) Caribbean–American Tobacco Corp. (CATCORP) NASCO Products, Inc. Chancellor Tobacco Company, PLC P.T. Djarum Commonwealth Brands, Inc. Pacific Stanford Manufacturing Corporation Cutting Edge Enterprises, Inc. Peter Stokkebye Tobaksfabrik A/S Daughters & Ryan, Inc. Planta Tabak–manufaktur Gmbh & Co. M/s. Dhanraj International Poschl Tabak GmbH & Co. KG Eastern Company S.A.E. Premier Manufacturing Incorporated Farmer’s Tobacco Co. of Cynthiana, Inc. Santa Fe Natural Tobacco Company, Inc. General Tobacco (Vibo Corporation d/b/a General Tobacco) Sherman’s 1400 Broadway N.Y.C. Inc. House of Prince A/S Societe Nationale d’Exploitation Industrielle des Tabacs et Allumettes (SEITA) Imperial Tobacco Limited/ITL (USA) Limited Tabacalera del Este, S.A. (TABESA) International Tobacco Group (Las Vegas), Inc. Top Tobacco, LP Japan Tobacco International USA, Inc. U.S. Flue Cured Tobacco Growers, Inc. King Maker Marketing Vector Tobacco Inc. Konci G&D Management Group (USA) Inc. Virginia Carolina Corporation, Inc. Kretek International Von Eicken Group Lane Limited Wind River Tobacco Company, LLC Liberty Brands, LLC VIP Tobacco USA, LTD. (formerly Winner Sales Company) Liggett Group, Inc. ZNF International, LLC (no current brands) The MSA restricts PMs from transferring their tobacco product brands, cigarette product formulas and cigarette businesses (unless they are being transferred exclusively for use outside the United States) to any entity that is not a PM under the MSA, unless the transferee agrees to assume the obligations of the transferring PM under the MSA related to such brands, formulas or businesses. The MSA expressly provides that the payment obligations of each PM are not the obligation or responsibility of any affiliate of such PM and, further, that the remedies, penalties or sanctions that may be imposed or assessed in connection with a breach or violation of the MSA will only apply to the PMs and not against any other person or entity. 43 Scope of Release Under the MSA, the PMs and the other “Released Parties” (defined below) are released from: • claims based on past conduct, acts or omissions (including any future damages arising therefrom) in any way relating to the use, sale, distribution, manufacture, development, advertising, marketing or health effects of, or exposure to, or research statements or warnings regarding, tobacco products; and • monetary claims based on future conduct, acts or omissions in any way relating to the use of or exposure to tobacco products manufactured in the ordinary course of business, including future claims for reimbursement of healthcare costs. This release is binding upon each Settling State and any of its past, present and future agents, officials acting in their official capacities, legal representatives, agencies, departments, commissions and divisions. The MSA is further stated to be binding on the following persons, to the full extent of the power of the signatories to the MSA to release past, present and future claims on their behalf: (i) any Settling State’s subdivisions (political or otherwise, including, but not limited to, municipalities, counties, parishes, villages, unincorporated districts and hospital districts), public entities, public instrumentalities and public educational institutions; and (ii) persons or entities acting in a parens patriae, sovereign, quasi–sovereign, private attorney general, qui tam, taxpayer, or any other capacity, whether or not any of them participate in the MSA (a) to the extent that any such person or entity is seeking relief on behalf of or generally applicable to the general public in such Settling State or the people of such Settling State, as opposed solely to private or individual relief for separate and distinct injuries, or (b) to the extent that any such entity (as opposed to an individual) is seeking recovery of healthcare expenses (other than premium or capitation payments for the benefit of present or retired state employees) paid or reimbursed, directly or indirectly, by a Settling State. All such persons or entities are referred to collectively in the MSA as “Releasing Parties.” To the extent that the Attorney General of the Virgin Islands does not have the power or authority to bind any of the Releasing Parties in the Virgin Islands, the release of claims contemplated by the MSA may be ineffective as to the Releasing Parties and any amounts that become payable by the PMs on account of their claims, whether by way of settlement, stipulated judgment or litigated judgment, will trigger the Litigating Releasing Parties Offset. See “–Adjustments to Payments” below. The release inures to the benefit of all PMs and their past, present and future affiliates, and the respective divisions, officers, directors, employees, representatives, insurers, lenders, underwriters, tobacco–related organizations, trade associations, suppliers, agents, auditors, advertising agencies, public relations entities, attorneys, retailers and distributors of any PM or any such affiliate (and the predecessors, heirs, executors, administrators, successors and assigns of each of the foregoing). They are referred to in the MSA individually as a “Released Party” and collectively as the “Released Parties.” However, the term “Released Parties” does not include any person or entity (including, but not limited to, an affiliate) that is an NPM at any time after the MSA execution date, unless such person or entity becomes a PM. 44 Overview of Payments by the Participating Manufacturers; MSA Escrow Agent The MSA requires that the PMs make several types of payments, including Initial Payments, Annual Payments and Strategic Contribution Payments.* See “–Initial Payments,” “–Annual Payments” and “–Strategic Contribution Payments” below. These payments (with the exception of the up–front Initial Payment) are subject to various adjustments and offsets, some of which could be material. See “Adjustments to Payments” below. SPMs were not required to make Initial Payments. Thus far, the OPMs have made all of the Initial Payments, and the PMs have made the Annual Payments for 2000, 2001, 2002, 2003, 2004 and 2005 (subject to certain withholdings described in “RISK FACTORS–Other Potential Payment Decreases Under the Terms of the MSA” herein). Pledged TSRs do not include any payments made before the date of delivery of the Series 2006 Bonds. See “–Payments Made to Date” below. Strategic Contribution Payments are scheduled to begin April 15, 2008 and continue through April 15, 2017. Payments required to be made by the OPMs are calculated by reference to the OPM’s domestic shipments of cigarettes, with the amount of the payments adjusted annually roughly in proportion to the changes in total volume of cigarettes shipped by the OPMs in the United States in the preceding year. Payments to be made by the PMs are recalculated each year, based on the United States market share of each individual PM for the prior year, with consideration under certain circumstances, for the profitability of each OPM. The Annual Payments and Strategic Contribution Payments required to be made by the SPMs are based on increases in their shipment market share. Pursuant to an escrow agreement (the “MSA Escrow Agreement”) established in conjunction with the MSA, remaining Annual Payments and Strategic Contribution Payments are to be made to Citibank, N.A., as escrow agent (the “MSA Escrow Agent”), which in turn will disburse the funds to the Settling States. Beginning with the payments due in the year 2000, the MSA Auditor has, among other things, calculated and determined the amount of all payments owed pursuant to the MSA, the adjustments, reductions and offsets thereto (and all resulting carry–forwards, if any), the allocation of such payments, adjustments, reductions, offsets and carry–forwards among the PMs and among the Settling States. This information is not publicly available and, the MSA Auditor has agreed to maintain the confidentiality of all such information, except that the MSA Auditor may provide such information to PMs and the Settling States as set forth in the MSA. The flow of Annual Payments and Strategic Contribution Payments to the Indenture Trustee under the MSA and the MOU is depicted in a diagram under “SUMMARY STATEMENT–Flow of TSR Payments.” Initial Payments Initial Payments were made only by the OPMs. In December 1998, the OPMs collectively made an up–front Initial Payment of $2.40 billion. The 2000 Initial Payment, which had a scheduled base amount of $2.47 billion, was paid in December 1999 in the approximate amount of $2.13 billion due to various adjustments. The 2001 Initial Payment, which had a scheduled base amount of $2.55 billion, was paid in December 2000 in the approximate amount of $2.04 billion after taking into account various adjustments and an earlier overpayment. The 2002 Initial Payment, which had a scheduled base amount of $2.62 billion, was paid in December 2001, in the approximate amount of $1.89 billion after taking into * Other payments that are required to be made by the PMs, such as payments of attorneys’ fees and payments to a national foundation established pursuant to the MSA, are not allocated to the States and are not available to the Bondholders, and consequently are not discussed here. 45 account various adjustments and a deposit made to the Disputed Payments Account. Approximately $204 million, which was substantially all of the money previously deposited in the Disputed Payments Account for payment to the Settling States, was distributed to the Settling States with the Annual Payment due April 15, 2002. The 2003 Initial Payment, which had a scheduled base amount of $2.70 billion, was paid in December 2002 and January 2003, in the approximate aggregate amount of $2.14 billion after taking into account various adjustments. Annual Payments The OPMs and the other PMs are required to make Annual Payments on each April 15 in perpetuity. The PMs made the first six Annual Payments due April 15 in each of the years 2000 through 2005, the scheduled base amounts of which (before adjustments discussed below) were $4.5 billion, $5.0 billion, $6.5 billion, $6.5 billion, $8.0 billion and $8.0 billion, respectively. After application of the adjustments, the Annual Payment made (i) in April 2000 was approximately $3.5 billion, (ii) in April 2001 was approximately $4.1 billion, (iii) in April 2002 was approximately $5.2 billion, (iv) in April 2003 was approximately $5.1 billion, (v) in April 2004 was approximately $6.2 billion, and (vi) in April 2005 was approximately $6.3 billion. The scheduled base amount (before adjustments discussed below) of each Annual Payment, subject to adjustment, is set forth below: Annual Payments Year Base Amount Year Base Amount 2000* $4,500,000,000 2010 $8,139,000,000 2001* 5,000,000,000 2011 8,139,000,000 2002* 6,500,000,000 2012 8,139,000,000 2003* 6,500,000,000 2013 8,139,000,000 2004* 8,000,000,000 2014 8,139,000,000 2005* 8,000,000,000 2015 8,139,000,000 2006 8,000,000,000 2016 8,139,000,000 2007 8,000,000,000 2017 8,139,000,000 2008 8,139,000,000 Thereafter 9,000,000,000 2009 8,139,000,000 * The 2000 through 2005 Annual Payments have been made. However, subsequent adjustments to these Annual Payments may impact subsequent Annual Payments and Strategic Contribution Payments. The respective portion of each base amount applicable to each OPM is calculated by multiplying the base amount by the OPM’s Relative Market Share during the preceding calendar year. The base Annual Payments in the above table will be increased by at least the minimum 3% Inflation Adjustment, adjusted by the Volume Adjustment, reduced by the Previously Settled States Reduction, and further adjusted by the other adjustments described below. The SPMs are required to make Annual Payments if their respective market share increases above the higher of their respective 1998 Market Share or 125% of their 1997 Market Share. “Relative Market Share” is defined as an OPM’s percentage share of the number of cigarettes shipped by all OPMs in or to the 50 states, the District of Columbia and Puerto Rico (defined hereafter as the “United States”), as measured by the OPM’s reports of shipments to Management Science Associates, Inc. (or any successor acceptable to all the OPMs and a majority of the attorneys general of the Settling States who are also members of the NAAG executive committee). The term “cigarette” is defined in the MSA to mean any product that contains nicotine, is intended to be burned, contains tobacco 46 and is likely to be offered to, or purchased by, consumers as a cigarette and includes “roll–your–own” tobacco. The base amounts shown in the table above are subject to the following adjustments applied in the following order: • the Inflation Adjustment, • the Volume Adjustment, • the Previously Settled States Reduction, • the Non–Settling States Reduction, • the NPM Adjustment, • the Offset for Miscalculated or Disputed Payments, • the Litigating Releasing Parties Offset, and • the Offset for Claims–Over. Application of these adjustments resulted in a material reduction of TSRs from the scheduled base amounts of the Annual Payments made by the PMs in April of the years 2000 through 2005, as discussed below under the heading “–Payments Made to Date.” Strategic Contribution Payments The OPMs are also required to make Strategic Contribution Payments on April 15, 2008 and on April 15 of each year thereafter through 2017. The base amount of each Strategic Contribution Payment is $861 million. The respective portion of each base amount applicable to each OPM is calculated by multiplying the base amount by the OPM’s Relative Market Share during the preceding calendar year. The SPMs will be required to make Strategic Contribution Payments if their respective market share increases above the higher of their respective 1998 market share or 125% of their 1997 market share. The base amounts of the Strategic Contribution Payments are subject to the following adjustments applied in the following order: • the Inflation Adjustment, • the Volume Adjustment, • the Non–Settling States Reduction, • the NPM Adjustment, • the Offset for Miscalculated or Disputed Payments, • the Litigating Releasing Parties Offset, and • the Offset for Claims–Over. Adjustments to Payments The base amounts of the Initial Payments were, and the Annual Payments and Strategic Contribution Payments shown in the tables above are, subject to certain adjustments to be applied sequentially and in accordance with formulas contained in the MSA. Inflation Adjustment. The base amount of the Annual Payments and Strategic Contribution Payments are increased each year to account for inflation. The increase in each year will be 3% or a percentage equal to the percentage increase in the Consumer Price Index for All Urban Consumers (the “CPI”) (or such other similar measures as may be agreed to by the Settling States and the PMs) for the 47 preceding year, whichever is greater (the “Inflation Adjustment”). The inflation adjustment percentages are compounded annually on a cumulative basis beginning in 1999 and were first applied in 2000. Volume Adjustment. Each of the Initial Payments was, and each of the Annual Payments and Strategic Contribution Payments is, increased or decreased by an adjustment which accounts for fluctuations in the number of cigarettes shipped by the OPMs in or to the United States (the “Volume Adjustment”). If the aggregate number of cigarettes shipped in or to the United States by the OPMs in any given year (the “Actual Volume”) is greater than 475,656,000,000 cigarettes (the “Base Volume”), the base amount allocable to the OPMs is adjusted to equal the base amount (in the case of Annual Payments and Strategic Contribution Payments after application of the Inflation Adjustment) multiplied by a ratio, the numerator of which is the Actual Volume and the denominator of which is the Base Volume. If the Actual Volume in a given year is less than the Base Volume, the base amount due from the OPMs (in the case of Annual Payments and Strategic Contribution Payments, after application of the Inflation Adjustment) is decreased by 98% of the percentage by which the Actual Volume is less than the Base Volume, multiplied by such base amount. If, however, the aggregate operating income of the OPMs from sales of cigarettes in the United States during the year (the “Actual Operating Income”) is greater than $7,195,340,000, as adjusted for inflation in accordance with the Inflation Adjustment (the “Base Operating Income”), all or a portion of the volume reduction is added back (the “Income Adjustment”). The amount by which the Actual Operating Income of the OPMs exceeds the Base Operating Income is multiplied by the percentage of the allocable shares under the MSA represented by Settling States in which State–Specific Finality has been reached and divided by four, then added to the payment due. However, in no case will the amount added back due to the increase in operating income exceed the amount deducted due to the decrease in domestic volume. Any add–back due to an increase in Actual Operating Income will be allocated among the OPMs on a Pro Rata basis in accordance with their respective increases in Actual Operating Income over 1997 Base Operating Income. Previously Settled States Reduction. The base amounts of the Annual Payments (as adjusted by the Inflation Adjustment and the Volume Adjustment, if any) are subject to a reduction reflecting the four states that had settled with the OPMs prior to the adoption of the MSA (Mississippi, Florida, Texas and Minnesota) (the “Previously Settled States Reduction”). The Previously Settled States Reduction reduces by 12.4500000% each applicable payment on or before December 31, 2007, by 12.2373756% each applicable payment between January 1, 2008 and December 31, 2017, and by 11.0666667% each applicable payment on or after January 1, 2018. The SPMs are not entitled to any reduction pursuant to the Previously Settled States Reduction. Initial Payments were not and Strategic Contribution Payments are not subject to the Previously Settled States Reduction. Non–Settling States Reduction. In the event that the MSA terminates as to any Settling State, the remaining Annual Payments and Strategic Contribution Payments due from the PMs shall be reduced to account for the absence of such state. This adjustment has no effect on the amounts to be collected by states which remain a party to the MSA, and the reduction is therefore not detailed. Non–Participating Manufacturers Adjustment. If the aggregate market share of the PMs in any year falls more than 2% below the aggregate market share held by those same PMs in 1997, and if a nationally recognized economic firm determines that the disadvantages experienced as a result of the provisions of the MSA were a significant factor contributing to the market share loss for the year in question, then an adjustment (the “NPM Adjustment”) is applied to the subsequent year’s Annual Payment and Strategic Contribution Payment due to those Settling States that have been proven to not diligently enforce their Model Statutes. The 1997 market share percentage for the PMs, less 2%, is 48 defined as the “Base Aggregate Participating Manufacturer Market Share.” If the PMs’ actual aggregate market share is between 0% and 16Ҁ% less than the Base Aggregate Participating Manufacturer Market Share, the amounts paid by the PMs will be decreased by three times the percentage decrease in the PMs’ actual aggregate market share. If, however, the aggregate market share loss from the Base Aggregate Participating Manufacturer Market Share is greater than 16Ҁ%, the NPM Adjustment will be calculated as follows: NPM Adjustment = 50% + [50% / (Base Aggregate Participating Manufacturer Market Share – 16Ҁ%)] x [market share loss – 16Ҁ%] Regardless of how the NPM Adjustment is calculated, it is always subtracted from the total Annual Payments and Strategic Contribution Payments due from the PMs. The NPM Adjustment applies only to the Annual Payments and Strategic Contribution Payments, and does not apply at all if the number of cigarettes shipped in or to the United States in the year prior to the year in which the payment is due by all manufacturers that were PMs prior to December 7, 1998 exceeds the number of cigarettes shipped in or to the United States by all such PMs in 1997. The MSA further provides that in no event shall the amount of an NPM Adjustment applied to any Settling State in any given year exceed the amount of Annual and Strategic Contribution Payments to be received by such Settling State in such year. The NPM Adjustment is also state–specific, in that a Settling State may avoid or mitigate the effects of an NPM Adjustment by enacting and enforcing the Model Statute or a Qualifying Statute (as defined herein). Any Settling State that adopts and diligently enforces a Model Statute or Qualifying Statute is exempt from the NPM Adjustment. The Virgin Islands has adopted the Model Statute. The decrease in total funds available due to the NPM Adjustment is allocated on a Pro Rata basis among those Settling States that either (i) did not enact and diligently enforce the Model Statute or Qualifying Statute, or (ii) enacted a Model Statute or Qualifying Statute that is declared invalid or unenforceable by a court of competent jurisdiction. If a Settling State enacts and diligently enforces the Model Statute but it is declared invalid or unenforceable by a court of competent jurisdiction, the NPM Adjustment will not exceed 65% of the amount of such state’s allocated payment. If a Qualifying Statute is held invalid or unenforceable, however, such state is not entitled to any protection from the NPM Adjustment. Moreover, if a state adopts a Model Statute or a Qualifying Statute but then repeals it or amends it in such fashion that it is no longer a Qualifying Statute, then such state will no longer be entitled to any protection from the NPM Adjustment. At all times, a state’s protection from the NPM Adjustment is conditioned upon the diligent enforcement of its Model Statute or Qualifying Statute, as the case may be. See “RISK FACTORS–Other Potential Payment Decreases under the Terms of the MSA–NPM Adjustment” and “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT–MSA Provisions Relating to Model/Qualifying Statutes” above. The MSA provides that if any Settling State resolves claims against any NPM that are comparable to any of the claims released in the MSA on overall terms more favorable to such NPM, the same terms will be extended to all PMs. Offset for Miscalculated or Disputed Payments. If the MSA Auditor receives notice of a miscalculation of an Initial Payment made by an OPM, an Annual Payment made by a PM within four years or a Strategic Contribution Payment made by a PM within four years, the MSA Auditor will recalculate the payment and make provisions for rectifying the error (the “Offset for Miscalculated or Disputed Payments”). There are no time limits specified for recalculations although the MSA Auditor is required to determine amounts promptly. Disputes as to determinations by the MSA Auditor may be submitted to binding arbitration governed by the Federal Arbitration Act. In the event that mispayments have been made, they will be corrected through payments with interest (in the event of underpayments) or 49 withholdings with interest (in the event of overpayments). Interest will be at the prime rate, except where a party fails to pay undisputed amounts or fails to provide necessary information readily available to it, in which case a penalty rate of prime plus 3% applies. If a PM disputes any required payment, it must determine whether any portion of the payment is undisputed and pay that amount for disbursement to the Settling States. The disputed portion is required to be paid into the Disputed Payments Account pending resolution of the dispute. Failure to pay such disputed amounts into the Disputed Payments Account can result in liability for interest at the penalty rate if the disputed amount was in fact properly due and owing. Litigating Releasing Parties Offset. If any Releasing Party initiates litigation against a PM for any of the claims released in the MSA, the PM may be entitled to an offset against such PM’s payment obligation under the MSA (the “Litigating Releasing Parties Offset”). A defendant PM may offset dollar–for–dollar any amount paid in settlement, stipulated judgment or litigated judgment against the amount to be collected by the applicable Settling State under the MSA only if the PM has taken all ordinary and reasonable measures to defend that action fully and only if any settlement or stipulated judgment was consented to by the state attorney general. The Litigating Releasing Parties Offset is state– specific. Any reduction in MSA payments as a result of the Litigating Releasing Parties Offset would apply only to the Settling State of the Releasing Party. Offset for Claims–Over. If a Releasing Party pursues and collects on a released claim against an NPM or a retailer, supplier or distributor arising from the sale or distribution of tobacco products of any NPM or the supply of component parts of tobacco products to any NPM (collectively, the “Non– Released Parties”), and the Non–Released Party in turn successfully pursues a claim for contribution or indemnification against a Released Party (as defined herein), the Releasing Party must (i) reduce or credit against any judgment or settlement such Releasing Party obtains against the Non–Released Party the full amount of any judgment or settlement such Non–Released Party may obtain against the Released Party, and (ii) obtain from such Non–Released Party for the benefit of such Released Party a satisfaction in full of such Non–Released Party’s judgment or settlement against the Released Party. In the event that such reduction or satisfaction in full does not fully relieve the Released Party of its duty to pay to the Non– Released Party, the PM is entitled to a dollar–for–dollar offset from its payment to the applicable Settling State (the “Offset for Claims–Over”). For purposes of the Offset for Claims–Over, any person or entity that is enumerated in the definition of Releasing Party set forth above is treated as a Releasing Party without regard to whether the applicable attorney general had the power to release claims of such person or entity. The Offset for Claims–Over is state–specific and would apply only to MSA payments owed to the Settling State of the Releasing Party. Subsequent Participating Manufacturers SPMs are obligated to make Annual Payments and Strategic Contribution Payments which are made at the same times as the Annual Payments and Strategic Contribution Payments to be made by OPMs. Annual Payments and Strategic Contribution Payments for SPMs are calculated differently, however, from Annual Payments and Strategic Contribution Payments for OPMs. Each SPM’s payment obligation is determined according to its market share if, and only if, its “Market Share” (defined in the MSA to mean a manufacturer’s share, expressed as a percentage, of the total number of cigarettes sold in the United States in a given year, as measured by excise taxes (or similar taxes, in the case of Puerto Rico)), for the year preceding the payment exceeds its “Base Share,” defined as the higher of its 1998 Market Share or 125% of its 1997 Market Share. If an SPM executes the MSA after February 22, 1999, its 1997 or 1998 Market Share, as applicable, is deemed to be zero. Fourteen of the current 44 SPMs signed the MSA on or before the February 22, 1999 deadline. For each Annual Payment and Strategic Contribution Payment, each SPM is required to pay an amount equal to the base amount of the Annual Payment and the Strategic Contribution Payment owed by 50 the OPMs, collectively, adjusted for the Volume Adjustment described above but prior to any other adjustments, reductions or offsets, multiplied by (i) the difference between that SPM’s Market Share for the preceding year and its Base Share, divided by (ii) the aggregate Market Share of the OPMs for the preceding year. Other than the application of the Volume Adjustment, payments by the SPMs are subject to the same adjustments (including the Inflation Adjustment), reductions and offsets as are the payments made by the OPMs, with the exception of the Previously Settled States Reduction. Because the Annual Payments and Strategic Contribution Payments to be made by the SPMs are calculated in a manner different from the calculations for Annual Payments and Strategic Contribution Payments to be made by the OPMs, a change in market share between the OPMs and the SPMs could cause the amount of Annual Payments and Strategic Contribution Payments required to be made by the PMs in the aggregate to be greater or less than the amount that would be payable if their market share remained the same. In certain circumstances, an increase in the market share of the SPMs could increase the aggregate amount of Annual Payments and Strategic Contribution Payments because the Annual Payments and Strategic Contribution Payments to be made by the SPMs are not adjusted for the Previously Settled States Reduction. However, in other circumstances, an increase in the market share of the SPMs could decrease the aggregate amount of Annual Payments and Strategic Contribution Payments because the SPMs are not required to make any Annual Payments or Strategic Contribution Payments unless their market share increases above their Base Share, or because of the manner in which the Inflation Adjustment is applied to each SPM’s payments. Payments Made to Date As required, the OPMs have made all the Initial Payments and the PMs have made the first six Annual Payments. These amounts are not pledged to the payment of the Series 2006 Bonds. Under the MSA, the computation of Initial Payments, Annual Payments and Strategic Contribution Payments by the MSA Auditor is confidential and may not be used for purposes other than those stated in the MSA.. MSA Payments Made to Date Year Type of Payment Actual Payment 1999/2000 Upfront and Initial Payment $801,935.43 2001 Initial Payment 336,186.29 2002 Initial Payment 9,733.76 2003 Initial Payment 371,220.43 2000 Annual Payment 592,395.62 2001 Annual Payment; Federal Tax Refund 696,377.55 2002 Annual Payment 556,834.03 2003 Annual Payment; Settlement Payment 1,212,323.29 2004 Annual Payment 1,095,408.65 2005 Annual Payment 1,106,657.93 Both the Settling States and one or more of the PMs are disputing or have disputed the calculations of the Initial Payments for the years 2000 through 2003, and Annual Payments for the years 2000 through 2005. In addition, subsequent revisions in the information delivered to the MSA Auditor (on which the MSA Auditor’s calculations of the Initial and Annual Payments are based) have in the past and may in the future result in a recalculation of the payments shown above. Such revisions may also result in routine recalculation of future payments. No assurance can be given as to the magnitude of any such recalculation and such recalculation could trigger the Offset for Miscalculated or Disputed Payments. 51 “Most Favored Nation” Provisions In the event that any non–foreign governmental entity other than the federal government should reach a settlement of released claims with PMs that provides more favorable terms to the governmental entity than does the MSA to the Settling States, the terms of the MSA will be modified to match those of the more favorable settlement. Only the non–economic terms may be considered for comparison. In the event that any Settling State should reach a settlement of released claims with NPMs that provides more favorable terms to the NPM than the MSA does to the PMs, the terms of the MSA will be deemed modified to match the NPM settlement, but only with respect to the particular Settling State. In the event that any Settling State agrees to reduce the burden placed upon any PM by the terms of the MSA, the MSA will be deemed modified so that each PM enjoys the same reduction in burden, but only with respect to the particular Settling State. In no event will the adjustments discussed in this paragraph modify the MSA with regard to other Settling States. State–Specific Finality and Final Approval The MSA provides that payments could not be disbursed to the individual Settling States until the occurrence of each of two events: State–Specific Finality and Final Approval. “State–Specific Finality” means, with respect to an individual Settling State, that (i) such state has settled its pending or potential litigation against the tobacco companies with a consent decree, which decree has been approved and entered by a court within the Settling State, and (ii) the time for all appeals against the consent decree has expired. All Settling States have achieved State Specific Finality. “Final Approval” marked the approval of the MSA by the Settling States and means the earlier of (i) the date on which at least 80% of the Settling States, both in terms of number and dollar volume entitlement to the proceeds of the MSA, have reached State–Specific Finality, or (ii) June 30, 2000. Final Approval was achieved on November 12, 1999. Disbursement of Funds from Escrow Account The MSA Auditor makes all calculations necessary to determine the amounts to be paid by each PM, as well as the amounts to be disbursed to each of the Settling States. Not less than 40 days prior to the date on which any payment is due, the MSA Auditor must provide copies of the disbursement calculations to all parties to the MSA, who must within 30 days prior to the date on which such payment is due advise the other parties if it questions or challenges the calculations. The final calculation is due from the MSA Auditor not less than 15 days prior to the payment due date. The calculation is subject to further adjustments if previously missing information is received. In the event of a challenge to the calculations, the non–challenged part of a payment shall be processed in the normal course. Challenges will be submitted to binding arbitration. The information provided by the MSA Auditor to the Virgin Islands with respect to calculations of amounts to be paid by PMs is confidential under the terms of the MSA and may not be disclosed to the Corporation or the Owners. Disbursement of the funds by the MSA Escrow Agent from the escrow accounts shall occur within ten business days of receipt of the particular funds. The MSA Escrow Agent will disburse the funds due to, or as directed by, each Settling State in accordance with instructions received from that state. 52 Advertising and Marketing Restrictions; Educational Programs The MSA prohibits the PMs from certain advertising, marketing and other activities that may promote the sale of cigarettes and smokeless tobacco products (“Tobacco Products”). Under the MSA, the PMs are generally prohibited from targeting persons under 18 years of age within the Settling States in the advertising, promotion or marketing of Tobacco Products and from taking any action to initiate, maintain or increase smoking by underage persons within the Settling States. Specifically, the PMs may not: (i) use any cartoon characters in advertising, promoting, packaging or labeling Tobacco Products; (ii) distribute any free samples of Tobacco Products except in a restricted facility where the operator thereof is able to ensure that no underage persons are present; or (iii) provide to any underage person any item in exchange for the purchase of Tobacco Products or for the furnishing of proofs–of–purchase coupons. The PMs are also prohibited from placing any new outdoor and transit advertising, and are committed to remove any existing outdoor and transit advertising for Tobacco Products in the Settling States. Other examples of prohibited activities include, subject to limited exceptions: (i) the sponsorship of any athletic, musical, artistic or other social or cultural event in exchange for the use of tobacco brand names as part of the event; (ii) the making of payments to anyone to use, display, make reference to or use as a prop any Tobacco Product or item bearing a tobacco brand name in any motion picture, television show, theatrical production, music performance, commercial film or video game; (iii) the sale or distribution in the Settling States of any non–tobacco items containing tobacco brand names or selling messages; and (iv) the sale of packs of cigarettes containing fewer than 20 cigarettes until at least December 31, 2001. In addition, the PMs have agreed under the MSA to provide funding for the organization and operation of a charitable foundation (the “Foundation”) and educational programs to be operated within the Foundation. The main purpose of the Foundation will be to support programs to reduce the use of Tobacco Products by underage persons and to prevent diseases associated with the use of Tobacco Products. On March 31, 1999, and on March 31 of each subsequent year for a period of nine years thereafter, each OPM is required to pay its Relative Market Share of $25,000,000 (which is not subject to any adjustments, offsets or reductions pursuant to the MSA) to fund the Foundation. In addition, each OPM is required to pay its Relative Market Share of $250,000,000 on March 31, 1999, and $300,000,000 on March 31 of each of the subsequent four years to fund the Foundation. Furthermore, each PM may be required to pay its Relative Market Share of $300,000,000 on April 15, 2004, and on April 15 of each year thereafter in perpetuity if, during the year preceding the year when payment is due, the sum of the Market Shares of the PMs equals or exceeds 99.05%. The Foundation may also be funded by contributions made by other entities. Remedies upon the Failure of a PM to Make a Payment Each PM is obligated to pay when due the undisputed portions of the total amount calculated as due from it by the MSA Auditor’s final calculation. Failure to pay such portion shall render the PM liable for interest thereon from the date such payment is due to (but not including) the date paid at the prime rate published from time to time by The Wall Street Journal or, in the event The Wall Street Journal is no longer published or no longer publishes such rate, an equivalent successor reference to rate determined by the MSA Auditor, plus three percentage points. In addition, any Settling State may bring an action in court to enforce the terms of the MSA. Before initiating such proceeding, the Settling State is required to provide thirty (30) days’ written notice to the attorney general of each Settling State, to NAAG and to each PM of its intent to initiate proceedings. 53 Termination of Agreement The MSA is terminated as to a Settling State if (i) the MSA or consent decree in that jurisdiction is disapproved by a court and the time for an appeal has expired, the appeal is dismissed or the disapproval is affirmed, or (ii) the representations and warranties of the attorney general of that jurisdiction relating to the ability to release claims are breached or not effectively given. In addition, in the event that a PM enters bankruptcy and fails to perform its financial obligations under the MSA, the Settling States, by vote of at least 75% of the Settling States, both in terms of number and of entitlement to the proceeds of the MSA, may terminate certain financial obligations of that particular manufacturer under the MSA. The MSA provides that if it is terminated, then the statute of limitations with respect to released claims will be tolled from the date the Settling State signed the MSA until the later of the time permitted by applicable law or one year from the date of termination and the parties will jointly move for the reinstatement of the claims and actions dismissed pursuant to the MSA. The parties will return to the positions they were in prior to the execution of the MSA. Severability By its terms, most of the major provisions of the MSA are not severable from its other terms. If a court materially modifies, renders unenforceable or finds unlawful any nonseverable provision, the attorneys general of the Settling States and the OPMs are to attempt to negotiate substitute terms. If any OPM does not agree to the substitute terms, the MSA terminates in all Settling States affected by the court’s ruling. Amendments and Waivers The MSA may be amended by all PMs and Settling States affected by the amendment. The terms of any amendment will not be enforceable against any Settling State which is not a party to the amendment. Any waiver will be effective only against the parties to such waiver and only with respect to the breach specifically waived. MSA Provisions Relating to Model/Qualifying Statutes General. The MSA sets forth the schedule and calculation of payments to be made by OPMs to the Settling States. As described above, the Annual Payments are subject to, among other adjustments and reductions, the NPM Adjustment, which may reduce the amount of money that a Settling State receives pursuant to the MSA. The NPM Adjustment will reduce payments of a PM if such PM experiences certain losses of market share in the United States as a result of participation in the MSA. Settling States may mitigate the effect of the NPM Adjustment by taking certain actions, including the adoption and diligent enforcement of a statute, law, regulation or rule (a “Qualifying Statute”) which eliminates the cost disadvantages that PMs experience in relation to NPMs as a result of the provisions of the MSA. “Qualifying Statute,” as defined in Section IX(d)(2)(E) of the MSA, means a statute, regulation, law, and/or rule adopted by a Settling State that “effectively and fully neutralizes the cost disadvantages that PMs experience vis–a–vis NPMs within such Settling State as a result of the provisions of the MSA.” Exhibit T to the MSA sets forth a model form of Qualifying Statute (a “Model Statute”) that will qualify as a Qualifying Statute so long as the statute is enacted without modification or addition (except for particularized state procedural or technical requirements) and is not enacted in conjunction with any other legislative or regulatory proposal. The MSA also provides a procedure by 54 which a Settling State may enact a statute that is not the Model Statute and receive a determination from a nationally recognized firm of economic consultants that such statute is a Qualifying Statute. If a Settling State continuously has a Qualifying Statute in full force and effect and diligently enforces the provisions of such statute, the MSA states that the payments allocated to such Settling State will not be subject to a reduction due to the NPM Adjustment. Furthermore, the MSA dictates that the aggregate amount of the NPM Adjustment is to be allocated, in a Pro Rata manner, among all Settling States that do not adopt and enforce a Qualifying Statute. In addition, if the NPM Adjustment allocated to a particular Settling State exceeds its allocated payment, that excess is to be reallocated equally among the remaining Settling States that have not adopted and enforced a Qualifying Statute. Thus, Settling States that do not adopt and enforce a Qualifying Statute will receive reduced allocated payments if an NPM Adjustment is in effect. The MSA provides an economic incentive for most states to adopt and diligently enforce a Qualifying Statute. The Virgin Island has enacted a Model Statute, which is a Qualifying Statute. The MSA provides that if a Settling State enacts a Qualifying Statute that is a Model Statute and uses its best efforts to keep the Model Statute in effect, but a court invalidates the statute, then, although that state remains subject to the NPM Adjustment, the NPM Adjustment is limited to no more, on a yearly basis, than 65% of the amount of such state’s allocated payment (including reallocations described above). The determination from a nationally recognized firm of economic consultants that a statute constitutes a Qualifying Statute is subject to reconsideration in certain circumstances and such statute may later be deemed not to constitute a Qualifying Statute. In the event that a Qualifying Statute that is not a Model Statute is invalidated or declared unenforceable by a court, or, upon reconsideration by a nationally recognized firm of economic consultants, is determined not to be a Qualifying Statute, the Settling State that adopted such statute will become fully subject to the NPM Adjustment. Moreover, if a state adopts a Model Statute or a Qualifying Statute but then repeals it or amends it in such fashion that it is no longer a Qualifying Statute, then such state will no longer be entitled to any protection from the NPM Adjustment. At all times, a state’s protection from the NPM Adjustment is conditioned upon the diligent enforcement of its Model Statute or Qualifying Statute, as the case may be. Summary of the Model Statute. One of the objectives of the MSA (as set forth in the Findings and Purpose section of the Model Statute) is to shift the financial burdens of cigarette smoking from the Settling States to the tobacco product manufacturers. The Model Statute provides that any tobacco manufacturer who does not join the MSA would be subject to the provisions of the Model Statute because, as provided under the MSA, [i]t would be contrary to the policy of the state if tobacco product manufacturers who determine not to enter into such a settlement could use a resulting cost advantage to derive large, short–term profits in the years before liability may arise without ensuring that the state will have an eventual source of recovery from them if they are proven to have acted culpably. It is thus in the interest of the state to require that such manufacturers establish a reserve fund to guarantee a source of compensation and to prevent such manufacturers from deriving large, short–term profits and then becoming judgment–proof before liability may arise. Accordingly, pursuant to the Model Statute, a tobacco manufacturer that is an NPM under the MSA must deposit an amount for each cigarette it sells into an escrow account (which amount increases on a yearly basis, as set forth in the Model Statute). 55 The Virgin Islands’ Qualifying Statute defines “units sold” as the number of individual cigarettes sold in the Virgin Islands by the applicable tobacco product manufacturer, whether directly or through a distributor, retailer, or similar intermediary or intermediaries, during the year in question, as measured by excise taxes collected by the Virgin Islands on packs bearing the excise tax stamp or imprint of the Virgin Islands, or on roll–your–own tobacco. The amounts deposited in the escrow accounts by the NPMs may only be used in limited circumstances. Although the NPM receives the interest or other appreciation on such funds, the principal may only be released (i) to pay a judgment or settlement on any claim of the type that would have been released by the MSA brought against such NPM by the applicable Settling State or any Releasing Party located within such state; (ii) to the extent that the NPM establishes that the amount it was required to deposit into the escrow account was greater than such state’s allocable share of the total payments that such NPM would have been required to make if it had been a Participating Manufacturer under the MSA (as determined before certain adjustments or offsets); or (iii) 25 years after the date that the funds were placed into escrow (less any amounts paid out pursuant to clause (i) or (ii)). Legislation to amend such clause (ii) in the release provision of the Model Statute is being prepared for introduction by the Governor to the Virgin Islands Legislature, but has not been adopted. The amendment would change the release calculation from being based on the Virgin Islands’ allocable share of the payments the NPM would have made if it were a signatory to the MSA to being based on the payments that the NPM would have made as a signatory to the MSA on account of cigarettes sold in the Virgin Islands by the NPM. No assurance can be made that such legislation will be introduced to the Legislature, or if introduced, that it will be adopted. If the NPM fails to place funds into escrow as required, the attorney general of the applicable Settling State may bring a civil action on behalf of the state against the NPM. If a court finds that an NPM violated the statute, it may impose civil penalties in the following amounts: (i) an amount not to exceed 5% of the amount improperly withheld from escrow per day of the violation and in an amount not to exceed 100% of the original amount improperly withheld from escrow; (ii) in the event of a knowing violation, an amount not to exceed 15% of the amount improperly withheld from escrow per day of the violation and in an amount not to exceed 300% of the original amount improperly withheld from escrow; and (iii) in the event of a second knowing violation, the court may prohibit the NPM from selling cigarettes to consumers within such state (whether directly or through a distributor, retailer or similar intermediary) for a period not to exceed two years. NPMs include foreign tobacco manufacturers that intend to sell cigarettes in the United States that do not themselves engage in an activity in the United States but may not include the wholesalers of such cigarettes. However, enforcement of the Model Statute against such foreign manufacturers that do not do business in the United States may be difficult. See “RISK FACTORS–Litigation Challenging the MSA, the Qualifying Statutes and Related Legislation” herein. Status of Virgin Islands Model Statute. The Virgin Islands Model Statute, in the form of the Model Statute attached to the MSA as Exhibit T, has been enacted as Section 20 of Bill No. 23-0306 enacted as Act 6391. Counsel for the OPMs has confirmed in writing that the Virgin Islands Model Statute, if maintained and preserved in its current form, would constitute a Model Statute within the meaning of the MSA. See “RISK FACTORS–Litigation Challenging the MSA, the Qualifying Statutes and Related Legislation” herein. 56 TOBACCO INDUSTRY The following description of the domestic tobacco industry has been compiled from certain publicly available documents of the tobacco companies and their parent companies and certain publicly available analyses of the tobacco industry and other public sources. Certain of the companies file annual, quarterly, and certain other reports with the Securities and Exchange Commission (the “SEC”). Such reports are available on the SEC’s website (www.sec.gov). The following information does not, nor is it intended to, provide a comprehensive description of the domestic tobacco industry, the business, legal and regulatory environment of the participants therein, or the financial performance or capability of such participants. Although the Corporation has no independent knowledge of any facts indicating that the following information is inaccurate in any material respect, the Corporation has not independently verified this information and cannot and does not warrant the accuracy or completeness of this information. To the extent that reports submitted to the MSA Auditor by the PMs pursuant to the requirements of the MSA provide information that is pertinent to the following discussion, including market share information, the Virgin Islands Attorney General has not consented to the release of such information pursuant to the confidentiality provisions of the MSA. Prospective investors in the Series 2006 Bonds should conduct their own independent investigations of the domestic tobacco industry to determine if an investment in the Series 2006 Bonds is consistent with their investment objectives. Retail market share information, based upon shipments or sales as reported by the OPMs for purposes of their filings with the SEC, may be different from Relative Market Share for purposes of the MSA and the respective obligations of the PMs to contribute to Annual Payments and Strategic Contribution Payments. The Relative Market Share information reported is confidential under the MSA. See “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT–Overview of Payments by the Participating Manufacturers; MSA Escrow Agent –Annual Payments” and “–Strategic Contribution Payments” herein. Additionally, aggregate market share information, based upon shipments as reported by Loews Corporation and reflected in the chart herein entitled “Manufacturers’ Domestic Market Share Based on Shipments” is different from that utilized in the bond structuring assumptions. See “METHODOLOGY AND BOND STRUCTURING ASSUMPTIONS” herein. MSA payments are computed based in part on cigarette shipments in or to the 50 states of the United States, the District of Columbia and Puerto Rico. The Global Insight Consumption Report states that the quantities of cigarettes shipped and cigarettes consumed within the 50 states of the United States, the District of Columbia and Puerto Rico may not match at any given point in time as a result of various factors, such as inventory adjustments, but are substantially the same when compared over a period of time. Industry Overview According to publicly available documents of Loews Corporation, the parent company of Lorillard, Inc., the three leading manufacturers of tobacco products in the United States in 2005 collectively accounted for approximately 86.1% of the domestic cigarette retail industry when measured by shipment volume. The market for cigarettes in the United States divides generally into premium and discount sales, approximately 71.2% and 28.8%, respectively, measured by volume of all domestic cigarette sales in 2005, as reported by Altria Group, Inc. Philip Morris USA Inc. (“Philip Morris”), a wholly–owned subsidiary of Altria Group, Inc. (“Altria”), is the largest tobacco company in the United States. Prior to a name change on January 27, 2003, the Altria Group, Inc. was named Philip Morris Companies Inc. In its Annual Report on Form 10– K filed with the SEC for the year ended December 31, 2005, Altria reported that Philip Morris’ domestic retail market share in 2005 was 50.0% (based on sales), which represents an increase of 0.2 share points 57 from its self–reported 2004 domestic retail market share (based on sales) of 49.8%. Philip Morris’ major premium brands are Marlboro, Virginia Slims and Parliament. Its principal discount brand is Basic. Marlboro is the largest selling cigarette brand in the United States, with approximately 40.0% of the United States domestic retail share for 2005, and has been the world’s largest–selling cigarette brand since 1972. Philip Morris’ market share information is based on data from the IRI/Capstone Total Retail Panel (“IRI/Capstone”), which was designed to measure market share in retail stores selling cigarettes, but was not designed to capture Internet or direct mail sales. Reynolds American Inc. (“Reynolds American”), is the second largest tobacco company in the United States. Reynolds American became the parent company of R.J. Reynolds Tobacco Company (“Reynolds Tobacco”) on July 30, 2004, following a transaction that combined Reynolds Tobacco and the U.S. operations of Brown & Williamson Tobacco Corp. (“B&W”), previously the third largest tobacco company in the United States, under the Reynolds Tobacco name. In connection with this merger, Reynolds American assumed all pre–merger liabilities, costs and expenses of B&W, including those related to the MSA and related agreements and with respect to pre–merger litigation of B&W. Reynolds American is also the parent company of Lane Limited, a manufacturer and marketer of specialty tobacco products, and Santa Fe Natural Tobacco Company, Inc., both of which are SPMs. In its Annual Report on Form 10–K filed with the SEC for the year ended December 31, 2005, Reynolds American reported that its domestic retail market share in 2005 was 29.98% (measured by sales volume), which represents a decrease of 0.84 share points from the 30.82% 2004 combined domestic retail market share of Reynolds Tobacco and B&W. Reynolds American’s major premium brands are Camel, Kool, Winston and Salem. Its discount brands include Doral and Pall Mall. Reynolds American’s market share information is based on IRI/Capstone data. Lorillard, Inc. (“Lorillard”), a wholly–owned subsidiary of Loews Corporation, is the third largest tobacco company in the United States. On February 6, 2002, in an initial public offering, Loews Corporation issued shares of Carolina Group stock, which is intended to reflect the economic performance of Loews Corporation’s stock in Lorillard. Carolina Group is not a separate legal entity. In its Annual Report on Form 10–K filed with the SEC for the year ended December 31, 2005, Loews Corporation reported that Lorillard’s domestic retail market share in 2005 was 9.2% (measured by shipment volume), which represents an increase of 0.4 share points from its self–reported 2004 domestic retail market share of 8.8%. Lorillard’s principal brands are Newport, Kent, True, Maverick, and Old Gold. Its largest selling brand is Newport, which accounted for approximately 91.6% of Lorillard’s unit sales in 2005. Market share data reported by Lorillard is based on data made available by Management Science Associates, Inc. (“MSAI”), an independent third–party database management organization that collects wholesale shipment data. Based on the domestic retail market shares discussed above, the remaining share of the United States retail cigarette market in 2004 was held by a number of other domestic and foreign cigarette manufacturers, including Liggett Group, Inc. (“Liggett”), a wholly–owned subsidiary of Vector Group Ltd. (“Vector”). Liggett, the operating successor to the Liggett & Myers Tobacco Company, is the fourth largest tobacco company in the United States. In its Form 10–K filed with the SEC for the year ended December 31, 2005, Vector reported that Liggett’s domestic retail market share in 2005 was 2.2% (measured by shipment volume and using MSAI data), which represents a decrease of 0.1 share points from its self–reported 2004 domestic retail market share of 2.3%. All of Liggett’s unit volume in 2005 was in the discount segment. Its brands include Liggett Select, Grand Prix, Eve, Pyramid and USA. In November 2001, Vector Group launched OMNI, which Vector Group claims is the first reduced– carcinogen cigarette that tastes, smokes and burns like other premium cigarettes. Additionally, Vector Group announced that it has introduced three varieties of a low nicotine cigarette in eight states, one of which is reported to be virtually nicotine free, under the brand name QUEST. Liggett and Vector Group Ltd. are SPMs under the MSA. 58 Shipment Trends The following table sets forth the approximate comparative positions of the leading producers in the United States domestic tobacco industry, each of which is an OPM under the MSA, based upon cigarette shipments. Individual domestic OPM shipments are as reported in the publicly available documents of the OPMs. Total industry shipments are based on data made available by MSAI, as reported in publicly available documents of Loews Corporation. Effective in June of 2004, MSAI changed the way it reports market share information to include actual units shipped by Commonwealth Brands, Inc. (“CBI”), an SPM who markets deep discount brands, and implemented a new model for estimating unit sales of smaller, primarily deep discount marketers. MSAI has restated its reports to reflect these changes as of January 1, 2001. As a result of these changes, market shares for the three OPMs are lower than had been reflected under MSAI’s prior methodology and market shares for CBI and other low volume companies are higher. All industry volume and market share information herein reflects MSAI’s revised reporting data. Despite the effects of MSAI’s new estimation model for deep discount manufacturers, Lorillard management has indicated that it continues to believe that volume and market share information for the deep discount manufacturers are understated and, correspondingly, market share information for the larger manufacturers are overstated by MSAI. Manufacturers’ Domestic Market Share Based on Shipments(1) Manufacturer 2003 2004 2005 Philip Morris 46.7% 47.4% 48.7% Reynolds American(2) 29.6 28.8 28.2 Lorillard 8.6 8.8 9.2 Other(3) 15.1 15.0 13.9 (1) Aggregate market share as reported by Loews Corporation is different from that utilized in the bond structuring assumptions and may differ from the market share information reported by the OPMs for purposes of their filings with the SEC. (2) Prior to July 2004, represents the combined market share of Reynolds Tobacco and B&W. (3) The market share based on shipments of the tobacco manufacturers, other than the OPMs, has been determined by subtracting the total retail market share percentages of the OPMs as reported in the publicly available documents of Loews Corporation from 100%. The following table sets forth the industry’s cigarette shipments in the United States for the three years ended December 31, 2005. The MSA payments are calculated in part on shipments by the OPMs in or to the United States rather than consumption. Years Ended December 31 Shipments (Billions of Cigarettes)(1) 2003 401.2 2004 394.5 2005 381.0 (1) As reported in SEC filings and other publicly available documents of the Loews Corporation and Reynolds American, based on MSAI data. 59 The information in the foregoing tables, which has been obtained from publicly available documents but has not been independently verified, may differ materially from the amounts used by the MSA Auditor for calculating Annual Payments and Strategic Contribution Payments under the MSA. Consumption Trends According to December 2005 estimates of the United States Department of Agriculture (the “USDA”) Economic Research Service (“USDA–ERS”), smokers in the United States consumed an estimated 378 billion cigarettes in 2005, which would represent a decrease of approximately 2.6% from the previous year. The USDA–ERS attributes declining cigarette use to a combination of higher consumer costs due to tax and price increases, restrictions on where people can smoke and greater awareness of the health risks associated with smoking. Annual per capita consumption (per adult over 18) has dropped from 2,505 cigarettes in 1995 to an estimated 1,770 in 2004. The following chart sets forth domestic cigarette consumption from 2001 through 2005: Years Ended December 31 U.S. Domestic Consumption (Billions of Cigarettes)(1) 2001 425 2002 415 2003 400 2004 388 2005* 378 * Estimated (1) USDA–ERS. The MSA Payments are calculated in part based on domestic industry shipments rather than consumption. The Global Insight Consumption Report states that the quantities of cigarettes shipped and cigarettes consumed within the 50 states of the United States, the District of Columbia and Puerto Rico may not match at any given time as a result of various factors, such as inventory adjustments, but are substantially the same when compared over a period of time. Distribution, Competition and Raw Materials Cigarette manufacturers sell tobacco products to wholesalers (including distributors), large retail organizations, including chain stores, and the armed services. They and their affiliates and licensees also market cigarettes and other tobacco products worldwide, directly or through export sales organizations and other entities with which they have contractual arrangements. The market for tobacco products is highly competitive and is characterized by brand recognition and loyalty, with product quality, price, marketing and packaging constituting the significant methods of competition. Promotional activities include, in certain instances, allowances, the distribution of incentive items, price reductions and other discounts. Considerable marketing support, merchandising display and competitive pricing are generally necessary to maintain or improve a brand’s market position. Increased selling prices and taxes on cigarettes have resulted in additional price sensitivity of cigarettes at the consumer level and in a proliferation of discounts and of brands in the discount segment of the market. Generally, sales of cigarettes in the discount segment are not as profitable as those in the premium segment. The tobacco products of the cigarette manufacturers and their affiliates and licensees are advertised and promoted through various media, although television and radio advertising of cigarettes is prohibited in the United States. The domestic tobacco manufacturers have agreed to additional marketing restrictions in the United States as part of the MSA and other settlement agreements. They are still 60 permitted, however, to conduct advertising campaigns in magazines, at retail cigarette locations, in direct mail campaigns targeted at adult smokers, and in other adult media. Grey Market A price differential exists between cigarettes manufactured for sale abroad and cigarettes manufactured for United States sale. Consequently, a domestic grey market has developed in cigarettes manufactured for sale abroad, but instead diverted for domestic sales that compete with cigarettes manufactured for domestic sale. The U.S. federal government and all states, except Massachusetts, have enacted legislation prohibiting the sale and distribution of grey market cigarettes. In addition, Reynolds American has reported that it has taken legal action against certain distributors and retailers who engage in such practices. Regulatory Issues Regulatory Restrictions and Legislative Initiatives. The tobacco industry is subject to a wide range of laws and regulations regarding the marketing, sale, taxation and use of tobacco products imposed by local, state, federal and foreign governments. Various state governments have adopted or are considering, among other things, legislation and regulations that would increase their excise taxes on cigarettes, restrict displays and advertising of tobacco products, establish ignition propensity standards for cigarettes, raise the minimum age to possess or purchase tobacco products, ban the sale of “flavored” cigarette brands, require the disclosure of ingredients used in the manufacture of tobacco products, impose restrictions on smoking in public and private areas, restrict the sale of tobacco products directly to consumers or other unlicensed recipients, including over the Internet and charging state employees who smoke higher health insurance premiums than non-smoking state employees. For example, on January 26, 2006, the California Environmental Protection Agency Air Resources Board (the “Air Board”) declared environmental tobacco smoke as a toxic air contaminant. It is unclear what, if any, regulatory steps the Air Board will take as a consequence of this finding. Five states, Alabama, Georgia, Idaho, Kentucky and West Virginia, charge higher health insurance premiums to smokers than non- smokers, and a number of states have implemented legislation that allows employers to provide incentives to employees who do not smoke. In addition, the U.S. Congress may consider legislation further increasing the federal excise tax, regulation of cigarette manufacturing and sale by the U.S. Food and Drug Administration (the “FDA”), amendments to the Federal Cigarette Labeling and Advertising Act to require additional warnings, reduction or elimination of the tax deductibility of advertising expenses, implementation of a national standard for “fire–safe” cigarettes, regulation of the retail sale of cigarettes over the Internet and in other non–face–to–face retail transactions, such as by mail order and telephone, and banning the delivery of cigarettes by the U.S. Postal Service. In March 2005, for example, bipartisan legislation was reintroduced in the U.S. Congress which would provide the FDA with authority to broadly regulate tobacco products. Philip Morris has indicated its strong support for this legislation. No assurance can be given that future federal or state legislation or administrative regulations will not seek to further regulate, restrict or discourage the manufacture, sale and use of cigarettes. In 1964, the Report of the Advisory Committee to the Surgeon General of the U.S. Public Health Service concluded that cigarette smoking was a health hazard of sufficient importance to warrant appropriate remedial action. Since 1966, federal law has required a warning statement on cigarette packaging. Since 1971, television and radio advertising of cigarettes has been prohibited in the United States. Cigarette advertising in other media in the United States is required to include information with respect to the “tar” and nicotine yield of cigarettes, as well as a warning statement. 61 During the past four decades, various laws affecting the cigarette industry have been enacted. In 1984, Congress enacted the Comprehensive Smoking Education Act. Among other things, the Smoking Education Act: • establishes an interagency committee on smoking and health that is charged with carrying out a program to inform the public of any dangers to human health presented by cigarette smoking; • requires a series of four health warnings to be printed on cigarette packages and advertising on a rotating basis; • increases type size and area of the warning required in cigarette advertisements; and • requires that cigarette manufacturers provide annually, on a confidential basis, a list of ingredients added to tobacco in the manufacture of cigarettes to the Secretary of Health and Human Services. Since the initial report in 1964, the Secretary of Health, Education and Welfare (now the Secretary of Health and Human Services) and the Surgeon General have issued a number of other reports which purport to find the nicotine in cigarettes addictive and to link cigarette smoking and exposure to cigarette smoke with certain health hazards, including various types of cancer, coronary heart disease and chronic obstructive lung disease. These reports have recommended various governmental measures to reduce the incidence of smoking. In 1992, the federal Alcohol, Drug Abuse and Mental Health Act was signed into law. This act requires states to adopt a minimum age of 18 for purchases of tobacco products and to establish a system to monitor, report and reduce the illegal sale of tobacco products to minors in order to continue receiving federal funding for mental health and drug abuse programs. Federal law prohibits smoking in scheduled passenger aircraft, and the U.S. Interstate Commerce Commission has banned smoking on buses transporting passengers interstate. Certain common carriers have imposed additional restrictions on passenger smoking. State and Local Regulation; Private Restrictions. Legislation imposing various restrictions on public smoking also has been enacted in all of the states and many local jurisdictions. A number of states have enacted legislation designating a portion of increased cigarette excise taxes to fund either anti– smoking programs, healthcare programs or cancer research. In addition, educational and research programs addressing healthcare issues related to smoking are being funded from industry payments made or to be made under the MSA. On January 27, 2006, the California Environmental Protection Agency Air Resources Board declared environmental tobacco smoke as a toxic air contaminant. The Air Resources Board is now required to prepare a report assessing the need and appropriate degree of control of environmental tobacco smoke. Several states have enacted or have proposed legislation or regulations that would require cigarette manufacturers to disclose the ingredients used in the manufacture of cigarettes. In September 2003, the Massachusetts Department of Public Health (“MDPH”) announced its intention to hold public hearings on amendments to its tobacco regulations. The proposed regulations would delete any ingredients–reporting requirement. (The United States Court of Appeals for the Second Circuit previously affirmed a ruling that the Massachusetts ingredient–reporting law was unconstitutional.) MDPH has proposed to inaugurate extensive changes to its regulations requiring tobacco companies to report nicotine yield rating for cigarettes according to methods prescribed by MDPH. Because MDPH 62 withdrew its notice for a public hearing in November 2003, it is impossible to predict the final form any new regulations will take or the effect they will have on the PMs. On May 21, 1999, the OPMs filed lawsuits in the United States District Court for the District of Massachusetts to enjoin implementation of certain Massachusetts attorney general regulations concerning the advertisement and display of tobacco products. The regulations went beyond those required by the MSA, and banned outdoor advertising of tobacco products within 1,000 feet of any school or playground, as well as any indoor tobacco advertising placed lower than five feet in stores within the 1,000–foot zone. The district court ruled against the industry on January 25, 2000, and the United States Court of Appeals for the First Circuit affirmed. The United States Supreme Court granted the industry’s petition for writ of certiorari on January 8, 2001, and ruled in favor of RJR Tobacco and the rest of the industry on June 28, 2001. The Supreme Court found that the regulations were preempted by the Federal Cigarette Labeling and Advertising Act, which precludes states from imposing any requirement or prohibition based on smoking and health with respect to the advertising or promotion of cigarettes labeled in conformity with federal law. In June 2000, the New York state legislature passed legislation charging New York’s Office of Fire Prevention and Control (“OFPC”) with developing standards for “fire–safe” or self–extinguishing cigarettes. On December 31, 2003, OFPC issued a final standard with accompanying regulations that requires all cigarettes offered for sale in New York State after June 28, 2004 to achieve specified test results when placed on 10 layers of filter paper in controlled laboratory conditions. Reynolds American’s operating companies that sell cigarettes in New York state have provided written certification to both the OFPC and the Office of the Attorney General for New York that each of their cigarette brand styles currently sold in New York has been tested and has met the performance standards set forth in the OFPC’s regulations. Design and manufacturing changes were made for cigarettes manufactured for sale in New York to comply with the standard. In June 2005, Vermont became the second state to pass legislation requiring that all cigarettes sold within the state be self–extinguishing. Vermont’s legislation goes into effect May 1, 2006. In October 2005, California enacted a similar law that will take effect on January 1, 2007. Similar legislation is being considered in a number of other states. Varying standards from state to state could have an adverse effect on the PMs. According to the Global Insight Consumption Report, all of the states and the District of Columbia now require smoke–free indoor air to some degree or in some public places. The most comprehensive bans have been enacted since 1998 in ten states and a few large cities. On March 26, 2003, New York State enacted legislation banning smoking in indoor workplaces, including restaurants and bars. Delaware had banned smoking in all indoor public areas in 2002. These states joined California in imposing comprehensive statewide smoking bans. The California ban has been in place since 1998. Also in 2003, Connecticut, Maine, and Florida passed laws which ban smoking in restaurants and bars. Similarly comprehensive bans took effect in March 2003 in New York City and Dallas and in Boston in May 2003. Since then Massachusetts, Montana, Rhode Island, and Vermont have established similar bans. Effective July 1, 2005, California banned smoking in its prisons. Voters in Washington State passed a ballot initiative on November 8, 2005 which bans smoking in all public places effective January 2006. The restrictions are stronger than those in other states as they include a ban on outdoor smoking within 25 feet of the entrances of restaurants and other public places. In January 2006, New Jersey adopted a comprehensive ban which will go into effect in April 2006. At the same time New Jersey increased the minimum legal age to purchase cigarettes from 18 to 19 years. Three states, Alabama, Alaska, and Utah, also set the minimum age at 19. In December 2005 Chicago passed a smoking ban which also applies within 15 feet of entrances to restaurants and public places. It went into effect in January 2006, with an exemption for bars until July 2008. In January 2006, the District of Columbia enacted an extensive ban which will be fully in effect in January 2007. On March 17, 2006, the Colorado legislature approved a statewide outdoor smoking ban, which is expected to be approved by the Governor, 63 and Calabasas, California became the first city in the United States to ban smoking in virtually all public places, including open spaces. Smoking will only be permitted in designated areas at shopping malls or workplaces. The ban also permits people to demand a smoker put out his cigarette in public. It is expected that these restrictions will continue to proliferate. Currently, at least four states, Arkansas, Iowa, Maryland and Utah, are considering comprehensive bans. The American Nonsmokers’ Rights Foundation documents clean indoor air ordinances by local governments throughout the U.S. As of January 3, 2006, there were 2,129 municipalities in the U.S. with indoor smoking restrictions. In addition, the Settling States’ attorneys general were recently successful in obtaining agreement from Philip Morris and Reynolds American that they will remove product advertising from various magazines that are circulated in schools for educational purposes. Voluntary Private Sector Regulation. In recent years, many employers have initiated programs restricting or eliminating smoking in the workplace and providing incentives to employees who do not smoke, including charging higher health insurance premiums to employees who smoke, and many common carriers have imposed restrictions on passenger smoking more stringent than those required by governmental regulations. Similarly, many restaurants, hotels and other public facilities have imposed smoking restrictions or prohibitions more stringent than those required by governmental regulations, including outright bans. International Agreements. On March 1, 2003, the member nations of the World Health Organization concluded four years of negotiations on an international treaty, the Framework Convention on Tobacco Control (the “FCTC”), aimed at imposing greater legal liability on tobacco manufacturers, banning advertisements of tobacco products (especially to youths), raising taxes and requiring safety labeling and comprehensive listing of ingredients on packaging, among other things. The FCTC entered into force on February 27, 2005 for the first forty countries, including the United States, that had ratified the treaty prior to November 30, 2004. As of April 27, 2005, 168 countries signed and 64 countries ratified the FCTC. On June 29, 2004 the FCTC was closed for signature, but there is no deadline for ratification. It has been reported that as of November 3, 2005, 100 countries had ratified the FCTC. Excise Taxes. Cigarettes are also currently subject to substantial excise taxes in the United States. The federal excise tax per pack of 20 cigarettes is currently $0.39. All states, the District of Columbia and the Commonwealth of Puerto Rico currently impose taxes at levels ranging from $0.07 per pack in South Carolina to $2.46 per pack in Rhode Island. In addition, certain municipalities also impose an excise tax on cigarettes ranging up to $1.50 per pack in New York City and $2.00 per pack in Cook County, Illinois, which includes Chicago. According to the Global Insight Consumption Report, excise tax increases were enacted in 20 states and New York City in 2002, in 13 states in 2003, in 11 states in 2004, and in 8 states (Kentucky, Maine, Minnesota, New Hampshire, North Carolina, Ohio, Virginia, and Washington) in 2005. The average state excise tax as of February 10, 2006 was $0.917 per pack. Currently, at least ten states are considering proposed excise tax increases, including a $1.00 per pack increase outside of New York City and a $0.50 per pack increase within New York City in a budget proposal by the Governor of the State of New York. An additional $2.60 per pack on cigarettes is being proposed for the November 2006 ballot in California. If such proposed increase becomes effective, California would have the nation’s highest cigarette tax. These tax increases and other legislative or regulatory measures could severely increase the cost of cigarettes, limit or prohibit the sale of cigarettes, make cigarettes less appealing to smokers or reduce the addictive qualities of cigarettes. 64 Civil Litigation The tobacco industry has been the target of litigation for many years. Both individual and class action lawsuits have been brought by or on behalf of smokers alleging that smoking has been injurious to their health, and by non–smokers alleging harm from ETS, also known as “secondhand smoke.” Plaintiffs in these actions seek compensatory and punitive damages aggregating billions of dollars. The MSA does not release PMs from liability in either individual or class action cases. Philip Morris, for example, has reported that, as of December 31, 2005, there were 12 cases on appeal in which verdicts were returned against Philip Morris, including a compensatory and punitive damages verdict totaling approximately $10.1 billion in the Price case in Illinois. The Supreme Court of Illinois subsequently reversed the verdict in Price and instructed the trial court to dismiss the case in its entirety. It has been reported that the plaintiffs have filed a motion asking the Supreme Court to reconsider its decision in Price. See “–Class Action Lawsuits” below. Healthcare cost recovery cases have also been brought by governmental and non–governmental healthcare providers seeking, among other things, reimbursement for healthcare expenditures incurred in connection with the treatment of medical conditions allegedly caused by smoking. The PMs are also exposed to liability in these cases, because the MSA only settled healthcare cost recovery claims of the Settling States. Litigation has also been brought against certain PMs and their affiliates in foreign countries. Pending claims related to tobacco products generally fall within four categories: (i) smoking and health cases alleging personal injury and purporting to be brought on behalf of a class of individual plaintiffs, including cases brought pursuant to a 1997 settlement agreement involving claims by flight attendants alleging injury from exposure to ETS in aircraft cabins (the Broin II cases, discussed below), (ii) smoking and health cases alleging personal injury brought on behalf of individual plaintiffs, (iii) healthcare cost recovery cases brought by governmental (both domestic and foreign) and non– governmental plaintiffs seeking reimbursement for healthcare expenditures allegedly caused by cigarette smoking and/or disgorgement of profits, and (iv) other tobacco–related litigation, including class action suits alleging that the use of the terms “Lights” and “Ultra Lights” constitute deceptive and unfair trade practices, suits by former asbestos manufacturers seeking contribution or reimbursement for amounts expended in connection with the defense and payment of asbestos claims that were allegedly caused in whole or in part by cigarette smoking, and various antitrust suits and suits by foreign governments seeking to recover damages for taxes lost as a result of the allegedly illegal importation of cigarettes into their jurisdictions. Plaintiffs seek various forms of relief, including compensatory and punitive damages, treble/multiple damages and other statutory damages and penalties, creation of medical monitoring and smoking cessation funds, disgorgement of profits, legal fees, and injunctive and equitable relief. Defenses raised in these cases include lack of proximate cause, statutes of limitation and preemption by the Federal Cigarette Labeling and Advertising Act. According to Altria, since January 1999 and through February 15, 2006, verdicts have been returned in 44 smoking and health cases, Lights/Ultra Lights cases and healthcare cost recovery cases in which Philip Morris was a defendant. Verdicts in favor of Philip Morris and other tobacco industry defendants were returned in 28 of these cases. Verdicts in favor of plaintiffs were returned in 16 cases. Appeals or post–trial motions by defendants and by plaintiffs are pending in many of these cases. Of the 16 cases in which verdicts were returned in favor of plaintiffs, four have reached final resolution with respect to Philip Morris. A $17.8 million verdict against defendants in a healthcare cost recovery case in New York was reversed, and all claims were dismissed with prejudice in February 2005 in the Blue Cross/Blue Shield case. In October 2004, after exhausting all appeals, Philip Morris paid $3.3 million in an individual smoking and health case in Florida (the Eastman case, discussed below). In March 2005, after exhausting all appeals, Philip Morris paid $17 million in an individual smoking and health case in California (the Henley case, discussed below). In addition, in February 2005, after exhausting all appeals, Reynolds Tobacco, due to its obligation to indemnify B&W, paid approximately $9.1 million in the 65 Boerner case (see below) and on June 17, 2005, after exhausting all appeals, Reynolds Tobacco paid a $196,416 plus interest and costs judgment in an individual case in Kansas (the Burton case, discussed below). In December 2005, after exhausting all appeals, Philip Morris paid $328,759 plus interest as its share of the judgment amount in a flight attendant ETS case in Florida (the French case, discussed below), and will also pay attorneys fees. Class Action Lawsuits. The MSA does not release the PMs from liability in class action lawsuits. Plaintiffs have brought claims as class actions on behalf of large numbers of individuals for damages allegedly caused by smoking, price fixing and consumer fraud. One OPM has reported that, as of February 15, 2006, there were 34 such class actions pending against it in the United States, as well as one each in Poland, Brazil and Israel. Plaintiffs in class action smoking and health lawsuits allege essentially the same theories of liability against the tobacco industry as those in the individual lawsuits. Other class action plaintiffs allege consumer fraud or violations of consumer protection or unfair trade statutes. Plaintiffs historically have had limited success in obtaining class certification, a prerequisite to proceeding as a class action lawsuit, because of the individual circumstances related to each smoker’s election to smoke and the individual nature of the alleged harm. One OPM reports that class certification has been denied or reversed in 56 smoking and health class actions involving that OPM. To date, plaintiffs have successfully maintained class certification in federal and state court class action cases in at least the following states: California, Florida, Illinois, Louisiana, Massachusetts, Minnesota, Missouri, New York, North Carolina, Ohio, Oregon, Washington and West Virginia. One OPM reports that 17 federal courts that have considered the issue, including two courts of appeals, have rejected class certification in smoking and health cases. Only one federal district court has certified a smoker class action (In re Simon (II) Litigation, discussed below); but that class was subsequently decertified by the United States Court of Appeals for the Second Circuit. On September 6, 2000, in In re Simon (II) Litigation, lawyers for plaintiffs in ten tobacco–related cases pending in United States District Court for the Eastern District of New York filed suit in the same court (before Judge Weinstein) to consolidate the pending cases and seek certification of a class and subclasses to obtain compensatory and punitive damages from the tobacco industry defendants. The pending cases included individual and purported nationwide class action lawsuits alleging tobacco– related personal injuries, as well as healthcare cost recovery cases brought by union trust funds, an insurance plan and an asbestos fund. The suit sought to certify a nationwide class action to consolidate all punitive damage aspects of the pending cases for a single trial and to try the compensatory damage aspects of the pending claims separately. On September 19, 2002, Judge Weinstein certified a class to hear the punitive damages claims. The class consisted of all smokers diagnosed with a variety of illnesses, including lung cancer, emphysema and some forms of heart disease, after April 9, 1993. In May 2005, the U.S. Court of Appeals for the Second Circuit, in a unanimous opinion, decertified the class. Plaintiffs’ motion for rehearing en banc was denied on August 8, 2005, and the time for plaintiffs to petition the United States Supreme Court for further review has expired. On February 6, 2006, Judge Weinstein dismissed the case upon plaintiffs’ motion. He stayed the order for 30 days to allow potential plaintiffs who expressed interest in the case to receive notices and to protect their interest. Two of the 10 original cases, Falise v. American Tobacco Co., and H.K. Porter Company, Inc. v. The American Tobacco Company were dismissed in June 2001 and July 2001, respectively. Other plaintiffs who would have been part of the Simon II class remain free to pursue their own individual lawsuits. A number of state courts also have rejected class certification. In May 2000, Maryland’s highest court ordered the trial court to vacate its certification of a class in Richardson v. Philip Morris. The parties agreed to dismiss the case in March 2001. In September 2000, in Walls v. American Tobacco Co., an Oklahoma state court answered a series of state law questions, certified to the state court by the federal court where the purported class was filed, in such a way that led the parties to stipulate that the case 66 should not be certified as a class action in federal court and that the individual plaintiffs would dismiss their federal court cases without prejudice. In October 2000, the federal court issued its order refusing to certify the case as a class action, and dismissed the individual plaintiffs’ cases. In December 2000, in Geiger v. American Tobacco Co., the Appellate Division of the Supreme Court of New York affirmed the trial court’s denial of class action status to a purported class defined as all New York residents, including their heirs, representatives, and estates, who contracted lung or throat cancer as a result of smoking cigarettes. Plaintiffs filed a motion for leave to appeal the order denying certification to the New York Court of Appeals, the highest court in the state. The New York Court of Appeals dismissed the plaintiff’s appeal in February 2001. In Engle v. R.J. Reynolds Tobacco Co., a Florida state court certified a class of Florida smokers alleging injury due to their tobacco use. The estimated size of the class ranges from 300,000 to 700,000 members. The court determined that the lawsuit could be tried as a class action because, even though certain factual issues are unique to individual plaintiffs and must be tried separately, certain other factual issues were common to all class members and could be tried in one proceeding for the whole class. In July 1999, in the first phase of a three–phase trial, the jury found against the defendants regarding the issues common to the class, such as whether smoking caused certain diseases, whether tobacco was addictive, and whether the tobacco companies withheld information from the public. In July 2000, in the second phase of the Engle trial, the jury returned a verdict assessing punitive damages totaling approximately $145 billion against the tobacco industry defendants. Following entry of judgment, the defendants appealed. The defendants posted bonds to stay collection of the final judgment with respect to the punitive damages against them and statutory interest thereon pending the exhaustion of all appeals. In May 2003, the Florida Third District Court of Appeal reversed the judgment entered by the trial court and instructed the trial court to order the decertification of the class. The plaintiffs petitioned the Florida Supreme Court for further review and, in May 2004, the Florida Supreme Court agreed to review the case. Oral arguments were heard in November 2004. Florida has enacted legislation capping the amount of the appeal bond necessary to stay execution of the punitive judgment pending appeal to the lesser of (i) the amount of punitive damages, plus twice the statutory rate of interest or (ii) 10% of a defendant’s net worth, but in no case more than $100 million. Thirty–two other states have passed and several additional states are considering statutes limiting the amount of bonds required to file an appeal of an adverse judgment in state court. The limitation on the amount of such bonds generally ranges from $25 million to $150 million. Such bonding statutes allow defendants that are subject to large adverse judgments, such as cigarette manufacturers, to reasonably bond such judgments and pursue the appellate process. In six jurisdictions–Connecticut, Maine, Massachusetts, New Hampshire, Vermont and Puerto Rico–the filing of a notice of appeal automatically stays the judgment of the trial court. One OPM has reported that the Engle plaintiffs believe the Florida appeal bond legislation is unconstitutional. In the event that a court of final jurisdiction were to declare the legislation unconstitutional, one OPM has stated that in a worst case scenario, it is possible that a judgment for punitive damages could be entered in an amount not capable of being bonded, resulting in an execution of the judgment before it could be set aside on appeal. On May 7, 2001, the trial court approved a stipulation (the “Stipulation”) among Philip Morris, Lorillard and Liggett (the “Stipulating Defendants”), the plaintiffs, and the plaintiff class that provides that execution or enforcement of the punitive damages component of the Engle judgment will remain stayed against the Stipulating Defendants through the completion of all judicial review, regardless of a challenge, if any, to the Florida bond statute. Under the Stipulation, Philip Morris has placed $1.2 billion into an interest–bearing escrow account. Should Philip Morris prevail in its appeal of the case, this escrow amount is to be returned to Philip Morris, together with its $100 million appeal bond previously posted. In addition, Philip Morris, 67 Lorillard and Liggett have also placed $500 million, $200 million (including Lorillard’s appeal bond), and $9.72 million (including Liggett’s appeal bond), respectively, into a separate interest–bearing escrow account for the benefit of the Engle class (the “Guaranteed Amount”). Even if the Stipulating Defendants prevail on appeal, the Guaranteed Amount will be paid to the court, and the court will determine how to allocate or distribute it consistent with the Florida Rules of Civil Procedure. One Engle class member has already gone to trial. In Lukacs v. Reynolds Tobacco, a Florida appellate court granted the plaintiff the right to proceed before he died, but stated that any award in favor of the plaintiff would not be enforced until after the Engle appeal is decided. On June 11, 2002, a Florida jury awarded $37.5 million in compensatory damages to the plaintiff. On April 1, 2003, the Dade County Circuit Court granted in part the defendants’ motion for remittitur, reducing the total award to $25.125 million. Because no final judgment will be entered until the Engle appeal is resolved, the defendant’s time to appeal the case has not yet begun to run. One OPM reports that it is a defendant in 11 separate cases pending in Florida courts in which the plaintiffs claim that they are members of the Engle class, that all liability issues associated with their claims were resolved in the earlier phases of the Engle proceedings, and that trials on their claims should proceed immediately. That OPM also reports that none of the cases in which plaintiffs contend they are members of the Engle class are expected to proceed until all appellate activity in Engle is concluded. In October 1997, the tobacco industry defendants settled another class action case, Broin I. Broin I was brought in Florida state court by flight attendants alleging injuries related to ETS. See “Individual Plaintiffs’ Lawsuits” above. The Broin I settlement established a protocol for the resolution of individual claims by class members against the tobacco companies. In addition to shifting the burden of proof to defendants as to whether ETS causes certain illnesses such as lung cancer and emphysema, the Broin I settlement required defendants to pay $300 million to be used to establish a foundation to sponsor research with respect to the early detection and cure of tobacco–related diseases. Individual members of the Broin I class retained the right to bring individual claims, although they are limited to non–fraud type claims and may not seek punitive damages. One OPM has reported that as of February 15, 2006, approximately 2,626 of these individual cases (known as Broin II cases) are pending in Florida. In October 2000, Judge Robert P. Kaye, the presiding judge of the original Broin I class action, held that the flight attendants will not be required to prove the substantive liability elements of their claims for negligence, strict liability and breach of implied warranty in order to recover damages, if any. The court also ruled that the trials of these suits will address whether the plaintiffs’ alleged injuries were caused by their exposure to ETS and, if so, the amount of damages. The defendants’ appeal of these rulings was dismissed by the intermediate appellate court on the basis that the appeal was premature and that the court lacked jurisdiction. On January 23, 2002, the defendants asked the Florida Supreme Court to review the district court’s order. That request was denied. Seven Broin II cases have gone to trial since Judge Kaye’s ruling in October 2000. Six of these cases have resulted in verdicts for the defendants: Fontana in June 2001, Tucker in June 2002, Janoff in October 2002, Seal in February 2003, Routh in October 2003 and Swaty in May 2005. Appeals are pending in some of these cases. On September 12, 2002, the plaintiff in the Janoff case filed a motion for a new trial, which the judge granted on January 8, 2003. The defendants appealed to the Florida Third District Court of Appeal, which, on October 27, 2004, affirmed the trial court’s order granting a new trial. The defendants’ motion for rehearing was denied. The defendants filed a notice of intent to invoke the discretionary jurisdiction of the Florida Supreme Court on June 17, 2005. In Swaty, the plaintiff filed a motion for a new trial on May 12, 2005, which was denied on June 23, 2005. On May 17, 2005, the court entered a final judgment in favor of the defendants. The plaintiff’s motion for a new trial was denied on June 23, 2005. The plaintiff filed a notice of appeal on July 21, 2005. The one plaintiff’s verdict was returned in French v. Philip Morris. On June 18, 2002, the French jury awarded the plaintiff $5.5 million in damages, finding that the flight attendant’s sinus disease was cause by ETS. On September 13, 2002, 68 the judge reduced the award to $500,000. The defendants appealed the trial court’s final judgment to the Florida Third District Court of Appeal on various grounds, the primary one being that under Judge Kaye’s October 2000 ruling, the burden of proof was erroneously shifted and the plaintiff was not required to show that the tobacco companies’ cigarettes were defective, that the tobacco company defendants acted negligently or that a warranty was made and breached. In December 2004, the Florida Third District Court of Appeal affirmed the judgment awarding plaintiff $500,000 and directed the trial court to hold the defendants jointly and severally liable. In April 2005, the appellate court denied defendants’ motion for a rehearing. On May 11, 2005, the defendants filed a notice of intent to invoke the discretionary jurisdiction of the Florida Supreme Court. On November 28, 2005, the Florida Supreme Court declined to hear the defendant’s appeal. In Scott v. American Tobacco Company, Inc., a Louisiana medical monitoring and/or smoking cessation case, the court certified a class consisting of smokers desiring to participate in a program designed to assist them in the cessation of smoking and/or monitor the medical condition of class members to ascertain whether they might be suffering from diseases caused by cigarette smoking. The class members may also choose to bring individual smoking and health lawsuits. On July 28, 2003, following the first phase of a trial, the jury returned a verdict in favor of the tobacco industry defendants on the medical monitoring claim and found that cigarettes were not defective products. The jury found against the defendants, however, on claims relating to fraud, conspiracy, marketing to minors and smoking cessation. On March 31, 2004, phase two of the trial began to address the scope and cost of smoking cessation programs. On May 21, 2004, the jury returned a verdict in the amount of $591 million ($590 million plus prejudgment interest accruing from the date the suit commenced) on the class’s claim for a smoking cessation program. On July 1, 2004, the judge upheld the jury’s verdict and awarded the plaintiffs prejudgment interest, which, as of February 15, 2006, totals $395 million. On August 31, 2004, the defendants’ motion for judgment notwithstanding the verdict or, in the alternative, for a new trial was denied. On September 29, 2004, pursuant to a stipulation of the parties, the defendants posted a $50 million bond (pursuant to legislation that limits the amount of the bond to $50 million collectively for MSA signatories) and noticed their appeal, which is pending. Under the terms of the stipulation, the plaintiffs reserved the right to contest the constitutionality of the bond cap law. In August 2000, a West Virginia state court conditionally certified, only to the extent of medical monitoring, in In re Tobacco Litigation (formerly known as Blankenship), a class of West Virginia residents. The plaintiffs proposed that the class include all West Virginia residents who (1) on or after January 1, 1995, smoked cigarettes supplied by defendants; (2) smoked at least a pack a day for five years without having developed any of a specified list of tobacco–related illness; and (3) do not receive healthcare paid or reimbursed by the state of West Virginia. Trial began in January 2001. On January 25, 2001, the trial court granted a motion for a mistrial, ruling that the plaintiffs had improperly introduced testimony about addiction to smoking as a basis for claiming damages. In March 2001, the court denied the defendants’ motion to decertify the class. The retrial began in September 2001, and on November 14, 2001 the jury returned a verdict that defendants were not liable for funding the medical monitoring program. On July 18, 2002, the plaintiffs petitioned the Supreme Court of West Virginia for leave to appeal, which was granted on February 25, 2003. The Supreme Court of West Virginia affirmed the judgment for the defendants on May 6, 2004. On July 1, 2004, the class’s petition for rehearing was denied. The plaintiffs did not seek review by the United States Supreme Court. Altria has reported that approximately 928 cases against Philip Morris and other tobacco industry defendants are pending in a single West Virginia court in a consolidated proceeding. The West Virginia court has scheduled a single trial for these consolidated cases, but it has certified a question to the Supreme Court of Appeals of West Virginia requesting a determination of the extent to which the claims in these individual cases can be consolidated in a single trial. On December 2, 2005, the Supreme Court of Appeals of West Virginia held that the Due Process Clause of the 14th Amendment, as interpreted by 69 State Farm v. Campbell, does not preclude a bifurcated trial plan in which a punitive damages multiplier is established prior to compensatory damages. In Daniels v. Philip Morris, a California state court case, the court certified a class comprised of individuals who were minors residing in California, who were exposed to defendants’ marketing and advertising activities, and who smoked one or more cigarettes within the applicable time period. Certification was granted as to plaintiff’s claims that defendants violated the state’s unfair business practice laws. On September 12, 2002, the trial court judge granted the defendants’ motion for summary judgment on First Amendment and preemption (Federal Cigarette Labeling and Advertising Act) claims. In November 2002, the court confirmed its earlier rulings granting defendant’s motion for summary judgment. The plaintiffs filed a petition for review with the California Supreme Court. On February 26, 2005, the California Supreme Court granted the petition. Briefing by the parties is complete. During April 2001, a California state court issued an oral ruling in the case of Brown v. The American Tobacco Company, Inc., in which it granted in part plaintiff’s motion for class certification and certified a class comprised of residents of California who smoked at least one of defendants’ cigarettes during the period from June 10, 1993 through April 23, 2001 and who were exposed to defendants’ marketing and advertising activities in California. Certification was granted as to plaintiff’s claims that defendants violated California Business and Professions Code Sections 17200 and 17500. The court denied the motion for class certification as to plaintiff’s claims under the California Legal Remedies Act. Defendants’ writ with the court of appeals challenging the trial court’s class certification was denied on January 16, 2002. The defendants filed a motion for summary judgment on January 31, 2003. On August 4, 2004, the defendants, motion for summary judgment was granted in part and denied in part. Following the November 2004 election, and the passage of a proposition in California that brought about a change in the law regarding the requirements for filing cases of this nature, the defendants filed a motion to decertify the class based on the changes in the law. On March 7, 2005, the court granted the defendants’ motion to decertify the class. On March 17, 2005, plaintiffs filed a motion for reconsideration of the court’s ruling decertifying the class. The trial judge denied the plaintiffs’ motion on April 20, 2005 and the plaintiffs have appealed on May 19, 2005. Altria has reported that, as of February 15, 2006, there were 24 putative class actions pending against Philip Morris in the United States on behalf of individuals who purchased and consumed various brands of cigarettes, including Marlboro Lights, Marlboro Ultra Lights, Virginia Slims Lights, Merit Lights and Cambridge Lights. These actions allege, among other things, that the use of the terms “Lights” and/or “Ultra Lights” constitutes deceptive and unfair trade practices and seek injunctive and equitable relief, including restitution. Classes have been certified in cases pending in Illinois, Massachusetts, Minnesota and Missouri, and in two cases pending in Ohio. Philip Morris has appealed or otherwise challenged these class certification orders. Additionally, an appellate court in Florida has overturned a class certification by a trial court in that state, and the plaintiffs have petitioned the Florida Supreme Court for further review. The Florida Supreme Court has stayed further proceedings pending its decision in the Engle case. In one of these cases, Price v. Philip Morris Cos., Inc. (formerly known as Miles v. Philip Morris, Inc.), a Madison County Illinois state court judge certified a class comprised of all residents of Illinois who purchased and consumed Cambridge Lights and Marlboro Lights within a specified time period but who do not have a claim for personal injury resulting from the purchase or consumption of cigarettes. The plaintiffs in the Price case alleged consumer fraud claims and sought economic damages in the form of a refund of purchase costs of the cigarettes. On March 21, 2003, after a non–jury trial, the trial court judge ruled in favor of the plaintiffs, ordering Philip Morris to pay $10.1 billion ($7.1 billion in compensatory damages, $3.0 billion in punitive damages) to the State of Illinois, and $1.78 billion in 70 plaintiff lawyer fees to be paid from the $10.1 billion. The court also stayed execution of the judgment for 30 days. After entry of the judgment on March 21, 2003, Philip Morris had 30 days within which to file a notice of appeal. Under Illinois state court rules applicable at the time, the enforcement of a trial court’s money judgment may be stayed only if, among other things, an appeal bond in an amount sufficient to cover the amount of the judgment, interest and costs is posted by a defendant within the 30–day period during which an appeal may be taken. With the approval of the trial court, such 30–day period may be extended for up to an additional 15 days. The trial court judge initially set the bond in the amount of $12 billion. Because of the difficulty of posting a bond of that magnitude, Philip Morris pursued various avenues of relief from the $12 billion bond requirement. In April 2003, the judge reduced the amount of the appeal bond. He ordered the bond to be secured by $800 million, payable in four equal quarterly installments beginning in September 2003, and a pre–existing 7.0%, $6 billion long–term note from Altria Group, Inc. to Philip Morris to be placed in an escrow account pending resolution of the case. The plaintiffs appealed the judge’s order reducing the amount of the bond. On July 14, 2003, the Illinois Fifth District Court of Appeals ruled that the trial court had exceeded its authority in reducing the bond and ordered the trial judge to reinstate the original bond. On September 16, 2003, the Illinois Supreme Court upheld the reduced bond set by the trial court and agreed to hear Philip Morris’ appeal without the need for intermediate appellate court review. On December 15, 2005, the Illinois Supreme Court reversed the trial court’s judgment and remanded the case to the trial court with instructions to dismiss the case in its entirety. In its decision, the court held that the defendant’s conduct alleged by the plaintiffs to be fraudulent under the Illinois Consumer Fraud Act was specifically authorized by the Federal Trade Commission and that the Illinois Consumer Fraud Act specifically exempts conduct so authorized by a regulatory body acting under the authority of the United States. The court declined to review the case on the merits, concluding that the action was barred entirely by the Illinois Consumer Fraud Act. It has been reported that the plaintiffs have filed a motion asking the court to reconsider its decision. It is possible that the plaintiffs will seek further appeals or rehearings. No assurance can be given that that such appeals and/or rehearings will not be granted or decided in the plaintiffs’ favor. Madison County Illinois courts have certified similar classes in Turner v. R.J. Reynolds Tobacco Co. and Howard v. Brown & Williamson. In Turner, for example, the state court judge certified a class defined as “[a]ll persons who purchased defendants’ Doral Lights, Winston Lights, Salem Lights and Camel Lights, in Illinois, for personal consumption, between the first date that defendants sold Doral Lights, Winston Lights, Salem Lights and Camel Lights through the date the court certifies this suit as a class action….” On June 6, 2003, Reynolds Tobacco filed a motion to stay the case pending Philip Morris’ appeal of the Price case. On July 11, 2003, the court denied the motion, and Reynolds Tobacco appealed to the Illinois Fifth District Court of Appeals. The Court of Appeals denied this motion on October 17, 2003. On October 20, 2003, the trial judge ordered that the case be stayed for 90 days, or pending the result of the Price appeal. The order stated that a hearing would be held at the end of the 90– day period to determine if the stay should be continued. However, on October 24, 2003, a justice on the Illinois Supreme Court ordered an emergency stay of all proceedings pending review by the entire Illinois Supreme Court of Reynolds Tobacco’s emergency stay order request filed on October 15, 2003. On November 5, 2003, the Illinois Supreme Court granted Reynolds Tobacco’s motion for a stay pending the court’s final appeal decision in Price. The Howard case also remains stayed by order of the trial judge, although the plaintiffs have appealed this stay order to the Illinois Fifth District Court of Appeals. Both cases still remain stayed, notwithstanding the Price decision. On December 31, 2003, a Missouri state court judge certified a similar class in Collora v. R.J. Reynolds Tobacco Co. On January 14, 2004, Reynolds Tobacco removed the case to the United States District Court for the Eastern District of Missouri. On September 30, 2004, the case was remanded to the Circuit Court for the City of St. Louis. In August 2004, Massachusetts’ highest court affirmed the class 71 certification order in another “lights” case, Aspinall v. Philip Morris Cos. In March 2005, a Minnesota appeals court declined to review a state trial court’s denial of class certification in a “lights” case, Curtis v. Philip Morris. In May 2005, also in Minnesota, a state court judge dismissed in its entirety a similar case, Dahl v. R.J. Reynolds Tobacco Company, ruling that the claims of the plaintiffs conflicted with the federal Cigarette Labeling and Advertising Act. On July 11, 2005, the plaintiffs filed a notice of appeal with the Minnesota Court of Appeals. According to Reynolds American, six other similar “lights” cases are pending against Reynolds Tobacco, although no classes have yet been certified in any of those cases. In August 2005, the Missouri Court of Appeals, Eastern District, affirmed the class certification order in Craft v. Philip Morris Cos. On August 31, 2005, a Louisiana federal district court ruled in a proposed class action, Sullivan v. Philip Morris, that the Federal Cigarette Labeling and Advertising Act (“FCLAA”) does not preempt plaintiffs’ claims of a breach of express warranty and certain state law remedies with respect to manufacturing defects. On September 14, 2005, the same district court ruled in a proposed class action, Brown v. Brown & Williamson, that the FCLAA does not preempt plaintiffs’ fraudulent misrepresentation/concealment and defective product claims. B&W filed a petition to the U.S. Court of Appeals for the Fifth Circuit for permission to appeal on January 9, 2006, which petition was granted on February 10, 2006. On June 9, 2005, a proposed “lights” class action was filed in a federal District Court in New Mexico. On June 27, 2005, a similar class action was filed in a Kansas state court against Philip Morris and its parent Altria. Philip Morris and Altria are reportedly seeking to have the Kansas case transferred to federal court in Kansas, and that on August 13, 2005, three individuals filed a similar class action in the U.S. District Court for the District of Maine against the same defendants. In Schwab v. Philip Morris USA, Inc., smokers of “Lights” cigarettes filed a purported class action suit in the United States District Court for the Eastern District of New York against the OPMs and their parent companies, Liggett and certain other entities. Plaintiffs allege that the defendants formed an “association–in–fact” enterprise, in violation of the federal RICO statute, to defraud the public into believing that “light” cigarettes were healthier alternatives to regular cigarettes. Plaintiffs seek to certify a nationwide class of smokers comprising all purchasers of “light” cigarettes manufactured by the defendants since the 1970’s. Oral argument on the plaintiffs’ motion for class certification occurred on September 12, 2005. That motion remains pending. The defendants filed a motion to deny class certification and to dismiss the complaint, asserting that the plaintiffs’ request–that any determination as to damages payable to a certified class be allocated among class members on a “fluid recovery” basis–is illegal. On November 14, 2005, the court denied the defendants’ motion, ruling that the plaintiffs’ request for “fluid recovery” is not illegal and does not require denial of class certification or dismissal of the action. The court is presently considering several defendant motions for summary judgment based on statute of limitations grounds. On May 23, 2001, a lawsuit was filed in the United States District Court for the District of Columbia styled Sims v. Philip Morris Incorporated, which sought class action status for millions of youths who began smoking cigarettes before they were legally allowed to buy cigarettes. Plaintiffs sought to recover moneys that underage smokers spent on cigarettes before they were legally allowed to buy cigarettes, whether or not they have suffered health problems, and/or profits the tobacco manufacturers have earned from sales to children. The lawsuit alleged that tobacco manufacturers concealed the addictive nature of cigarettes and concealed the health risks of smoking in their advertising. In February 2003, the court denied plaintiffs’ motion for class certification. On April 3, 2002, in Deloach v. Philip Morris, a federal district court in North Carolina granted class certification to a group of tobacco growers and quota–holders from Alabama, Florida, Georgia, North Carolina, South Carolina and Tennessee. The class accused cigarette manufacturers of conspiring to set prices offered for tobacco in violation of antitrust laws. In June 2002, the defendants’ petition to 72 the Fourth Circuit Court of Appeals seeking permission to appeal the class certification was denied. In May 2003, the plaintiffs reached a settlement with all of the tobacco industry defendants other than Reynolds Tobacco. The settling defendants agreed to pay $210 million to the plaintiffs, to pay plaintiffs’ attorney fees of $75.3 million as set by the court and to purchase a minimum amount of U.S. leaf for ten years. The case continued against Reynolds Tobacco. On April 22, 2004, after the trial began, the parties settled the case. Under the settlement, Reynolds Tobacco has paid $33 million into a settlement fund, which, after deductions for attorneys’ fees and administrative costs, will be distributed to the class pending final settlement approval. Reynolds Tobacco has also agreed to purchase a minimum amount of U.S. leaf for the next ten years. On March 21, 2005, the court approved the settlement and dismissed the suit. It has been reported that a lawsuit was filed on January 19, 2006 in the U.S. District Court for the Eastern District of New York against Philip Morris to require Philip Morris to pay for low dose CAT scans (on an annual basis) for a class of smokers over the age of 50 who have been smoking at least a pack of Marlboro a day for 20 years and have not been diagnosed with lung cancer. Individual Plaintiffs’ Lawsuits. The MSA does not release PMs from liability in individual plaintiffs’ cases. Numerous cases have been brought by individual plaintiffs who allege that their cancer and/or other health effects have resulted from their use of cigarettes, addiction to smoking, or exposure to environmental tobacco smoke. Individual plaintiffs’ allegations of liability are based on various theories of recovery, including but not limited to, negligence, gross negligence, strict liability, fraud, misrepresentation, design defect, failure to warn, breach of express and implied warranties, breach of special duty, conspiracy, concert of action, restitution, indemnification, violations of deceptive trade practice laws and consumer protection statutes, and claims under federal and state RICO statutes. The tobacco industry has traditionally defended individual health and smoking lawsuits by asserting, among other defenses, assumption of risk and/or comparative fault on the part of the plaintiff, as well as lack of proximate cause. Altria has reported that as of February 15, 2006, there were approximately 1,156 individual plaintiff smoking and health cases pending in the United States against it (many of which cases include other tobacco industry defendants), including 928 cases pending before a single West Virginia state court in a consolidated proceeding. In addition, 2,626 additional individual cases (referred to herein as the Broin II cases) are pending in Florida by individual current and former flight attendants claiming personal injury allegedly related to ETS in airline cabins. The individuals in the Broin II cases are limited by the settlement of a previous class action lawsuit, Broin v. Philip Morris (known as Broin I), to the recovery of compensatory damages only, and are precluded from seeking or recovering punitive damages. As a result of the settlement, however, the burden of proof as to whether ETS causes certain illnesses such as lung cancer and emphysema was shifted to the tobacco industry defendants. To date, seven individual Broin II flight attendant cases have gone to trial, one of which has resulted in a jury verdict against the tobacco industry defendants. The defendants’ appeal in that case is pending. See also “Class Action Lawsuits” below. In the last ten years, juries have returned verdicts in individual smoking and health cases against the tobacco industry, including one or more of the PMs. Thus far, a number of those cases have resulted in significant verdicts against the defendants and some have been appealed, some have been overturned and others have been affirmed. All post–trial motions and appeals have been exhausted and plaintiffs have been paid in only four cases. 73 By way of example only, and not as an exclusive or complete list, the following individual matters are illustrative of individual cases. • In February 1999, a California jury in Henley v. Philip Morris awarded $1.5 million in compensatory damages and $50 million in punitive damages. The award was subsequently reduced by the trial judge to $25 million in punitive damages, and both Philip Morris and the plaintiff appealed. In September 2003, a California Court of Appeal further reduced the punitive damage award to $9 million, but otherwise affirmed the judgment for compensatory damages, and Philip Morris appealed to the California Supreme Court. In September 2004, the California Supreme Court dismissed Philip Morris’ appeal. In October 2004, the California Court of Appeal issued an order allowing the execution of the judgment. In December 2004, Philip Morris filed with the United States Supreme Court a petition for a writ of certiorari. On March 21, 2005, the United States Supreme Court denied Philip Morris’ petition. Philip Morris subsequently satisfied the judgment, paying $1.5 million in compensatory damages, $9 million in punitive damages and $6.4 million in accumulated interest. • In March 1999, an Oregon jury in Williams–Branch v. Philip Morris awarded $821,500 in actual damages and $79.5 million in punitive damages. The trial judge subsequently reduced the punitive damages award to $32 million, but the reduction was overturned and the full amount of the punitive damages award was reinstated by the Oregon Court of Appeals. The Oregon Supreme Court declined to review the reinstated punitive damage award and Philip Morris petitioned the United States Supreme Court for further review. In October 2003, the United States Supreme Court set aside the Oregon appellate court’s ruling and directed the Oregon court to reconsider the case in light of State Farm v. Campbell. In June 2004, the Oregon Court of Appeals reinstated the punitive damages award. In December 2004, the Oregon Supreme Court granted Philip Morris’ petition for review of the case. Oral argument occurred on May 10, 2005. On February 2, 2006, the Oregon Supreme Court affirmed the Court of Appeals’ ruling reinstating the award for $79.5 million in punitive damages against Philip Morris. • In April 1999, a Maryland jury in Connor v. Lorillard awarded $2.225 million in damages. An appellate court has remanded the case for a determination of the date of injury to determine whether a statutory cap on non–economic damages applies. • In March 2000, a California jury in Whiteley v. Raybestos–Manhattan, Inc. returned a verdict in favor of the plaintiffs and found the defendants, including Philip Morris and Reynolds Tobacco, liable for negligent product design and fraud, and awarded $1.72 million in compensatory damages and $20 million in punitive damages. Both damage awards were upheld by the trial judge, who denied the defendants’ post–verdict challenge. The defendants appealed the verdict. In April 2004, the California Court of Appeal reversed the judgment and remanded the case for a new trial. The plaintiff’s motion for rehearing was denied on April 29, 2004. It is not known whether the plaintiffs will retry the case. • In October 2000, a Tampa, Florida jury in Jones v. R.J. Reynolds Tobacco Co. found Reynolds Tobacco liable for negligence and strict liability and returned a verdict in favor of the widower of a deceased smoker, awarding approximately $200,000 in compensatory damages; the jury rejected the plaintiff’s conspiracy claim and did not award punitive damages. Reynolds Tobacco filed a motion for judgment notwithstanding the verdict, or, in the alternative, for a new trial. On December 28, 2000, the court 74 granted the motion for a new trial and on August 30, 2002 the Second District Court of Appeal of Florida affirmed the decision to grant a new trial. The plaintiff has filed for permission to appeal to the Florida Supreme Court. On December 9, 2002, the Supreme Court of Florida issued an order to show cause as to why Jones’ notice of appeal should not be treated as a notice to invoke discretionary jurisdiction. On April 27, 2005 the Florida Supreme Court denied the plaintiff’s notice of appeal without prejudice. On May 25, 2005 the plaintiff served an amended notice of intent to invoke discretionary jurisdiction. On June 22, 2005 the defendants filed their response. The motion has not yet been decided. On August 31, 3005, the Florida Supreme Court denied review for lack of jurisdiction. Retrial is scheduled to begin on September 11, 2006. • In November 2000, the Supreme Court of Florida reinstated the verdict by a Florida jury in Carter v. Brown & Williamson Tobacco Corporation to award $750,000 in damages to the plaintiff. In 1996, the jury had found that cigarettes were a defective product and that B&W was negligent for not warning people of the danger, but an appeals court reversed this decision. In March 2001, the plaintiff received slightly over $1 million from a trust account that contained the $750,000 jury award plus interest and became the first smoker to be paid by a tobacco company in an individual lawsuit. On June 29, 2001, the United States Supreme Court denied B&W’s petition for a writ of certiorari, thus leaving the jury verdict intact. • In June 2001, in Boeken v. Philip Morris Incorporated, a California state court jury found against Philip Morris on all six claims of fraud, negligence and making a defective product alleged by the plaintiff. The jury awarded the plaintiff $5.5 million in compensatory damages and $3 billion in punitive damages. The $3 billion punitive damages award was reduced to $100 million post–trial. Philip Morris appealed. In September 2004, the California Second District Court of Appeal further reduced the punitive damage award to $50 million, but otherwise affirmed the judgment entered in the case. In October 2004 the Court of Appeal granted the parties’ motions for rehearing and, in April 2005, reaffirmed the amount of the September 2004 ruling. On August 10, 2005, the California Supreme Court denied Philip Morris’s request for review. On March 20, 2006, the United States Supreme Court declined to review the $50 million award. • In December 2001, a Florida state court jury awarded the plaintiff $165,000 in compensatory damages but no punitive damages in Kenyon v. R.J. Reynolds Tobacco Co. Reynolds Tobacco appealed to the Second District Court of Appeal of Florida, which, on May 30, 2003, affirmed per curium (that is, without writing an opinion) the trial court’s judgment in favor of the plaintiff. Reynolds Tobacco sent the plaintiff’s counsel the amount of the judgment plus accrued interest ($196,000) in order to pursue further appeals. On September 5, 2003, Reynolds Tobacco petitioned the Florida Supreme Court to require the Second District Court of Appeal to write an opinion. On April 22, 2004, the Florida Supreme Court denied the petition. On January 26, 2004, the United States Supreme Court denied Reynolds Tobacco’s petition for a writ of certiorari, thus leaving the jury verdict intact. The only issue remaining in this case is the amount of attorneys’ fees to be awarded to plaintiff’s counsel. 75 • In February 2002, a federal jury in Kansas City awarded $198,000 in compensatory damages to a former smoker in Burton v. R.J. Reynolds Tobacco Co. The jury also determined that punitive damages were appropriate and, after a separate hearing was held to address that issue, the court awarded the plaintiff $15 million in punitive damages. On February 9, 2005, the United States Court of Appeals for the Tenth Circuit upheld the compensatory damages award, but unanimously reversed the award of punitive damages in its entirety. On May 17, 2005, the District Court entered a second amended judgment for $196,416 plus interest and costs. On June 17, 2005, Reynolds Tobacco paid the judgment. • In March 2002, a Portland, Oregon jury awarded approximately $168,500 in compensatory damages and $150 million in punitive damages to the family of a light cigarette smoker in Schwarz v. Philip Morris Incorporated. The trial judge subsequently reduced the punitive damages awarded to $100 million. Philip Morris and the plaintiffs have each appealed. • In September 2002, in Figueroa–Cruz v. R.J. Reynolds Tobacco Co., a Puerto Rico jury awarded two sons of a deceased smoker $500,000 each. The trial judge vacated one of the awards on statute of limitations grounds, and granted Reynolds Tobacco’s motion for judgment as a matter of law on the other award on October 9, 2002. On October 28, 2003, the United States Court of Appeals for the First Circuit affirmed the trial court’s ruling. The plaintiffs’ petition for a writ of certiorari was denied by the United States Supreme Court in November 2004. • In October 2002, in Bullock v. Philip Morris, Inc., a Los Angeles, California jury awarded a smoker $850,000 in compensatory damages. In October 2002, the same jury awarded the plaintiff $28 billion in punitive damages. In December 2002, the trial judge reduced the punitive damage award to $28 million. Philip Morris and the plaintiff each appealed and the appeal was argued on January 18, 2006. • In April 2003, in Eastman v. Philip Morris, a Florida jury awarded a smoker $3.26 million in damages, after reducing the award to reflect the plaintiff’s partial responsibility. Defendants Philip Morris and B&W appealed to the Second District of Florida Court of Appeal. In May 2004, the Second District Court of Appeal rejected the appeal in a per curium decision (that is, without a written opinion). The defendants’ petition for a written opinion and rehearing was denied on October 14, 2004, and that ruling is not subject to review by the Florida Supreme Court. On October 29, 2004, Philip Morris and Reynolds Tobacco, due to its obligation to indemnify B&W, satisfied their respective portions the judgment. • In May 2003, in Boerner v. Brown & Williamson, an Arkansas jury awarded the plaintiff $15 million in punitive damages and $4 million in compensatory damages. Following a series of appeals, on January 7, 2005, the United States Court of Appeals for the Eighth Circuit affirmed the trial court’s May 2003 judgment, but reduced the punitive damages award to $5 million. Reynolds Tobacco, due to its obligation to indemnify B&W, satisfied the approximately $9.1 million judgment on February 16, 2005. • In November 2003, in Thompson v. Philip Morris, Inc., a Missouri jury returned a split verdict, awarding approximately $1.6 million in compensatory damages to the plaintiff and an additional $500,000 in damages to his wife. The jury apportioned 40% of fault to Philip Morris, 10% of fault to B&W and the remaining 50% to the plaintiff. 76 Accordingly, under Missouri law, the court must reduce the damages award by half. The defendants appealed to the Missouri Court of Appeals for the Western District on March 8, 2004. The defendants’ opening appellate brief was filed on May 23, 2005. The appeal was argued on November 3, 2005 and remains pending. • In December 2003, in Frankson v. Brown & Williamson, a New York jury awarded the plaintiff $350,000 in compensatory damages and $20 million in punitive damages. On June 22, 2004, the trial judge granted a new trial unless the parties agree to an increase in compensatory damages to $500,000 and a decrease in punitive damages to $5 million. On January 21, 2005, the plaintiff stipulated to the court’s reduction in the amount of punitive damages. Defendants have appealed. • In April 2004, a Florida jury returned a verdict in favor of the plaintiff in Davis v. Liggett Group, Inc., awarding a total of $540,000 in actual damages. In addition, the jury awarded legal fees of $752,000. The jury did not award punitive damages. Liggett has appealed. • In October 2004, in Arnitz v. Philip Morris, Inc., a Florida jury returned a verdict in favor of the plaintiff, who claims that as a result of his smoking he developed lung cancer and emphysema. The jury awarded a total of $240,000 in compensatory damages. Philip Morris, the sole defendant in the case, has appealed to the Florida Second District Court of Appeals. • In February 2005, in Smith v. Brown & Williamson, a Missouri state court jury returned a split verdict, finding in favor of the defendant on counts of fraudulent concealment and conspiracy and in favor of the plaintiffs on a negligence count. The jury awarded the plaintiffs $500,000 in compensatory damages and $20 million in punitive damages. On March 10, 2005, the defendant filed a motion for judgment notwithstanding the verdict or, in the alternative, for a new trial. On May 23, 2005, the trial court denied defendant’s motion and on June 1, 2005, the defendant appealed. • In March 2005, in Rose v. Philip Morris, a New York jury awarded $3.42 million in compensatory damages against B&W and Philip Morris. The jury also returned a punitive damages award totaling $17.1 million against Philip Morris. In December 2005, Philip Morris’ post-trial motions challenging the verdict were denied by the trial court. Philip Morris has appealed. In August 2002, the California Supreme Court issued a decision limiting evidence of wrongdoing between 1988 and 1998 by tobacco companies. One OPM has reported that this decision worked to the advantage of the tobacco industry defendants in the Whiteley case and it believes that it will have a favorable impact for tobacco industry defendants in other California cases, both at the trial court level and on appeal. Healthcare Cost Recovery Lawsuits. In certain pending proceedings, domestic and foreign governmental entities and non–governmental plaintiffs, including Native American tribes, insurers and self–insurers such as Blue Cross and Blue Shield plans, hospitals and others, are seeking reimbursement of healthcare cost expenditures allegedly caused by tobacco products and, in some cases, of future expenditures and damages as well. Relief sought by some but not all plaintiffs includes punitive damages, multiple damages and other statutory damages and penalties, injunctions prohibiting alleged marketing and sales to minors, disclosure of research, disgorgement of profits, funding of anti–smoking programs, additional disclosure of nicotine yields, and payment of attorney and expert witness fees. The 77 PMs are exposed to liability in these cases, because the MSA only settled healthcare cost recovery claims belonging to the Settling States. Altria has reported that as of February 15, 2006, there were four healthcare cost recovery actions pending against Philip Morris in the United States. In addition, it has been reported that on August 4, 2005, a national senior citizens’ organization has filed a lawsuit against cigarette manufacturers under the federal “Medicare as Secondary Payer” statute, which permits Medicare beneficiaries or others to bring actions on behalf of Medicare to recover healthcare costs paid by Medicare for which another party may be liable. The plaintiffs are reportedly seeking to recover more than $60 billion in alleged Medicare spending on treatment of smoking related illnesses since 1999. This lawsuit reportedly does not seek to recover Medicare payments in Florida, where a similar suit has been filed. The Florida case was dismissed on July 26, 2005 and the plaintiffs have appealed. The claims asserted in the healthcare cost recovery actions include the equitable claim that the tobacco industry was “unjustly enriched” by plaintiffs’ payment of healthcare costs allegedly attributable to smoking, the equitable claim of indemnity, common law claims of negligence, strict liability, breach of express and implied warranty, violation of a voluntary undertaking or special duty, fraud, negligent misrepresentation, conspiracy, public nuisance, claims under federal and state statutes governing consumer fraud, antitrust, deceptive trade practices and false advertising, and claims under federal Racketeer Influenced and Corrupt Organizations Act (“RICO”) and parallel state statutes. Defenses raised include lack of proximate cause, remoteness of injury, failure to state a valid claim, lack of benefit, adequate remedy at law, “unclean hands” (namely, that plaintiffs cannot obtain equitable relief because they participated in, and benefited from, the sale of cigarettes), lack of antitrust standing and injury, federal preemption, lack of statutory authority to bring suit, and statutes of limitations. In addition, defendants argue that they should be entitled to “set off” any alleged damages to the extent the plaintiff benefits economically from the sale of cigarettes through the receipt of excise taxes or otherwise. Defendants also argue that these cases are improper because plaintiffs must proceed under principles of subrogation and assignment. Under traditional theories of recovery, a payor of medical costs (such as an insurer) can seek recovery of healthcare costs from a third party solely by “standing in the shoes” of the injured party. Defendants argue that plaintiffs should be required to bring any actions as subrogees of individual healthcare recipients and should be subject to all defenses available against the injured party. Although there have been some decisions to the contrary, most courts that have decided motions in these cases have dismissed all or most of the claims against the industry. In addition, eight federal circuit courts of appeals, the Second, Third, Fifth, Seventh, Eighth, Ninth, Eleventh and District of Columbia circuits, as well as California, Florida, New York and Tennessee intermediate appellate courts, relying primarily on grounds that plaintiffs’ claims were too remote, have affirmed dismissals of, or reversed trial courts that had refused to dismiss, healthcare cost recovery actions. The United States Supreme Court has refused to consider plaintiffs’ appeals from the cases decided by the courts of appeals for the Second, Third, Fifth, Ninth and District of Columbia circuits. A number of foreign governmental entities have filed suit in state and federal courts in the United States against tobacco industry defendants to recover funds for healthcare and medical and other assistance paid by those foreign governments to their citizens. Such suits have been brought in the United States by 13 countries, a Canadian province, 11 Brazilian states and 11 Brazilian cities. Thirty–four of these suits have been dismissed and two remain pending. In addition to these cases brought in the United States, healthcare cost recovery actions have also been brought in Israel, the Marshall Islands (where the suit was dismissed), Canada, France and Spain. In September 2003, the case pending in France was dismissed and the plaintiff has appealed. In May 2004, the case pending in Spain was dismissed and the plaintiff has appealed. Other governmental entities have stated that they are considering filing such actions. On September 29, 2005, the Supreme Court of Canada upheld legislation passed in 1998 by the 78 province of British Columbia allowing the provincial government to seek damages from tobacco companies for healthcare costs incurred during the past 50 years, as well as for future illness–related expenses in connection with tobacco use. The legislation also lightens the required burden of proof and curtails certain traditional defenses in civil suits. Other provinces are reported to have already adopted or are expected to adopt similar legislation. In September 1999, the United States government filed a lawsuit in the United States District Court for the District of Columbia against the OPMs, certain related parent companies and two tobacco industry research and lobbying organizations, seeking medical cost recovery for federal funds spent to treat alleged tobacco–related illnesses and asserting violation of RICO. In September 2000, the trial court dismissed the government’s medical cost recovery claims, but permitted discovery to proceed on the government’s claims for relief under RICO. The government alleged that disgorgement by defendants of approximately $280 billion is an appropriate remedy. In May 2004, the court issued an order denying defendants’ motion for partial summary judgment limiting the disgorgement remedy. In June 2004, the trial court certified that order for immediate appeal, and in July 2004, the United States Court of Appeals for the District of Columbia agreed to hear the appeal on an expedited basis. On February 4, 2005, the Appeals Court, in a 2–1 decision, ruled that disgorgement is not an available remedy in this case. This ruling eliminated the government’s claim for $280 billion and limits the government’s potential remedies principally to forward–looking relief, including funding for anti–smoking programs. The government appealed this ruling to seek a rehearing en banc. On April 20, 2005, the Appeals Court denied the government’s appeal. On July 18, 2005, the government appealed the ruling rejecting the $280 billion disgorgement remedy to the United States Supreme Court. On October 17, 2005 the U.S. Supreme Court, without comment, refused to hear the appeal. In addition to the claim for disgorgement, in the RICO suit the United States government seeks relief consisting of, among other things, (i) prohibitory injunctions (including prohibitions on committing acts of racketeering, making false or misleading statements about cigarettes, and on youth marketing); (ii) disclosure of documents concerning the health risks and addictive nature of smoking, the ability to develop less hazardous cigarettes and youth marketing campaigns; (iii) mandatory corrective statements about the health risks of smoking and the addictive properties of nicotine in future marketing campaigns; and (iv) funding of remedial programs (including research, public education campaigns, medical monitoring programs, and smoking cessation programs). The trial phase of the case concluded on June 9, 2005. In its closing argument and submissions, the government requested that the tobacco industry be required to fund an up to ten–year, $14 billion smoking cessation program. The government has reportedly also asked the court to appoint a lawyer as monitor with power to order the defendants to sell off their research and development facilities related to developing so–called safer cigarettes. The monitor would also have power to review the business policies of the defendants. The government has also reportedly requested that restrictions be placed on the defendants’ ability to sell their cigarette businesses and that the defendants be compelled to run public advertisements regarding the dangers of smoking. It has been reported that the defendants have filed a motion to dismiss the government’s request for the $14 billion award, arguing that the award was barred by the February 4, 2005 appellate decision. On July 22, 2005, the District Court judge granted the motion made under Federal Rule of Civil Procedure 24 by six public interest groups to intervene in this action for the very limited purpose of being heard on the issue of permissible and appropriate remedies in this case, should the government prevail on its claims with respect to smoking cessation programs. On August 15, 2005, the parties filed their proposed findings of fact. Post-trial briefing was completed on October 9, 2005, and the case remains pending in the District Court. In January of 2001, the Canadian Province of British Columbia enacted the Damages and Healthcare Costs Recovery Act (the “HCCR Act”). The HCCR Act authorizes an action by the government of British Columbia against a manufacturer of tobacco products for the recovery by the 79 government of the present value of past and reasonably expected future healthcare expenditures incurred by the government in treating British Columbians with diseases caused by exposure to tobacco products, where such exposure was caused by a manufacturer’s tort in British Columbia or a breach of a duty owed to persons in British Columbia. The HCCR Act allows the government to bring such action for expenditures related to a particular individual or on an aggregate basis for a population of persons. In an action brought on an aggregate basis, the Act does not require the government identify a particular person or to prove particular injury, healthcare costs or causation of harm with respect to any particular person. Where the government proves in an aggregate claim with respect of a type of tobacco product that a manufacturer breached a legal duty owed to persons who have been or might become exposed to the tobacco product and that exposure to the tobacco product can cause or contribute to a disease, the court is required to presume that (1) the population of persons who were exposed to the tobacco product would not have been exposed to the product but for the breach of duty and (2) such exposure caused or contributed to disease or risk of disease in such population of persons. In such cases, the court is required to determine on an aggregate basis the cost of healthcare benefits provided after the date of the breach of duty and to assess liability among defendants based on the proportion of the aggregate cost equal to each defendant’s market share in the type of tobacco product. Statistical information and information derived from epidemiological and other relevant studies is admissible as evidence under the HCCR Act to establish causation and for quantifying damages in an action brought by the government under the HCCR Act or in an action brought by a class of persons under Canada’s class action statute. Subsequently to the enactment of the HCCR Act, the government of British Columbia brought an action under the HCCR Act against certain foreign and domestic tobacco manufacturers, including Philip Morris International, a subsidiary of Altria. The defendants challenged the constitutionality of the HCCR Act and in a decision dated June 5, 2003, British Columbia’s trial level court held that the HCCR Act was unconstitutional as exceeding the territorial jurisdiction of the Province. On appeal, British Columbia’s highest court reversed the lower court in a decision dated May 20, 2004, holding that the HCCR Act was constitutional. The matter was appealed to the Canadian Supreme Court, Canada’s highest court. By a unanimous decision dated September 29, 2005 the Canadian Supreme Court affirmed the lower court, holding that the HCCR Act was constitutional. In the decision, the court also vacated the stay of proceedings and the action will now continue. While the judgment only applies to British Columbia, it is expected that other provincial governments may follow suit. It has been reported that Newfoundland has enacted and Saskatchewan and Nova Scotia are considering enacting legislation similar to the HCCR Act. Other Tobacco–Related Litigation. The tobacco industry is also the target of other litigation. By way of example only, and not as an exclusive or complete list, the following are additional tobacco– related litigation: • Asbestos Contribution Cases. These cases, which have been brought against cigarette manufacturers on behalf of former asbestos manufacturers, their personal injury settlement trusts and insurers, seek, among other things, contribution or reimbursement for amounts expended in connection with the defense and payment of asbestos claims that were allegedly caused in whole or in part by cigarette smoking. In January 2005, one case was dismissed; currently, one case (Fibreboard Corp. v. R.J. Reynolds Tobacco Co.) remains pending. • Cigarette Price–Fixing Cases. According to one OPM, as of August 1, 2005, there were two cases pending against domestic cigarette manufacturers in Kansas (Smith v. Philip Morris) and New Mexico (Romero v. Philip Morris), alleging that defendants conspired to fix cigarette prices in violation of antitrust laws. The plaintiffs’ motions for class certification have been granted in both cases. In February 2005, the New Mexico Court 80 of Appeals affirmed the class certification decision in the Romero case. On April 19, 2005, the defendants filed motions for summary judgment in that case. • Cigarette Contraband Cases. In May 2001 and August 2001, various governmental entities of Colombia, the European Community and ten member states filed suits in the United States against certain PMs, alleging that defendants sold to distributors cigarettes that would be illegally imported into various jurisdictions. The claims asserted in these cases include negligence, negligent misrepresentation, fraud, unjust enrichment, violations of RICO and its state–law equivalents and conspiracy. Plaintiffs in these cases seek actual damages, treble damages and undisclosed injunctive relief. In February 2002, the trial court granted defendants’ motions to dismiss all of the actions. Plaintiffs in each case have appealed. In January 2004, the United States Court of Appeals for the Second Circuit affirmed the dismissals of the cases. In April 2004, plaintiffs petitioned the United States Supreme Court for further review. The European Community and the 10 member states moved to dismiss their petition in July 2004 following an agreement entered into among Philip Morris, the European Commission and 10 member states of the European Community. The terms of this cooperation agreement provide for broad cooperation with European law enforcement agencies on anti–contraband and anti– counterfeit efforts and resolve all disputes between the parties on these issues. In May 2005, the U.S. Supreme Court granted the petitions for review, vacated the judgment of the Second Circuit Court of Appeals and remanded the case to that court for further review in light of the Supreme Court’s recent decision in U.S. v. Pasquantino. On September 13, 2005, the Second Circuit Court of Appeals found that Pasquantino was inapplicable to the case and affirmed its earlier decision that the revenue rule bars foreign sovereigns’ civil claims for recovery of lost tax revenue and law enforcement costs related to cigarette smuggling. On January 9, 2006, the U.S. Supreme Court declined to hear any further appeal in this action. One OPM has stated that it is possible that future litigation related to cigarette contraband issues may be brought. • Patent Litigation. In 2001 and 2002, Star Scientific, Inc. (“Star”) filed two patent infringement actions against Reynolds Tobacco in the United States District Court for the District of Maryland. Such actions have been consolidated. Reynolds Tobacco filed various motions for summary judgment, which were all denied. Reynolds Tobacco has also filed counterclaims seeking a declaration that the claims of the two Star patents in dispute are invalid, unenforceable and not infringed by Reynolds Tobacco. Between January 31, 2005 and February 8, 2005, the District Court held a first bench trial on Reynolds Tobacco’s affirmative defense and counterclaim based upon inequitable conduct. The District Court has not yet issued a ruling on this issue. Additionally, in response to the court’s invitation, Reynolds Tobacco filed two summary judgment motions on January 20, 2005. The District Court has indicated that it will rule on Reynolds Tobacco’s two pending summary judgment motions and the issue of inequitable conduct at the same time. The District Court has not yet set a trial date for the remaining issues in the case. • Vermont Litigation. On July 22, 2005, Vermont announced that it had sued Reynolds Tobacco for using false and misleading advertising to promote its “Eclipse” brand of cigarettes. The lawsuit charges that Reynolds Tobacco’s advertising, which claims that smoking Eclipse cigarettes is less harmful than smoking other brands of cigarettes, violated Vermont’s consumer protection statutes. According to the Vermont Attorney General, the offices of Attorneys General across the country, including California, Connecticut, the District of Columbia, Idaho, Illinois, Iowa, Maine, New York and 81 Tennessee, have actively participated in the investigation leading up to this lawsuit and will continue to assist Vermont in it. • Foreign Lawsuits. Lawsuits have been filed in foreign jurisdictions against certain OPMs and/or their subsidiaries and affiliates, including individual smoking and health actions, class actions and healthcare cost recovery suits. The foregoing discussion of civil litigation against the tobacco industry is not exhaustive and is not based upon the Corporation’s examination or analysis of the court records of the cases mentioned or of any other court records. It is based on SEC filings by OPMs and on other publicly available information published by the OPMs or others. Prospective purchasers of the Series 2006 Bonds are referred to the reports filed with the SEC by certain of the OPMs and applicable court records for additional descriptions thereof. Litigation is subject to many uncertainties. In its SEC filing, one OPM states that it is not possible to predict the outcome of litigation pending against it, and that it is unable to make a meaningful estimate of the amount or range of loss that could result from an unfavorable outcome of pending litigation, and that it is possible that its business, volume, results of operations, cash flows or financial position could be materially affected by an unfavorable outcome or settlement of certain pending litigation or by the enactment of federal or state tobacco legislation. It can be expected that at any time and from time to time there will be developments in the litigation presently pending and filing of new litigation that could adversely affect the business of the PMs and the market for or prices of securities such as the Series 2006 Bonds payable from tobacco settlement payments made under the MSA. See also “RISK FACTORS – Litigation Seeking Monetary Relief from Tobacco Industry Participants.” THE GLOBAL INSIGHT CONSUMPTION REPORT The following information has been extracted from the Global Insight Consumption Report, a copy of which is attached hereto as Appendix A. This summary does not purport to be complete and the Global Insight Consumption Report should be read in its entirety for an understanding of the assumptions on which it is based and the conclusions it reaches. The Global Insight Consumption Report forecasts future United States domestic cigarette consumption. The MSA payments are based in part on cigarettes shipped in and to the United States. Cigarette shipments and cigarette consumption may not match as a result of various factors such as inventory adjustments but one substantially the same when compared over a period of time. General Global Insight has prepared a report, dated March 30, 2006 (the “Global Insight Consumption Report”) for the Corporation on the consumption of cigarettes in the United States from 2004 through 2034 entitled, “A Forecast of U. S. Cigarette Consumption (2004–2034) for Tobacco Settlement Financing Corporation.” Global Insight is an internationally recognized econometric and consulting firm of over 200 economists in 16 offices worldwide. Global Insight has developed a cigarette consumption model based on historical United States data between 1965 and 2003. Global Insight constructed this cigarette consumption model after considering the impact of demographics, cigarette prices, disposable income, employment and unemployment, industry advertising expenditures, the future effect of the incidence of smoking among underage youth and qualitative variables that captured the impact of anti–smoking regulations, legislation, and health warnings. After determining which variables were effective in building this cigarette consumption model (real cigarette prices, real per capita disposable personal income, the impact of 82 restrictions on smoking in public places, and the trend over time in individual behavior and preferences), Global Insight employed standard multivariate regression analysis to determine the nature of the economic relationship between these variables and adult per capita cigarette consumption in the United States. The multivariate regression analysis showed: (i) long run price elasticity of demand of –0.33; (ii) income elasticity of demand of 0.27; and (iii) a trend decline in adult per capita cigarette consumption of 2.40% per year holding other recognized significant factors constant. Global Insight’s model, coupled with its long term forecast of the United States economy, was then used to project total United States cigarette consumption from 2004 through 2034 (the “Base Case Forecast”). The Base Case Forecast indicates that the total United States cigarette consumption in 2034 will be 226 billion cigarettes (approximately 11 billion packs), a 43% decline from the 2003 level. After 2003, the rate of decline in total cigarette consumption is projected to moderate and average less than 2% per year. From 2004 through 2034, the average annual rate of decline is projected to be 1.82%. On a per capita basis, consumption is forecast to fall during the same period at an average annual rate of 2.62%. Total consumption of cigarettes in the United States is forecast to fall from an estimated 381 billion in 2005 to 373 billion in 2006, to 299 billion by 2018, and to 226 billion by 2034, as set forth in the following table. The Global Insight Consumption Report states that Global Insight believes that the assumptions on which the Base Case Forecast is based are reasonable. Global Insight Base Case Forecast of Cigarette Consumption Year Cigarettes (billions) Year Cigarettes (billions) 2004 393.00 2020 288.43 2005 381.00 2021 283.17 2006 373.34 2022 278.11 2007 366.86 2023 273.09 2008 360.59 2024 268.43 2009 353.96 2025 263.84 2010 347.62 2026 259.36 2011 341.27 2027 254.97 2012 334.93 2028 250.69 2013 328.54 2029 246.48 2014 322.14 2030 242.34 2015 316.45 2031 238.16 2016 310.82 2032 234.12 2017 305.06 2033 230.14 2018 299.41 2034 226.19 2019 293.71 The following graph displays the projected time trend of cigarette consumption in the United States: 83 2030 2020 2010 2000 1990 550 500 450 400 350 300 250 200 150 Billions of Cigarettes Annual U.S. Cigarette Consumption Actual Base Case Forecast Low Case 2 Extreme Low Case 3 Extreme The Global Insight Consumption Report also presents alternative forecasts that project higher and lower paths of cigarette consumption, predicting that by 2034 total United States consumption could be as low as 185 billion or as high as 237 billion cigarettes. In addition, the Global Insight Consumption Report presents scenarios with more extreme variations in assumptions for the purposes of illustrating alternative paths of consumption. Comparison with Prior Forecasts In October 2001, Global Insight (then DRI•WEFA, Inc.) presented another similar study “A Forecast of U.S. Cigarette Consumption (1999-2030).” Its long run conclusions were quite similar to those in the Global Insight Consumption Report. The Global Insight Consumption Report forecast of consumption for the year 2030 is 2.4% less than that of the 2001 study, 242.3 billion versus 248.2 billion. This forecast also differs from those provided in similar studies in 2005 and 2006. In February 2006 full year data on industry shipments for 2005 were reported by the manufacturers and by the U.S. Bureau of Alcohol Tobacco and Firearms. From this data Global Insight estimated that consumption in 2005 was 381 billion cigarettes, 4 billion fewer than had been projected. This new data has been incorporated into this revised forecast. Its long term implications are that consumption levels in 2030 are forecast to be 242 billion, 4 billion fewer than the 246 billion in Global Insight’s forecasts in 2005. Historical Cigarette Consumption The USDA, which has compiled data on cigarette consumption since 1900, reports that consumption (which is defined as taxable United States consumer sales, plus shipments to overseas armed forces, ship stores, Puerto Rico and other United States possessions, and small tax–exempt categories, as reported by the Bureau of Alcohol, Tobacco and Firearms) grew from 2.5 billion in 1900 to a peak of 640 billion in 1981. Consumption declined in the 1980’s and 1990’s, reaching a level of 465 billion cigarettes in 1998, and decreasing to less than 400 billion cigarettes in 2004. 84 The following table sets forth United States domestic cigarette consumption for the eight years ended December 31, 2005. The data in this table vary from statistics on cigarette shipments in the United States. While the Cigarette Consumption Report is based on consumption, payments under the MSA are computed based in part on shipments in or to the 50 states of the United States, the District of Columbia and Puerto Rico. The quantities of cigarettes shipped and cigarettes consumed may not match at any given point in time as a result of various factors such as inventory adjustments, but are substantially the same when compared over a period of time. U.S. Cigarette Consumption Year Ended December 31 Consumption (Billions of Cigarettes) Percentage Change 2005 381(est.) –3.05% 2004 393(est.) –1.75 2003 400 –3.61 2002 415 –2.35 2001 425 –1.16 2000 430 –1.15 1999 435 –6.45 1998 465 –3.13 Factors Affecting Cigarette Consumption Most empirical studies have found a common set of variables that are relevant in building a model of cigarette demand. These conventional analyses usually evaluate one or more of the following factors: (i) general population growth, (ii) price elasticity of demand and price increases, (iii) changes in disposable income, (iv) youth consumption, (v) trends over time, (vi) smoking bans in public places, (vii) nicotine dependence, and (viii) health warnings. While some of these factors were not found to have a measurable impact on changes in demand for cigarettes, all of these factors are thought to affect smoking in some manner and to be incorporated into current levels of consumption. Since 1964 there has been a significant decline in United States adult per capita cigarette consumption. The 1964 Surgeon General’s health warning and numerous subsequent health warnings, together with the increased health awareness of the population over the past 30 years, may have contributed to decreases in cigarette consumption levels. If, as assumed by Global Insight, the awareness of the adult population continues to change in this way, overall consumption of cigarettes will decline gradually over time. Global Insight’s analysis includes a time trend variable in order to capture the impact of these changing health trends and the effects of other such variables which are difficult to quantify. METHODOLOGY AND BOND STRUCTURING ASSUMPTIONS The following discussion describes the methodology and assumptions used to calculate a forecast of Collections to be received by the Indenture Trustee (the “Collection Methodology and Assumptions”), as well as the methodology and assumptions used to structure the schedules of maturities for the Series 2006 Bonds (the “Structuring Assumptions”). For sensitivity analyses which evaluate the impact of different consumption levels on Turbo Redemptions, see “– Effect of Changes in Consumption Level on Turbo Redemptions” below. The assumptions are only assumptions and no guarantee can be made as to the ultimate outcome of certain events assumed here. If actual results are different from those assumed, it could have a material effect on the forecast of Collections as well as assumed Turbo Redemptions. 85 Collection Methodology and Assumptions In calculating a forecast of Collections to be received by the Indenture Trustee, the Global Insight Base Case Consumption Forecast was applied to calculate Annual Payments and Strategic Contribution Payments to be made by the PMs pursuant to the MSA. As described below, certain assumptions were made with respect to consumption of cigarettes in the U.S. and the applicability of certain adjustments and offsets to such payments set forth in the MSA. In addition, it was assumed that the PMs make all payments as required pursuant to the MSA, and that the relative market share for each of the PMs remains constant throughout the forecast period at 84.4% for the OPMs, 9.4% for the SPMs and 6.2% for the NPMs.† It was further assumed that each company that is currently a PM remains such throughout the term of the Series 2006 Bonds. In applying the consumption forecast from the Global Insight Consumption Report, it was assumed that U.S. consumption was equal to the number of cigarettes shipped in and to the U.S., the District of Columbia and Puerto Rico, which is the number that is applied to determine the Volume Adjustment. The Global Insight Consumption Report states that the quantities of cigarettes shipped and cigarettes consumed may not match at any given point in time as a result of various factors such as inventory adjustments, but are substantially the same when compared over a period of time. The Global Insight Base Case Forecast for U.S. cigarette consumption and a discussion of the assumptions underlying the cigarette consumption projections is set forth herein in Appendix A – “GLOBAL INSIGHT CONSUMPTION REPORT”. Annual Payments In accordance with the Collection Methodology and Assumptions, the amount of Annual Payments to be made by the PMs was calculated by applying the adjustments applicable to the Annual Payments in the order, and in the amounts, set out in the MSA, as follows: Inflation Adjustment. First, the Inflation Adjustment was applied to the schedule of base amounts for the Annual Payments set forth in the MSA. Inflation was assumed to be at a rate of 3.4% for 2000, 3.0% for 2001 through 2003, 3.256% for 2004, and 3.416% for 2005. Thereafter, the rate of inflation was assumed to be the minimum provided in the MSA, at a rate of 3% per year, compounded annually, for the rest of the forecast period. Volume Adjustment. Next, the annual amounts calculated for each year after application of the Inflation Adjustment were adjusted for the Volume Adjustment by applying the Global Insight Base Case Forecast for U.S. cigarette consumption to the market share of the OPMs for the prior year. No add back or benefit was assumed from any Income Adjustment. See “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT —Adjustments to Payments – Volume Adjustment” for a description of the formula used to calculate the Volume Adjustment. Previously Settled States Reduction. Next, the annual amounts calculated for each year after application of the Inflation Adjustment and the Volume Adjustment were reduced by the Previously Settled States Reduction which applies only to the payments owed by the OPMs. The Previously Settled States Reduction is as follows for each year of the following periods: 2002 through 2007 12.4500000% 2008 through 2017 12.2373756% 2018 and after 11.0666667% † The aggregate market share information utilized in the bond structuring assumptions may differ materially from the market share information used by the MSA Auditor in calculating adjustments to Annual Payments and Strategic Contribution Payments. 86 Non-Settling States Reduction. The Non-Settling States Reduction was not applied to the Annual Payments because such reduction has no effect on the amount of payments to be received by Settling States that remain parties to the MSA. Thus, the Collection Methodology and Assumptions include an assumption that the Virgin Islands will remain a party to the MSA. NPM Adjustment. The NPM Adjustment will not apply to the Annual Payments payable to any Settling State that enacts and diligently enforces a Qualifying Statute so long as such statute is not held to be unenforceable. The Collection Methodology and Assumptions include an assumption that the Virgin Islands will diligently enforce a Qualifying Statute that is not held to be unenforceable. For a discussion of the Virgin Islands Model Statute, see “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT–MSA Provisions Relating to Model/Qualifying Statutes.” Should a PM be determined with finality to be entitled to an NPM Adjustment in a future year due to non-diligent enforcement of the Qualifying Statute by the Virgin Islands, the NPM Adjustment could reduce the payments by the PMs under the MSA and the amounts of TSRs available to the Corporation to make Turbo Redemptions on the Series 2001 Bonds and the Series 2006 Bonds, and pay the Accreted Value of the Series 2006 Bonds. In such a situation the estimated redemption schedule for the Series 2001 Bonds described herein under “Structuring Assumptions – Series 2001 Bonds” and the estimated redemption schedules set forth under Appendix G – “DEFEASANCE TURBO SCHEDULES” attached hereto may not be realized. See “RISK FACTORS–Other Potential Payment Decreases Under the Terms of the MSA–NPM Adjustment” herein. Offset for Miscalculated or Disputed Payments. The Collection Methodology and Assumptions include an assumption that there will be no adjustments to the Annual Payments due to miscalculated or disputed payments. However, a deposit into the Disputed Payments Account or withholding of payment by a PM based upon a claim of entitlement to an adjustment to an Annual Payment due in one or more future years could reduce the amount of Collections available to the Authority to make Turbo Redemptions and pay principal or interest on the Series 2001 Bonds or the Accreted Value of the Series 2006 Bonds. See “RISK FACTORS— Other Potential Payment Decreases Under the Terms of the MSA– Disputed or Recalculated Payments” and “–Other Disputes Arising Under the MSA” herein. Offset for Claims-Over. The Collection Methodology and Assumptions include an assumption that the Offset for Claims-Over will not apply. Litigating Releasing Parties Offset. The Collection Methodology and Assumptions include an assumption that the Litigating Releasing Parties Offset will have no effect on payments. Subsequent Participating Manufacturers. The Collection Methodology and Assumptions assume that the relative market share of the SPMs remains constant at 9.4%. Because the 9.4% market share is greater than 3.125% (125% of 2.5%, the SPMs’ estimated 1997 market share), the Collection Methodology and Assumptions assume that the SPMs are required to make Annual Payments in each year. State Allocation Percentage. The amount of Annual Payments, after application of the Inflation Adjustment, the Volume Adjustment and the Previously Settled States Reduction (with respect to the OPMs only) for each year, was multiplied by the State Allocation Percentage for the Virgin Islands (0.0173593%) in order to determine the amount of Annual Payments to be made by the PMs in each year to be allocated to the United States Virgin Islands State-Specific Account. The following table shows the projection of Annual Payments to be received by the Indenture Trustee each year from 2006 through 2035, calculated in accordance with the Collection Methodology and Assumptions. 87 PROJECTION OF ANNUAL PAYMENTS TO BE RECEIVED BY INDENTURE TRUSTEE Date Global Insight Base Case Consumption Forecast OPM-Adjusted Consumption Base Annual Payments Inflation Adjustment Volume Adjustment Previously Settled States Reduction Subtotal Virgin Islands Allocation Annual Payments to Virgin Islands Pledged TSRs Allocation OPM Payments to Virgin Islands SPM Payments to Virgin Islands Total Annual Payments to Virgin Islands 4/25/2005 381,000,000,000 321,564,000,000 4/25/2006 373,340,000,000 315,098,960,000 $8,000,000,000 $1,941,741,289 $(3,156,280,889) $(844,789,820) $5,940,670,580 0.0173593% $1,031,259 100.00% $1,031,259 $ 87,576 $1,118,834 4/25/2007 366,860,000,000 309,629,840,000 8,000,000,000 2,239,993,527 (3,387,366,057) (853,152,120) 5,999,475,350 0.0173593% 1,041,467 100.00% 1,041,467 88,442 1,129,909 4/25/2008 360,590,000,000 304,337,960,000 8,139,000,000 2,591,450,817 (3,670,519,942) (863,950,258) 6,195,980,617 0.0173593% 1,075,579 100.00% 1,075,579 91,118 1,166,697 4/25/2009 353,960,000,000 298,742,240,000 8,139,000,000 2,913,364,342 (3,901,138,656) (875,122,347) 6,276,103,339 0.0173593% 1,089,488 100.00% 1,089,488 92,296 1,181,784 4/25/2010 347,620,000,000 293,391,280,000 8,139,000,000 3,244,935,272 (4,149,417,429) (885,315,121) 6,349,202,722 0.0173593% 1,102,177 100.00% 1,102,177 93,371 1,195,548 4/25/2011 341,270,000,000 288,031,880,000 8,139,000,000 3,586,453,330 (4,403,168,968) (896,055,440) 6,426,228,922 0.0173593% 1,115,548 100.00% 1,115,548 94,504 1,210,052 4/25/2012 334,930,000,000 282,680,920,000 8,139,000,000 3,938,216,930 (4,668,621,135) (906,617,694) 6,501,978,101 0.0173593% 1,128,698 100.00% 1,128,698 95,618 1,224,316 4/25/2013 328,540,000,000 277,287,760,000 8,139,000,000 4,300,533,438 (4,945,821,268) (917,033,705) 6,576,678,465 0.0173593% 1,141,665 100.00% 1,141,665 96,716 1,238,382 4/25/2014 322,140,000,000 271,886,160,000 8,139,000,000 4,673,719,441 (5,236,565,655) (927,122,395) 6,649,031,392 0.0173593% 1,154,225 100.00% 1,154,225 97,781 1,252,006 4/25/2015 316,450,000,000 267,083,800,000 8,139,000,000 5,058,101,024 (5,540,532,950) (936,962,993) 6,719,605,081 0.0173593% 1,166,476 100.00% 1,166,476 98,818 1,265,295 4/25/2016 310,820,000,000 262,332,080,000 8,139,000,000 5,454,014,055 (5,841,243,145) (948,613,322) 6,803,157,589 0.0173593% 1,180,981 100.00% 1,180,981 100,047 1,281,028 4/25/2017 305,060,000,000 257,470,640,000 8,139,000,000 5,861,804,477 (6,153,548,708) (960,298,163) 6,886,957,606 0.0173593% 1,195,528 100.00% 1,195,528 101,279 1,296,807 4/25/2018 299,410,000,000 252,702,040,000 9,000,000,000 6,946,364,111 (7,168,369,432) (971,431,414) 7,806,563,265 0.0173593% 1,355,165 100.00% 1,355,165 113,292 1,468,457 4/25/2019 293,710,000,000 247,891,240,000 9,000,000,000 7,424,755,034 (7,544,790,549) (982,716,073) 7,897,248,413 0.0173593% 1,370,907 100.00% 1,370,907 114,608 1,485,515 4/25/2020 288,430,000,000 243,434,920,000 9,000,000,000 7,917,497,685 (7,938,816,296) (993,640,743) 7,985,040,646 0.0173593% 1,386,147 100.00% 1,386,147 115,882 1,502,029 4/25/2021 283,170,000,000 238,995,480,000 9,000,000,000 8,425,022,616 (8,336,967,093) (1,005,744,814) 8,082,310,709 0.0173593% 1,403,033 100.00% 1,403,033 117,294 1,520,326 4/25/2022 278,110,000,000 234,724,840,000 9,000,000,000 8,947,773,294 (8,751,237,814) (1,017,749,930) 8,178,785,551 0.0173593% 1,419,780 100.00% 1,419,780 118,694 1,538,474 4/25/2023 273,090,000,000 230,487,960,000 9,000,000,000 9,486,206,493 (9,176,432,361) (1,030,281,674) 8,279,492,459 0.0173593% 1,437,262 100.00% 1,437,262 120,155 1,557,417 4/25/2024 268,430,000,000 226,554,920,000 9,000,000,000 10,040,792,688 (9,617,938,062) (1,042,795,915) 8,380,058,711 0.0173593% 1,454,720 100.00% 1,454,720 121,615 1,576,334 4/25/2025 263,840,000,000 222,680,960,000 9,000,000,000 10,612,016,469 (10,065,398,090) (1,056,492,437) 8,490,125,942 0.0173593% 1,473,826 100.00% 1,473,826 123,212 1,597,038 4/25/2026 259,360,000,000 218,899,840,000 9,000,000,000 11,200,376,963 (10,528,590,718) (1,070,344,348) 8,601,441,897 0.0173593% 1,493,150 100.00% 1,493,150 124,827 1,617,978 4/25/2027 254,970,000,000 215,194,680,000 9,000,000,000 11,806,388,272 (11,006,536,213) (1,084,516,964) 8,715,335,094 0.0173593% 1,512,921 100.00% 1,512,921 126,480 1,639,402 4/25/2028 250,690,000,000 211,582,360,000 9,000,000,000 12,430,579,920 (11,500,328,791) (1,098,947,795) 8,831,303,334 0.0173593% 1,533,052 100.00% 1,533,052 128,163 1,661,216 4/25/2029 246,480,000,000 208,029,120,000 9,000,000,000 13,073,497,317 (12,009,620,836) (1,113,735,667) 8,950,140,814 0.0173593% 1,553,682 100.00% 1,553,682 129,888 1,683,570 4/25/2030 242,340,000,000 204,534,960,000 9,000,000,000 13,735,702,237 (12,536,352,644) (1,128,728,025) 9,070,621,568 0.0173593% 1,574,596 100.00% 1,574,596 131,636 1,706,233 4/25/2031 238,160,000,000 201,007,040,000 9,000,000,000 14,417,773,304 (13,081,029,214) (1,143,933,016) 9,192,811,074 0.0173593% 1,595,808 100.00% 1,595,808 133,410 1,729,217 4/25/2032 234,120,000,000 197,597,280,000 9,000,000,000 15,120,306,503 (13,648,781,376) (1,158,848,784) 9,312,676,343 0.0173593% 1,616,615 100.00% 1,616,615 135,149 1,751,765 4/25/2033 230,140,000,000 194,238,160,000 9,000,000,000 15,843,915,698 (14,232,777,576) (1,174,299,289) 9,436,838,833 0.0173593% 1,638,169 100.00% 1,638,169 136,951 1,775,120 4/25/2034 226,190,000,000 190,904,360,000 9,000,000,000 16,589,233,169 (14,836,859,813) (1,189,929,322) 9,562,444,035 0.0173593% 1,659,973 100.00% 1,659,973 138,774 1,798,747 4/25/2035 9,000,000,000 17,356,910,164 (15,463,002,520) (1,205,592,450) 9,688,315,195 0.0173593% 1,681,824 100.00% 1,681,824 140,601 1,822,424 88 Strategic Contribution Payments In accordance with the Collection Methodology and Assumptions, the amount of Strategic Contribution Payments to be made by the PMs was calculated by applying the adjustments applicable to the Strategic Contribution Payments in the amounts, set out in the MSA, as follows: Inflation Adjustment. First, the Inflation Adjustment was applied to the schedule of base amounts for the Strategic Contribution Payments set forth in the MSA. Inflation was assumed to be at a rate of 3.4% for 2000, 3.0% for 2001 through 2003, and 3.256% for 2004, and 3.416% for 2005. Thereafter, the rate of inflation was assumed to be the minimum provided in the MSA, at a rate of 3% per year, compounded annually, for the rest of the forecast period. Volume Adjustment. Next, the Strategic Contribution Payments calculated for each year after application of the Inflation Adjustment was adjusted for the Volume Adjustment by applying the Global Insight Base Case Forecast for U.S. cigarette consumption to the market share of the OPMs for the prior year. No add back or benefit was assumed from any Income Adjustment as it does not apply to Strategic Contribution Payments. See “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT – Adjustments to Payments – Volume Adjustment” for a description of the formula used to calculate the Volume Adjustment. Non-Settling States Reduction. The Non-Settling States Reduction was not applied to the Strategic Contribution Payments because such reduction has no effect on the amount of payments to be received by Settling States that remain parties to the MSA. Thus, the Collection Methodology and Assumptions include an assumption that the Virgin Islands will remain a party to the MSA. NPM Adjustment. The NPM Adjustment will not apply to the Strategic Contribution Payments payable to any Settling State that enacts and diligently enforces a Qualifying Statute so long as such statute is not held to be unenforceable. The Collection Methodology and Assumptions include an assumption that the Virgin Islands will diligently enforce a Qualifying Statute that is not held to be unenforceable. For a discussion of the Virgin Islands Model Statute, see “SUMMARY OF THE MASTER SETTLEMENT AGREEMENT–MSA Provisions Relating to Model/Qualifying Statutes.” Should a PM be determined with finality to be entitled to an NPM Adjustment in a future year due to non- diligent enforcement of the Qualifying Statute by the Virgin Islands, the NPM Adjustment could reduce the payments by the PMs under the MSA and the amounts of TSRs available to the Corporation to make Turbo Redemptions on the Series 2001 Bonds and the Series 2006 Bonds, and pay the Accreted Value of the Series 2006 Bonds during such period. In such a situation the estimated redemption schedule for the Series 2001 Bonds described herein under “Structuring Assumptions – Series 2001 Bonds” and the estimated redemption schedules set forth under Appendix G – “DEFEASANCE TURBO SCHEDULES” attached hereto may not be realized. See “RISK FACTORS – Other Potential Payment Decreases Under the Terms of the MSA – NPM Adjustment” herein. Offset for Miscalculated or Disputed Payments. The Collection Methodology and Assumptions include an assumption that there will be no adjustments to the Strategic Contribution Payments due to miscalculated or disputed payments. However, a deposit into the Disputed Payments Account or withholding of payment by a PM based upon a claim of entitlement to an adjustment to a Strategic Contribution Payment due in one or more future years could reduce the amount of Collections available to the Authority to make Turbo Redemptions and pay principal or interest on the Series 2001 Bonds or the Accreted Value of the Series 2006 Bonds. See “RISK FACTORS–Other Potential Payment Decreases Under the Terms of the MSA–Disputed or Recalculated Payments” and “–Other Disputes Arising Under the MSA” herein. 89 Litigating Releasing Parties Offset. The Collection Methodology and Assumptions include an assumption that the Litigating Releasing Parties Offset will have no effect on payments. Offset for Claims-Over. The Collection Methodology and Assumptions include an assumption that the Offset for Claims-Over will not apply. Subsequent Participating Manufacturers. The Collection Methodology and Assumptions assume that the relative market share of the SPMs remains constant at 9.4%. Because the 9.4% market share is greater than 3.125% (125% of 2.5%, the SPMs’ estimated 1997 market share), Collection Methodology and Assumptions assume that the SPMs are required to make Strategic Contribution Payments in each year. State Allocation Percentage. The amount of Strategic Contribution Payments, after application of the Inflation Adjustment and the Volume Adjustment for each year was multiplied by 0.1800232%, or the Virgin Islands’ percentage allocation of Strategic Contribution Payments, in order to determine the amount of Strategic Contribution Payments to be made by the PMs in each year to be allocated to the Virgin Islands State-Specific Account. The following table shows the projection of Strategic Contribution Payments and total payments (including Annual Payments) to be received by the Indenture Trustee from 2006 through 2035, calculated in accordance with the Collection Methodology and Assumptions. 90 PROJECTION OF STRATEGIC CONTRIBUTION AND TOTAL PAYMENTS TO BE RECEIVED BY THE INDENTURE TRUSTEE Strategic Contribution Payments Total Payments Date Global Insight Base Case Consumption Forecast OPM-Adjusted Consumption Base Strategic Contribution Payments Inflation Adjustment Volume Adjustment Previously Settled States Reduction Subtotal Virgin Islands Allocation Annual Payments to Virgin Islands Pledged TSRs Allocation OPM Payments to Virgin Islands SPM Payments to Virgin Islands Total Annual Payments to Virgin Islands Total Strategic Contribution Payments to Virgin Islands Total Payments to Virgin Islands 4/25/2005 381,000,000,000 321,564,000,000 4/25/2006 373,340,000,000 315,098,960,000 $ 0 $ 0 $ 0 $ 0 $ 0 0.1800232% $ 0 100.00% $ 0 $ 0 $1,118,834 $ 0 $1,118,834 4/25/2007 366,860,000,000 309,629,840,000 0 0 0 0 0 0.1800232% 0 100.00% 0 0 1,129,909 0 1,129,909 4/25/2008 360,590,000,000 304,337,960,000 861,000,000 274,141,682 (388,293,116) 0 746,848,567 0.1800232% 1,344,501 100.00% 1,344,501 99,961 1,166,697 1,444,462 2,611,159 4/25/2009 353,960,000,000 298,742,240,000 861,000,000 308,195,933 (412,689,567) 0 756,506,366 0.1800232% 1,361,887 100.00% 1,361,887 101,254 1,181,784 1,463,141 2,644,925 4/25/2010 347,620,000,000 293,391,280,000 861,000,000 343,271,811 (438,954,221) 0 765,317,590 0.1800232% 1,377,749 100.00% 1,377,749 102,433 1,195,548 1,480,183 2,675,731 4/25/2011 341,270,000,000 288,031,880,000 861,000,000 379,399,965 (465,797,823) 0 774,602,142 0.1800232% 1,394,464 100.00% 1,394,464 103,676 1,210,052 1,498,140 2,708,192 4/25/2012 334,930,000,000 282,680,920,000 861,000,000 416,611,964 (493,879,199) 0 783,732,766 0.1800232% 1,410,901 100.00% 1,410,901 104,898 1,224,316 1,515,799 2,740,115 4/25/2013 328,540,000,000 277,287,760,000 861,000,000 454,940,323 (523,203,356) 0 792,736,967 0.1800232% 1,427,111 100.00% 1,427,111 106,103 1,238,382 1,533,214 2,771,596 4/25/2014 322,140,000,000 271,886,160,000 861,000,000 494,418,533 (553,960,318) 0 801,458,215 0.1800232% 1,442,811 100.00% 1,442,811 107,271 1,252,006 1,550,082 2,802,087 4/25/2015 316,450,000,000 267,083,800,000 861,000,000 535,081,089 (586,116,092) 0 809,964,997 0.1800232% 1,458,125 100.00% 1,458,125 108,409 1,265,295 1,566,534 2,831,829 4/25/2016 310,820,000,000 262,332,080,000 861,000,000 576,963,521 (617,927,306) 0 820,036,215 0.1800232% 1,476,256 100.00% 1,476,256 109,757 1,281,028 1,586,013 2,867,040 4/25/2017 305,060,000,000 257,470,640,000 861,000,000 620,102,427 (650,965,160) 0 830,137,267 0.1800232% 1,494,440 100.00% 1,494,440 111,109 1,296,807 1,605,549 2,902,356 4/25/2018 299,410,000,000 252,702,040,000 0 0 0 0 0 0.1800232% 0 100.00% 0 0 1,468,457 0 1,468,457 4/25/2019 293,710,000,000 247,891,240,000 0 0 0 0 0 0.1800232% 0 100.00% 0 0 1,485,515 0 1,485,515 4/25/2020 288,430,000,000 243,434,920,000 0 0 0 0 0 0.1800232% 0 100.00% 0 0 1,502,029 0 1,502,029 4/25/2021 283,170,000,000 238,995,480,000 0 0 0 0 0 0.1800232% 0 100.00% 0 0 1,520,326 0 1,520,326 4/25/2022 278,110,000,000 234,724,840,000 0 0 0 0 0 0.1800232% 0 100.00% 0 0 1,538,474 0 1,538,474 4/25/2023 273,090,000,000 230,487,960,000 0 0 0 0 0 0.1800232% 0 100.00% 0 0 1,557,417 0 1,557,417 4/25/2024 268,430,000,000 226,554,920,000 0 0 0 0 0 0.1800232% 0 100.00% 0 0 1,576,334 0 1,576,334 4/25/2025 263,840,000,000 222,680,960,000 0 0 0 0 0 0.1800232% 0 100.00% 0 0 1,597,038 0 1,597,038 4/25/2026 259,360,000,000 218,899,840,000 0 0 0 0 0 0.1800232% 0 100.00% 0 0 1,617,978 0 1,617,978 4/25/2027 254,970,000,000 215,194,680,000 0 0 0 0 0 0.1800232% 0 100.00% 0 0 1,639,402 0 1,639,402 4/25/2028 250,690,000,000 211,582,360,000 0 0 0 0 0 0.1800232% 0 100.00% 0 0 1,661,216 0 1,661,216 4/25/2029 246,480,000,000 208,029,120,000 0 0 0 0 0 0.1800232% 0 100.00% 0 0 1,683,570 0 1,683,570 4/25/2030 242,340,000,000 204,534,960,000 0 0 0 0 0 0.1800232% 0 100.00% 0 0 1,706,233 0 1,706,233 4/25/2031 238,160,000,000 201,007,040,000 0 0 0 0 0 0.1800232% 0 100.00% 0 0 1,729,217 0 1,729,217 4/25/2032 234,120,000,000 197,597,280,000 0 0 0 0 0 0.1800232% 0 100.00% 0 0 1,751,765 0 1,751,765 4/25/2033 230,140,000,000 194,238,160,000 0 0 0 0 0 0.1800232% 0 100.00% 0 0 1,775,120 0 1,775,120 4/25/2034 226,190,000,000 190,904,360,000 0 0 0 0 0 0.1800232% 0 100.00% 0 0 1,798,747 0 1,798,747 4/25/2035 0 0 0 0 0 0.1800232% 0 100.00% 0 0 1,822,424 0 1,822,424 91 Interest Earnings The Collection Methodology and Assumptions assume that the Indenture Trustee will receive the Corporation’s share of the Annual Payments and Strategic Contribution Payments to be paid by the PMs ten days after April 15 in each year commencing after the Crossover Date. Interest is assumed to be earned on amounts on deposit in the Debt Service Account at the rate of 4.0% per annum, from the receipt thereof until the next Distribution Date. No interest earnings have been assumed on the Annual Payments or Strategic Contribution Payments prior to the time they are received by the Indenture Trustee. Structuring Assumptions – Series 2001 Bonds The Structuring Assumptions for the Series 2001 Bonds were applied to the forecast of Collections described above. The Structuring Assumptions assume that no optional redemption is exercised on the Series 2001 Bonds. The amount on deposit in the Series 2001 Bonds Debt Service Reserve Account is assumed to equal the Debt Service Reserve Requirement on Series 2001 Bonds and is invested at the rate of 4.25% as provided for in the guaranteed investment contract entered into by the Corporation at the time of the issuance of the Series 2001 Bonds. The outstanding amounts of Series 2001 Bonds shown in the table below have been projected based on outstanding interest rates, the terms of the outstanding Series 2001 Bonds, and the forecast of Annual Payments and Strategic Contribution Payments reflecting the Global Insight Base Case Forecast and the Collection Methodology and Assumptions and other Structuring Assumptions outlined herein. Projected Outstanding Amounts of Series 2001 Bonds* Date Projected Outstanding Amounts† Projected Serial Principal Payments and Turbo Redemptions** Settlement $13,720,000 $ 0 5/15/2006 13,335,000 385,000 5/15/2007 12,915,000 420,000 5/15/2008 12,255,000 660,000 5/15/2009 11,585,000 670,000 5/15/2010 10,795,000 790,000 5/15/2011 9,945,000 850,000 5/15/2012 9,065,000 880,000 5/15/2013 8,120,000 945,000 5/15/2014 7,100,000 1,020,000 5/15/2015 4,525,000 2,575,000 5/15/2016 0 4,525,000 ___________ * Assuming Global Insight Base Case Consumption Forecast and other structuring assumptions. † Outstanding amounts represent principal balances after the application of amounts on deposit in the Debt Service Account to serial principal payments and on deposit in the Turbo Redemption Account to Turbo Redemptions in the year of the referenced date. ** Projected Turbo Redemptions represent Turbo Redemptions made in the year ending on the referenced date. 92 Structuring Assumptions – Series 2006 Bonds General. The Structuring Assumptions for the Series 2006 Bonds were applied to the forecast of Collections described above. The Structuring Assumptions assume that no optional redemption is exercised on the Series 2006 Bonds. Turbo Redemption payments for the Series 2006 Bonds were structured to allow for amortization of the Series 2006 Bonds prior to maturity using the Global Insight Base Case Consumption Forecast and the other assumptions presented herein. Sizing. The Series 2006A Bonds, the Series 2006B Bonds and the Series 2006C Bonds were sized consistent with such Series’ credit ratings. Operating Expense Assumptions. Operating expenses of the Corporation have been assumed at the Operating Cap of $59,702.61 inflated at 3% per year beginning in 2006. No arbitrage rebate expense was assumed since it has been assumed that the yield on the Corporation’s investments will not exceed the yield on the Series 2006 Bonds. Issuance Date. The Series 2006 Bonds were assumed to be issued on April 12, 2006. Accretion. The Series 2006 Bonds were assumed to accrete interest at the rates set forth on the inside cover hereof. Effect of Changes in Consumption Level on Turbo Redemptions Weighted Average Lives and Final Principal Payments. The tables below have been prepared to show the effect of changes in consumption on the weighted average lives and payments of Accreted Value for the Series 2006 Bonds. For the purpose of measuring the effect of changes in consumption level, the Series 2006 Bonds were assumed to have yields as shown in the inside cover. The tables are based on the Collection Methodology and Assumptions and the Structuring Assumptions, except that the annual cigarette consumption varies in each case. In addition to the Global Insight Base Case Forecast, several alternative cigarette consumption scenarios are presented below, including four alternative forecasts of Global Insight (the Global Insight High Forecast, the Global Insight Low Case 1, the Global Insight Low Case 2 and the Global Insight Low Case 3, each as hereinafter defined) and two other consumption scenarios prepared by Global Insight (assuming a 3.5% and a 4.0% annual consumption decline), and four other consumption scenarios (assuming a 3.96%, a 3.68%, a 3.16%, and a 2.50% annual consumption decline). In each case, if actual cigarette consumption in the U.S. is as forecasted and assumed, and events occur as assumed by the Collection Methodology and Assumptions and the Structuring Assumptions, the payments of Accreted Value for and weighted average lives (in years) of the Series 2006 Bonds will be as set forth in such tables. The tables presented below are for illustrative purposes only. Actual cigarette consumption in the U.S. cannot be definitively forecast. To the degree actual consumption and other structuring variables vary from the alternative scenarios presented below, the weighted average lives (and final principal payment dates) for the Series 2006 Bonds will be either shorter (sooner) or longer (later) than projected below. 93 Effect of Changes in Consumption Level Series 2006A Bonds Maturing May 15, 2035 Consumption Forecast Weighted Average Life (in years)∗ Final Principal Payment (in years) Global Insight Base Case Forecast 13.1 17.1 Global Insight High Forecast 12.8 16.1 Global Insight Low Case 1 13.6 17.1 Global Insight Low Case 2 14.2 18.1 Global Insight Low Case 3 21.0 27.1 3.5% Annual Consumption Decline 17.9 24.1 3.96% Annual Consumption Decline 20.6 29.1 4.0% Annual Consumption Decline n/a** n/a** Series 2006B Bonds Maturing May 15, 2035 Consumption Forecast Weighted Average Life (in years)∗ Final Principal Payment (in years) Global Insight Base Case Forecast 17.2 18.1 Global Insight High Forecast 16.7 17.1 Global Insight Low Case 1 17.9 18.1 Global Insight Low Case 2 18.9 19.1 3.5% Annual Consumption Decline 25.8 27.1 3.68% Annual Consumption Decline 27.7 29.1 Global Insight Low Case 3 n/a† n/a† 4.0% Annual Consumption Decline n/a** n/a** * The Series 2006 Bonds Weighted Average Life is calculated based on Accreted Value at the time of Turbo Redemption. ** In the event of an Annual Consumption Decline of 4.0%, and assuming the values of all other structuring variables as outlined in the Collection Methodology and Assumptions above, the Series 2006A, 2006B, 2006C and Series 2006D Bonds may never be repaid. † In the event of consumption declines forecast by the Global Insight Low Case 3, and assuming the values of all other structuring variables as outlined in the Collection Methodology and Assumptions above, the Series 2006B, 2006C and 2006D Bonds may never be repaid. †† In the event of an Annual Consumption Decline of 3.5%, and assuming the values of all other structuring variables as outlined in the Collection Methodology and Assumptions above, the Series 2006C and Series 2006D Bonds may never be repaid. 94 Series 2006C Bonds Maturing May 15, 2035 Consumption Forecast Weighted Average Life (in years)∗ Final Principal Payment (in years) Global Insight Base Case Forecast 18.8 20.1 Global Insight High Forecast 18.2 19.1 Global Insight Low Case 1 19.7 21.1 Global Insight Low Case 2 20.9 22.1 3.16% Annual Consumption Decline 26.4 29.1 Global Insight Low Case 3 n/a† n/a† 3.5% Annual Consumption Decline n/a†† n/a†† 4.0% Annual Consumption Decline n/a** n/a** Series 2006D Bonds Maturing May 15, 2035 Consumption Forecast Weighted Average Life (in years)* Final Principal Payment (in years) Global Insight Base Case Forecast 21.7 23.1 Global Insight High Forecast 20.9 23.1 Global Insight Low Case 1 23.0 25.1 Global Insight Low Case 2 24.7 27.1 2.50% Annual Consumption Decline 26.2 29.1 Global Insight Low Case 3 n/a† n/a† 3.5% Annual Consumption Decline n/a†† n/a†† 4.0% Annual Consumption Decline n/a** n/a** * The Series 2006 Bonds Weighted Average Life is calculated based on Accreted Value at the time of Turbo Redemption. ** In the event of an Annual Consumption Decline of 4.0%, and assuming the values of all other structuring variables as outlined in the Collection Methodology and Assumptions above, the Series 2006A, 2006B, 2006C and Series 2006D Bonds may never be repaid. † In the event of consumption declines forecast by the Global Insight Low Case 3, and assuming the values of all other structuring variables as outlined in the Collection Methodology and Assumptions above, the Series 2006B, 2006C and 2006D Bonds may never be repaid. †† In the event of an Annual Consumption Decline of 3.5%, and assuming the values of all other structuring variables as outlined in the Collection Methodology and Assumptions above, the Series 2006C and Series 2006D Bonds may never be repaid. Turbo Redemptions of the Series 2006 Bonds. The tables below have been prepared to show the effect of changes in cigarette consumption on the estimated Turbo Redemptions with respect to the Series 2006 Bonds. The tables are based upon the same assumptions and utilize the same alternative Global Insight forecasts as shown in the preceding paragraph and tables. 95 Projected Outstanding Amounts of Series 2006A Bonds with a Maturity Date of May 15, 2035* Date Global Insight Base Case Forecast Global Insight High Forecast Global Insight Low Case 1 Forecast Global Insight Low Case 2 Forecast Global Insight Low Case 3 Forecast 3.5% Annual Consumption Decline 4.0% Annual Consumption Decline Settlement $4,764,710 $4,764,710 $4,764,710 $4,764,710 $4,764,710 $4,764,710 $4,764,710 5/15/2006 4,791,547 4,791,547 4,791,547 4,791,547 4,791,547 4,791,547 4,791,547 5/15/2007 5,095,890 5,095,890 5,095,890 5,095,890 5,095,890 5,095,890 5,095,890 5/15/2008 5,419,361 5,419,361 5,419,361 5,419,361 5,419,361 5,419,361 5,419,361 5/15/2009 5,763,389 5,763,389 5,763,389 5,763,389 5,763,389 5,763,389 5,763,389 5/15/2010 6,129,114 6,129,114 6,129,114 6,129,114 6,129,114 6,129,114 6,129,114 5/15/2011 6,518,251 6,518,251 6,518,251 6,518,251 6,518,251 6,518,251 6,518,251 5/15/2012 6,931,940 6,931,940 6,931,940 6,931,940 6,931,940 6,931,940 6,931,940 5/15/2013 7,371,896 7,371,896 7,371,896 7,371,896 7,371,896 7,371,896 7,371,896 5/15/2014 7,839,830 7,839,830 7,839,830 7,839,830 7,839,830 7,839,830 7,839,830 5/15/2015 8,337,457 8,337,457 8,337,457 8,337,457 8,337,457 8,337,457 8,337,457 5/15/2016 8,256,503 7,994,072 8,681,984 8,866,774 8,866,774 8,866,774 8,866,774 5/15/2017 5,953,477 5,628,142 6,480,290 7,058,297 9,429,780 9,343,904 9,429,780 5/15/2018 4,945,600 4,571,519 5,544,481 6,203,075 10,028,188 8,814,619 9,891,200 5/15/2019 3,858,772 3,431,057 4,540,500 5,285,733 10,664,853 8,257,323 9,478,831 5/15/2020 2,687,464 2,202,807 3,460,135 4,304,312 10,698,212 7,675,063 9,051,569 5/15/2021 1,427,982 876,646 2,298,291 3,248,871 10,215,566 7,061,753 8,612,255 5/15/2022 71,888 0 1,051,362 2,118,450 9,689,155 6,418,251 8,157,042 5/15/2023 0 0 0 907,858 9,116,806 5,743,396 7,685,735 5/15/2024 0 0 0 0 8,496,268 5,030,685 7,197,945 5/15/2025 0 0 0 0 7,819,588 4,282,670 6,690,152 5/15/2026 0 0 0 0 7,086,051 3,494,176 6,163,658 5/15/2027 0 0 0 0 6,292,201 2,661,732 5,613,780 5/15/2028 0 0 0 0 5,433,833 1,787,445 5,043,845 5/15/2029 0 0 0 0 4,506,885 864,050 4,448,129 5/15/2030 0 0 0 0 3,502,847 0 3,829,975 5/15/2031 0 0 0 0 2,419,609 0 3,181,845 5/15/2032 0 0 0 0 1,255,429 0 2,502,544 5/15/2033 0 0 0 0 0 0 1,794,885 5/15/2034 0 0 0 0 0 0 1,053,147 5/15/2035 0 0 0 0 0 0 275,000 ________________________ * Outstanding amounts represent principal balances after the application of amounts on deposit in the Turbo Redemption Account to Turbo Redemptions in the year of the referenced date. 96 Projected Outstanding Amounts of Series 2006B Bonds with a Maturity Date of May 15, 2035* Date Global Insight Base Case Forecast Global Insight High Forecast Global Insight Low Case 1 Forecast Global Insight Low Case 2 Forecast Global Insight Low Case 3 Forecast 3.5% Annual Consumption Decline 4.0% Annual Consumption Decline Settlement $ 512,471 $ 512,471 $ 512,471 $ 512,471 $ 512,471 $ 512,471 $ 512,471 5/15/2006 515,503 515,503 515,503 515,503 515,503 515,503 515,503 5/15/2007 549,540 549,540 549,540 549,540 549,540 549,540 549,540 5/15/2008 585,851 585,851 585,851 585,851 585,851 585,851 585,851 5/15/2009 624,534 624,534 624,534 624,534 624,534 624,534 624,534 5/15/2010 665,788 665,788 665,788 665,788 665,788 665,788 665,788 5/15/2011 709,776 709,776 709,776 709,776 709,776 709,776 709,776 5/15/2012 756,664 756,664 756,664 756,664 756,664 756,664 756,664 5/15/2013 806,649 806,649 806,649 806,649 806,649 806,649 806,649 5/15/2014 859,929 859,929 859,929 859,929 859,929 859,929 859,929 5/15/2015 916,735 916,735 916,735 916,735 916,735 916,735 916,735 5/15/2016 977,297 977,297 977,297 977,297 977,297 977,297 977,297 5/15/2017 1,041,846 1,041,846 1,041,846 1,041,846 1,041,846 1,041,846 1,041,846 5/15/2018 1,110,679 1,110,679 1,110,679 1,110,679 1,110,679 1,110,679 1,110,679 5/15/2019 1,184,058 1,184,058 1,184,058 1,184,058 1,184,058 1,184,058 1,184,058 5/15/2020 1,262,249 1,262,249 1,262,249 1,262,249 1,262,249 1,262,249 1,262,249 5/15/2021 1,345,645 1,345,645 1,345,645 1,345,645 1,345,645 1,345,645 1,345,645 5/15/2022 1,434,511 883,781 1,434,511 1,434,511 1,434,511 1,434,511 1,434,511 5/15/2023 143,877 0 1,243,842 1,529,275 1,529,275 1,529,275 1,529,275 5/15/2024 0 0 0 1,241,898 1,630,300 1,630,300 1,630,300 5/15/2025 0 0 0 0 1,738,014 1,738,014 1,738,014 5/15/2026 0 0 0 0 1,852,811 1,852,811 1,852,811 5/15/2027 0 0 0 0 1,975,188 1,975,188 1,975,188 5/15/2028 0 0 0 0 2,105,670 2,105,670 2,105,670 5/15/2029 0 0 0 0 2,244,785 2,244,785 2,244,785 5/15/2030 0 0 0 0 2,393,060 2,284,119 2,393,060 5/15/2031 0 0 0 0 2,551,121 1,412,988 2,551,121 5/15/2032 0 0 0 0 2,719,660 495,234 2,719,660 5/15/2033 0 0 0 0 2,899,303 0 2,899,303 5/15/2034 0 0 0 0 1,735,356 0 3,090,809 5/15/2035 0 0 0 0 485,000 0 3,295,000 ________________________ * Outstanding amounts represent principal balances after the application of amounts on deposit in the Turbo Redemption Account to Turbo Redemptions in the year of the referenced date. 97 Projected Outstanding Amounts of Series 2006C Bonds with a Maturity Date of May 15, 2035* Date Global Insight Base Case Forecast Global Insight High Forecast Global Insight Low Case 1 Forecast Global Insight Low Case 2 Forecast Global Insight Low Case 3 Forecast 3.5% Annual Consumption Decline 4.0% Annual Consumption Decline Settlement $ 867,690 $ 867,690 $ 867,690 $ 867,690 $ 867,690 $ 867,690 $ 867,690 5/15/2006 873,084 873,084 873,084 873,084 873,084 873,084 873,084 5/15/2007 934,154 934,154 934,154 934,154 934,154 934,154 934,154 5/15/2008 999,440 999,440 999,440 999,440 999,440 999,440 999,440 5/15/2009 1,069,376 1,069,376 1,069,376 1,069,376 1,069,376 1,069,376 1,069,376 5/15/2010 1,144,148 1,144,148 1,144,148 1,144,148 1,144,148 1,144,148 1,144,148 5/15/2011 1,224,128 1,224,128 1,224,128 1,224,128 1,224,128 1,224,128 1,224,128 5/15/2012 1,309,750 1,309,750 1,309,750 1,309,750 1,309,750 1,309,750 1,309,750 5/15/2013 1,401,386 1,401,386 1,401,386 1,401,386 1,401,386 1,401,386 1,401,386 5/15/2014 1,499,346 1,499,346 1,499,346 1,499,346 1,499,346 1,499,346 1,499,346 5/15/2015 1,604,188 1,604,188 1,604,188 1,604,188 1,604,188 1,604,188 1,604,188 5/15/2016 1,716,408 1,716,408 1,716,408 1,716,408 1,716,408 1,716,408 1,716,408 5/15/2017 1,836,440 1,836,440 1,836,440 1,836,440 1,836,440 1,836,440 1,836,440 5/15/2018 1,964,842 1,964,842 1,964,842 1,964,842 1,964,842 1,964,842 1,964,842 5/15/2019 2,102,296 2,102,296 2,102,296 2,102,296 2,102,296 2,102,296 2,102,296 5/15/2020 2,249,298 2,249,298 2,249,298 2,249,298 2,249,298 2,249,298 2,249,298 5/15/2021 2,406,592 2,406,592 2,406,592 2,406,592 2,406,592 2,406,592 2,406,592 5/15/2022 2,574,860 2,574,860 2,574,860 2,574,860 2,574,860 2,574,860 2,574,860 5/15/2023 2,754,970 2,221,750 2,754,970 2,754,970 2,754,970 2,754,970 2,754,970 5/15/2024 1,663,970 855,756 2,900,062 2,947,604 2,947,604 2,947,604 2,947,604 5/15/2025 254,335 0 1,627,744 3,153,754 3,153,754 3,153,754 3,153,754 5/15/2026 0 0 326,544 1,959,264 3,374,288 3,374,288 3,374,288 5/15/2027 0 0 0 698,760 3,610,260 3,610,260 3,610,260 5/15/2028 0 0 0 0 3,862,724 3,862,724 3,862,724 5/15/2029 0 0 0 0 4,132,858 4,132,858 4,132,858 5/15/2030 0 0 0 0 4,421,902 4,421,902 4,421,902 5/15/2031 0 0 0 0 4,731,158 4,731,158 4,731,158 5/15/2032 0 0 0 0 5,061,990 5,061,990 5,061,990 5/15/2033 0 0 0 0 5,416,010 4,979,235 5,416,010 5/15/2034 0 0 0 0 5,794,706 4,299,298 5,794,706 5/15/2035 0 0 0 0 6,200,000 3,600,000 6,200,000 * Outstanding amounts represent principal balances after the application of amounts on deposit in the Turbo Redemption Account to Turbo Redemptions in the year of the referenced date. 98 Projected Outstanding Amounts of Series 2006D Bonds with a Maturity Date of May 15, 2035* Date Global Insight Base Case Forecast Global Insight High Forecast Global Insight Low Case 1 Forecast Global Insight Low Case 2 Forecast Global Insight Low Case 3 Forecast 3.5% Annual Consumption Decline 4.0% Annual Consumption Decline Settlement $1,145,138 $1,145,138 $1,145,138 $1,145,138 $1,145,138 $1,145,138 $1,145,138 5/15/2006 1,153,016 1,153,016 1,153,016 1,153,016 1,153,016 1,153,016 1,153,016 5/15/2007 1,242,603 1,242,603 1,242,603 1,242,603 1,242,603 1,242,603 1,242,603 5/15/2008 1,339,159 1,339,159 1,339,159 1,339,159 1,339,159 1,339,159 1,339,159 5/15/2009 1,443,189 1,443,189 1,443,189 1,443,189 1,443,189 1,443,189 1,443,189 5/15/2010 1,555,299 1,555,299 1,555,299 1,555,299 1,555,299 1,555,299 1,555,299 5/15/2011 1,676,196 1,676,196 1,676,196 1,676,196 1,676,196 1,676,196 1,676,196 5/15/2012 1,806,486 1,806,486 1,806,486 1,806,486 1,806,486 1,806,486 1,806,486 5/15/2013 1,946,775 1,946,775 1,946,775 1,946,775 1,946,775 1,946,775 1,946,775 5/15/2014 2,098,073 2,098,073 2,098,073 2,098,073 2,098,073 2,098,073 2,098,073 5/15/2015 2,261,087 2,261,087 2,261,087 2,261,087 2,261,087 2,261,087 2,261,087 5/15/2016 2,436,827 2,436,827 2,436,827 2,436,827 2,436,827 2,436,827 2,436,827 5/15/2017 2,626,202 2,626,202 2,626,202 2,626,202 2,626,202 2,626,202 2,626,202 5/15/2018 2,830,222 2,830,222 2,830,222 2,830,222 2,830,222 2,830,222 2,830,222 5/15/2019 3,050,200 3,050,200 3,050,200 3,050,200 3,050,200 3,050,200 3,050,200 5/15/2020 3,287,146 3,287,146 3,287,146 3,287,146 3,287,146 3,287,146 3,287,146 5/15/2021 3,542,575 3,542,575 3,542,575 3,542,575 3,542,575 3,542,575 3,542,575 5/15/2022 3,817,901 3,817,901 3,817,901 3,817,901 3,817,901 3,817,901 3,817,901 5/15/2023 4,114,538 4,114,538 4,114,538 4,114,538 4,114,538 4,114,538 4,114,538 5/15/2024 4,434,304 4,434,304 4,434,304 4,434,304 4,434,304 4,434,304 4,434,304 5/15/2025 4,778,815 4,163,720 4,778,815 4,778,815 4,778,815 4,778,815 4,778,815 5/15/2026 3,926,384 2,906,544 5,150,192 5,150,192 5,150,192 5,150,192 5,150,192 5/15/2027 2,692,746 1,538,712 4,451,274 5,550,354 5,550,354 5,550,354 5,550,354 5/15/2028 1,362,152 59,224 3,316,544 5,330,160 5,981,624 5,981,624 5,981,624 5/15/2029 0 0 2,042,432 4,340,168 6,446,426 6,446,426 6,446,426 5/15/2030 0 0 687,860 3,301,728 6,947,386 6,947,386 6,947,386 5/15/2031 0 0 0 2,075,668 7,487,231 7,487,231 7,487,231 5/15/2032 0 0 0 798,910 8,068,991 8,068,991 8,068,991 5/15/2033 0 0 0 0 8,695,999 8,695,999 8,695,999 5/15/2034 0 0 0 0 9,371,689 9,371,689 9,371,689 5/15/2035 0 0 0 0 10,100,000 10,100,000 10,100,000 ________________________ * Outstanding amounts represent principal balances after the application of amounts on deposit in the Turbo Redemption Account to Turbo Redemptions in the year of the referenced date. 99 Explanation of Alternative Global Insight Forecasts The alternative Global Insight forecasts of cigarette consumption decline are based upon the methodology described below. See also “GLOBAL INSIGHT CONSUMPTION REPORT” herein and Appendix A − “GLOBAL INSIGHT CONSUMPTION REPORT” attached hereto. Global Insight’s high forecast of consumption (the “Global Insight High Forecast”) deviates from the Global Insight Base Case Forecast by assuming a lower price forecast, under which prices are increasing at an annual rate 0.5% more slowly than the Global Insight Base Case Forecast. Under the Global Insight High Forecast, the average annual rate of decline in cigarette consumption is moderated slightly, from an average annual rate in the Global Insight Base Case Forecast of 1.82%, to 1.68%. Global Insight’s low forecast of consumption (the “Global Insight Low Case 1”) deviates from the Global Insight Base Case Forecast by assuming a sharper price elasticity of demand. The Global Insight Base Case Forecast applied a price elasticity of demand of -0.33. However, in order to develop the lowest consumption forecast that Global Insight believed may be reasonably anticipated, a price elasticity of -0.4 was applied. Under the Global Insight Low Case 1, the average rate of decline in cigarette consumption increased to 2.01%. Under the Global Insight Base Case Forecast, the rate of decline was 1.82%. Although beyond the range of Global Insight’s reasonably anticipated decline in consumption, Global Insight also prepared an alternative low case (the “Global Insight Low Case 2”) that deviated from the Base Case Forecast by assuming a price elasticity of demand of –0.5. This produces a decline in consumption of an average annual rate of 2.21%. Global Insight prepared another alternative low case (the “Global Insight Low Case 3”) that deviated from the Global Insight Base Case Forecast by assuming an adverse federal government settlement and tort claims of three times the size of the MSA, resulting in an immediate real price increase of 57% and a decline in consumption of 18% over two years. Under the Global Insight Low Case 3, the average annual rate of decline in cigarette consumption would be 2.46%, compared to the Global Insight Base Case Forecast of 1.82%. Finally, for comparative purposes, Global Insight calculated the volume of total cigarette consumption under two alternative annual rates of decline, 3.5% and 4%. Global Insight states that at 3.5% per year, consumption falls to 136 billion by 2034, and at 4% per year, it falls to 117 billion by 2034. Average Annual Rate of Cigarette Consumption Decline (2004-2034) Global Insight Base Case Forecast Global Insight High Forecast Global Insight Low Case 1 Global Insight Low Case 2 Global Insight Low Case 3 1.82% 1.68% 2.01% 2.21% 2.46% No assurance can be given that actual cigarette consumption in the U.S. during the term of the Series 2006 Bonds will be as assumed, or that the other assumptions underlying the Collection Methodology and Assumptions and Structuring Assumptions, including that certain adjustments and offsets will not apply to payments due under the MSA, will be consistent with future events. If actual events deviate from one or more of the assumptions underlying the Collection Methodology and Assumptions or the Structuring Assumptions, the amount of Collections available to pay the Accreted Value for the Series 2006 Bonds (and, accordingly, the amount of Collections available to make Turbo 100 Redemptions of the Series 2006 Bonds) could be adversely affected. See “RISK FACTORS” and “LEGAL CONSIDERATIONS” herein. THE CORPORATION The Corporation is a special purpose independent instrumentality of the Virgin Islands created by the Act. The Corporation is governed by a three-person board of directors consisting of the Governor and two independent members, one appointed by the Governor and the other by the President of the Senate of the Virgin Islands. The directors of the Corporation are: Name Principal Occupation The Honorable Charles W. Turnbull Governor Rosalie Simmonds Ballentine Attorney/Private Practice José A. Penn Chief Financial Officer Penn’s Corporation The officers of the Corporation are: Name Title The Honorable Charles W. Turnbull President Kent Bernier* Vice President and Treasurer Rosalie Simmonds Ballentine Vice President and Secretary José A. Penn Vice President and Assistant Secretary/ Assistant Treasurer CONTINUING DISCLOSURE Pursuant to the Continuing Disclosure Certificate, the Corporation shall provide within 305 days after the end of each Fiscal Year (commencing with the report for the Fiscal Year ending September 30, 2006) to each nationally recognized municipal securities information repository and to any State information depository (each, a “Repository”): (a)(i) core financial information and operating data for the prior Fiscal Year, including its audited financial statements, prepared in accordance with generally accepted accounting principles in effect from time to time; and (ii) material historical quantitative data on the Corporation's revenues, expenditures, financial operations, indebtedness, the debt service coverage for the most recent full Fiscal Year for all Series of Outstanding Bonds, and (b)(i) payment delinquencies; (ii) non–payment related defaults; (iii) unscheduled draws on debt service reserves reflecting financial difficulties, (iv) modifications to rights of security holders; (v) bond calls; (vi) defeasance; (vii) rating changes; (viii) adverse tax opinions or events or affecting the tax–exempt status of the Bonds; (ix) unscheduled draws on the credit enhancements reflecting financial difficulties; (x) substitution of the * Kent Bernier holds the office of Vice President and Treasurer ex officio as the Acting Director, Finance and Administration, U.S. Virgin Islands Public Finance Authority. 101 credit or liquidity providers or their failure to perform; (xi) release, substitution or sale of property securing payment of the Bonds, and (xii) failure to comply with clause (a) of this paragraph. These covenants have been made in order to assist the Underwriter in complying with SEC Rule 15c2 12(b)(5) (the “Rule”). The Corporation has never failed to comply in all material respects with any previous undertakings with regard to said Rule to provide annual reports or notices of material events. The Corporation may comply with the requirements of the Rule in any manner permitted from time to time by the SEC. LITIGATION There is no litigation pending in any court (either State or federal) to restrain or enjoin the issuance or delivery of the Series 2006 Bonds or questioning the creation, organization or existence of the Corporation, the validity or enforceability of the Indenture, the Purchase Agreement, the transfer of the TSRs by the Virgin Islands to the Corporation, the proceedings for the authorization, execution, authentication and delivery of the Series 2006 Bonds or the validity of the Series 2006 Bonds. For a discussion of other legal matters, including certain pending litigation involving the MSA and the PMs, see “RISK FACTORS,” “TOBACCO INDUSTRY” and “LEGAL CONSIDERATIONS” herein. TAX MATTERS Federal Income Taxes The following is a summary of certain anticipated United States Federal income tax consequences of the purchase, ownership and disposition of the Series 2006 Bonds. The summary is based upon the provisions of the Internal Revenue Code of 1986, as amended (the “Code”), the regulations promulgated thereunder and the judicial and administrative rulings and decisions now in effect, all of which are subject to change. Potential purchasers of the Series 2006 Bonds should consult their own tax advisors in determining the Federal, state or local tax consequences to them of the purchase, ownership and disposition of the Series 2006 Bonds. The Code imposes certain requirements that must be met subsequent to the issuance and delivery of the Series 2006 Bonds for interest (including for such purposes the Accretions (defined below)) thereon to be and remain excluded from gross income for Federal income tax purposes. Noncompliance with such requirements could cause interest on the Series 2006 Bonds to be included in gross income for Federal income tax purposes retroactive to the date of issue of the Series 2006 Bonds. Pursuant to the Tax Certificate (the “Tax Certificate”), the Corporation and the Virgin Islands have made certain representations with respect to the use of the proceeds of the Series 2006 Bonds and have covenanted to comply with the applicable requirements of the Code in order to maintain the exclusion of interest on the Series 2006 Bonds from gross income for Federal income tax purposes pursuant to Section 103 of the Code. Transaction Counsel will not independently verify the accuracy of those representations and certifications. For purposes hereof, “Accretions” shall mean the difference between the Accreted Value at maturity of the Series 2006 Bonds, and the "Initial Principal Amount" of the applicable Series 2006 Bonds as set forth on the inside cover of this Offering Circular. It is assumed for purposes of this Section that all of the Series 2006 Bonds will be sold at the Initial Principal Amounts to the public (excluding bond houses, brokers or similar persons or organizations acting in the capacity of underwriters or wholesalers). In the opinion of Transaction Counsel, under existing law and assuming compliance with the aforementioned covenants, and the accuracy of certain representations and certifications made by the Corporation and others, interest on the Series 2006 Bonds (including for such purposes the Accretions) is excluded from gross income for Federal income tax purposes under Section 103 of the Code. Transaction Counsel is also of the opinion that interest on the Series 2006 Bonds is not treated as a preference item in calculating the alternative minimum tax imposed under the Code with respect to individuals and 102 corporations. Interest on the Series 2006 Bonds is, however, included in the adjusted current earnings of certain corporations for purposes of computing the alternative minimum tax imposed on such corporations. Virgin Islands Taxes Transaction Counsel is also of the opinion that, under existing law, interest on the Series 2006 Bonds will be exempt from personal income taxes imposed by the Virgin Islands, any state, other territory or possession of the United States or any political subdivision thereof, or by the District of Columbia. Original Issue Discount The Accretions will be treated as "original issue discount" for Federal income tax purposes. Original issue discount accrues actuarially on a constant interest rate basis over the term of each Series 2006 Bond and the basis of each Series 2006 Bond acquired at such initial offering price by an initial purchaser thereof will be increased by the amount of such accrued original issue discount. The accrual of original issue discount may be taken into account as an increase in the amount of tax-exempt income for purposes of determining various other tax consequences of owning the Series 2006 Bonds, even though there will not be a corresponding cash payment. Owners of the Series 2006 Bonds are advised that they should consult with their own advisors with respect to the state and local tax consequences of owning the Series 2006 Bonds. Ancillary Tax Matters Ownership of the Series 2006 Bonds may result in other Federal tax consequences to certain taxpayers, including, without limitation, certain S corporations, foreign corporations with branches in the United States, property and casualty insurance companies, individuals receiving Social Security or Railroad Retirement benefits, individuals seeking to claim the earned income credit, and taxpayers (including banks, thrift institutions and other financial institutions) who may be deemed to have incurred or continued indebtedness to purchase or to carry the Series 2006 Bonds. Changes in Federal Tax Law and Post Issuance Events From time to time proposals are introduced in Congress that, if enacted into law, could have an adverse impact on the potential benefits of the exclusion from gross income for Federal income tax purposes of the interest on the Series 2006 Bonds, and thus on the economic value of the Series 2006 Bonds. This could result from reductions in Federal income tax rates, changes in the structure of the Federal income tax rates, changes in the structure of the Federal income tax or its replacement with another type of tax, repeal of the exclusion of the interest on the Series 2006 Bonds from gross income for such purposes, or otherwise. It is not possible to predict whether any legislation having an adverse impact on the tax treatment of holders of the Series 2006 Bonds may be proposed or enacted. Form of Transaction Counsel Opinion Transaction Counsel has not undertaken to advise in the future whether any events after the date of issuance and delivery of the Series 2006 Bonds may affect the tax status of interest on the Series 2006 Bonds. Transaction Counsel expresses no opinion as to any Federal, Virgin Islands or local tax law consequences with respect to the Series 2006 Bonds, or the interest thereon, if any action is taken with respect to the Series 2006 Bonds or the proceeds thereof upon the advice or approval of other counsel. 103 Transaction Counsel is not rendering any opinion as to any Federal tax matters other than those described above under the caption “TAX MATTERS—Federal Income Taxes.” The proposed form of Transaction Counsel opinion is included in this Offering Circular as Appendix C. Descriptions of the opinion of Transaction Counsel in this Offering Circular are qualified in their entirety by reference to Appendix C. Prospective investors, particularly those who may be subject to special rules, are advised to consult their own tax advisors regarding the Federal tax consequences of owning and disposing of the Series 2006 Bonds, as well as any tax consequences arising under the laws of any state or other taxing jurisdiction. RATINGS All Series 2006 Bonds will be rated, except for the Series 2006D Bonds, as to which no rating has been sought. It is a condition to the obligation of the Underwriter to purchase the Series 2006 Bonds, that, at the date of delivery thereof to the Underwriter, the Series 2006A Bonds be assigned a rating of “BBB” by Fitch Ratings (“Fitch” or the “Rating Agency”), that the Series 2006B Bonds be assigned a rating of “BBB–” by the Rating Agency, and that the Series 2006C Bonds be assigned a rating of “BB” by the Rating Agency. The ratings address the Rating Agency’s assessment of the ability of the Corporation to pay the Accreted Value on such Series 2006 Bonds on the Maturity Date therefor set forth on the inside cover page of this Offering Circular. However, projections of Turbo Redemptions Payments for such Series 2006 Bonds have not been rated by the Rating Agency. The ratings of such Series 2006 Bonds by Fitch reflect only the views of such organization and any desired explanation of the significance of such ratings and any outlooks or other statements given by Fitch with respect thereto should be obtained from Fitch, at the following address: One State Street Plaza, New York, New York 10004. There is no assurance that the initial ratings assigned to the rated Series 2006 Bonds will continue for any given period of time or that any of such ratings will not be revised downward, suspended or withdrawn entirely by the Rating Agency. Any such downward revision, suspension or withdrawal of such ratings may have an adverse effect on the availability of a market for or the market price of such Series 2006 Bonds. UNDERWRITING The Underwriter has agreed, subject to certain conditions, to purchase all, but not less than all, of the Series 2006 Bonds at a price of $6,931,573.96 (which represents the initial principal amount of the Series 2006 Bonds less an underwriting discount of $358,434.89). The Purchase Contract relating to the Series 2006 Bonds provides that the Underwriter will purchase all of the Series 2006 Bonds if any are purchased, the obligation to make such purchase being subject to certain terms and conditions set forth in the Purchase Contract, the approval of certain legal matters by counsel and certain other conditions. The Underwriter may offer and sell the Series 2006 Bonds to certain dealers and others at prices lower than the offering prices stated on the inside cover page. The offering prices may be changed from time to time by the Underwriter. LEGAL MATTERS The validity of the Series 2006 Bonds and certain other legal matters are subject to the approving opinion of Buchanan Ingersoll PC, New York, New York, Transaction Counsel. A complete copy of the proposed form of Transaction Counsel opinion is contained in Appendix C hereto. Transaction Counsel undertakes no responsibility for the accuracy, completeness or fairness of this Offering Circular. Certain 104 legal matters will be passed upon for the Virgin Islands by its Attorney General, and for the Underwriter by its counsel, Nixon Peabody LLP, New York, New York. OTHER PARTIES Global Insight Global Insight has been retained as an independent econometric consultant. The Global Insight Consumption Report attached as Appendix A hereto is included herein in reliance on Global Insight as experts in such matters. Global Insight’s fees for acting as independent economic consultant are not contingent upon the issuance of the Series 2006 Bonds. The Global Insight Consumption Report should be read in its entirety. Banc of America Securities LLC Banc of America Securities LLC has been retained by the Corporation as its Financial Advisor (the “Financial Advisor”) in connection with the issuance of the Series 2006 Bonds. The Financial Advisor has assisted the Corporation in matters relating to the planning, structuring, execution and delivery of the Series 2006 Bonds. The Financial Advisor has not audited, authenticated or otherwise independently verified the information set forth in this Offering Circular, or any other related information available to the Corporation, with respect to accuracy and completeness of disclosure of such information. The Financial Advisor makes no guaranty, warranty or other representation respecting the accuracy and completeness of this Offering Circular. TOBACCO SETTLEMENT FINANCING CORPORATION By: /s/ Kent Bernier Vice President and Treasurer APPENDIX A GLOBAL INSIGHT CONSUMPTION REPORT [THIS PAGE INTENTIONALLY LEFT BLANK] A Forecast of U.S. Cigarette Consumption (2004-2034) for Tobacco Settlement Financing Corporation Submitted to: Tobacco Settlement Financing Corporation Prepared by: Global Insight (USA), Inc. March 30, 2006 Jim Diffley Group Managing Director Jeannine Cataldi Senior Economist Global Insight, Inc. 800 Baldwin Tower Eddystone, PA 19022 (610) 490-2642 Copyright ¤ 2006 Global Insight Inc. A - 2 Executive Summary Global Insight1 has developed a cigarette consumption model based on historical U.S. data between 1965 and 2003. This econometric model, coupled with our long term forecast of the U.S. economy, has been used to project total U.S. cigarette consumption from 2004 through 2034. Our Base Case Forecast indicates that total consumption in 2034 will be 226 billion cigarettes (approximately 11 billion packs), a 43% decline from the 2003 level. From 2004 through 2034 the average annual rate of decline is projected to be 1.82%. On a per capita basis consumption is projected to fall at an average rate of 2.62% per year. We also present alternative forecasts that project higher and lower paths of cigarette consumption. Under these, less likely, scenarios we forecast that by 2034 U.S. cigarette consumption could be as low as 213 billion and as high as 237 billion cigarettes. In addition, we also present scenarios with more extreme variations in assumptions for the purposes of illustrating alternative paths of consumption. Our model was constructed from widely accepted economic principles and Global Insight’s long experience in building econometric forecasting models. A review of the economic research literature indicates that our model is consistent with the prevalent consensus among economists concerning cigarette demand. We considered the impact of demographics, cigarette prices, disposable income, employment and unemployment, industry advertising expenditures, the future effect of the incidence of smoking amongst underage youth, and qualitative variables that captured the impact of anti-smoking regulations, legislation, and health warnings. After extensive analysis, we found the following variables to be effective in building an empirical model of adult per capita cigarette consumption: real cigarette prices, real per capita disposable personal income, the impact of restrictions on smoking in public places, and the trend over time in individual behavior and preferences. The projections and forecasts are based on reasonable assumptions regarding the future paths of these factors. 1 On November 4, 2002, DRI•WEFA was re-named Global Insight. A - 3 Disclaimer The projections and forecasts included in this report, including, but not limited to, those regarding future taxable cigarette sales, are estimates, which have been prepared on the basis of certain assumptions and hypotheses. No representation or warranty of any kind is or can be made with respect to the accuracy or completeness of, and no representation or warranty should be inferred from, these projections and forecasts. The projections and forecasts contained in this report are based upon assumptions as to future events and, accordingly, are subject to varying degrees of uncertainty. Some assumptions inevitably will not materialize and, additionally, unanticipated events and circumstances may occur. Therefore, for example, actual cigarette consumption inevitably will vary from the projections and forecasts included in this report and the variations may be material and adverse. A - 4 Historical Cigarette Consumption People have used tobacco products for centuries. Tobacco was first brought to Europe from America in the late 15th century and became America's major cash crop in the 17th and 18th centuries2. Prior to 1900, tobacco was most frequently used in pipes, cigars and snuff. With the widespread production of manufactured cigarettes (as opposed to hand- rolled cigarettes) in the United States in the early 20th century, cigarette consumption expanded dramatically. Consumption is defined as taxable United States consumer sales, plus shipments to overseas armed forces, ship stores, Puerto Rico and other United States possessions, and small tax-exempt categories3 as reported by the Bureau of Alcohol Tobacco and Firearms. The USDA, which has compiled data on cigarette consumption since 1900, reports that consumption grew from 2.5 billion in 1900 to a peak of 640 billion in 19814. Consumption declined in the 1980's and 1990's, reaching a level of 465 billion cigarettes in 1998, and decreasing to less than 400 billion cigarettes in 20045. 2000 1990 1980 1970 1960 1950 700 600 500 400 300 200 Billions of Cigarettes Historical U.S. Cigarette Consumption: 1945-2005 Number of Cigarettes (Billions) Total Consumption While the historical trend in consumption prior to 1981 was increasing, there was a decline in cigarette consumption of 9.82% during the Great Depression between 1931 and 1932. Notwithstanding this steep decline, consumption rapidly increased after 1932, and exceeded previous levels by 1934. Following the release of the Surgeon General's 2 Source: “Tobacco Timeline,” Gene Borio (1998). 3 Bureau of Alcohol, Tobacco and Firearms reports as categories such as transfer to export warehouses, use of the U.S., and personal consumption/experimental. 4 Source: “Tobacco Situation and Outlook”. U.S. Department of Agriculture-Economic Research Service. September 1999 (USDA-ERS). 5 Source: USDA-ERS. April 2005. A - 5 Report in 1964, cigarette consumption continued to increase at an average annual rate of 1.20% between 1965 and 1981. Between 1981 and 1990, however, cigarette consumption declined at an average annual rate of 2.18%. From 1990 to 1998, the average annual rate of decline in cigarette consumption was 1.51%; but for 1998 the decline increased to 3.13% and increased further to 6.45% for 1999. These recent declines are correlated with large price increases in 1998 and 1999 following the Master Settlement Agreement (“MSA”). In 2000 and 2001, the rate of decline moderated, to 1.15% and 1.16%, respectively. More recently, coincident with a large number of state excise tax increases, the rate of decline accelerated in 2002-2005 to an annual rate of 2.70%. Adult per capita cigarette consumption (total consumption divided by the number of people 18 years and older) began to decline following the Surgeon General’s Report in 1964. Population growth offset this decline until 1981. The adult population grew at an average annual rate of 1.86% for the period 1965 through 1981, 1.17% from 1981 to 1990 and 1.02% from 1990 to 1999. Adult per capita cigarette consumption declined at an average annual rate of 0.65% for the period 1965 to 1981, 3.31% for the period 1981 to 1990 and 2.47% for the period 1990 to 1998. In 1998 the per capita decline in cigarette consumption was 4.21% and in 1999 the decline accelerated to 7.50%. These sharp declines are correlated with large price increases in 1998 and 1999 following the MSA. All percentages are based upon compound annual growth rates. The following table sets forth United States domestic cigarette consumption for the eight years ended December 31, 20056. The data in this table vary from statistics on cigarette shipments in the United States. While our Report is based on consumption, payments made under the MSA dated November 23, 1998 between certain cigarette manufacturers and certain settling states are computed based in part on shipments in or to the fifty United States, the District of Columbia and Puerto Rico. The quantities of cigarettes shipped and cigarettes consumed may not match at any given point in time as a result of various factors such as inventory adjustments, but are substantially the same when compared over a period of time. U.S. Cigarette Consumption Year Ended December 31, Consumption (Billions of Cigarettes) Percentage Change 2005 381est -3.05 2004 393est -1.75 2003 400 -3.61 2002 415 -2.35 2001 425 -1.16 2000 430 -1.15 1999 435 -6.45 1998 465 -3.13 6 Source: USDA-ERS; 2004, 2005 estimates by Global Insight. A - 6 The U.S. Cigarette Industry The domestic cigarette market is an oligopoly in which, according to reports of the manufacturers, the three leading manufacturers accounted for 86.1% of U.S. shipments in 2005. These top companies were Philip Morris, Reynolds American Inc. (following the merger of RJ Reynolds and Brown & Williamson in 2004), and Lorillard. These companies commanded 48.7%, 28.2%, and 9.2%, respectively of the domestic market in 2005. The market share of the leading manufacturers has declined from over 96% in 1998 due to inroads by smaller manufacturers and importers following the Master Settlement Agreement. The United States government has raised revenue through tobacco taxes since the Civil War. Although the federal excise taxes have risen through the years, excise taxes as a percentage of total federal revenue have fallen from 3.4% in 1950 to approximately 0.42% today. In 2004, the federal government received $7.9 billion in excise tax revenue from tobacco sales. In addition, state and local governments also raise significant revenues, $12.6 billion in 2004, from excise and sales taxes. Cigarettes constitute the majority of these sales, which include cigars and other tobacco products. U.S. consumers spent $86.7 billion on tobacco products in 2003.7 Survey of the Economic Literature on Smoking Many organizations have conducted studies on United States cigarette consumption. These studies have utilized a variety of methods to estimate levels of smoking, including interviews and/or written questionnaires. Although these studies have tended to produce varying estimates of consumption levels due to a number of factors, including different survey methods and different definitions of smoking, taken together such studies provide a general approximation of consumption levels and trends. Set forth below is a brief summary of some of the more recent studies on cigarette consumption levels. Incidence of Smoking Approximately 44.5 million American adults were current smokers in 2004, representing approximately 20.9% of the population age 18 and older, according to a Centers for Disease Control and Prevention (“CDC”) study8 released November 11, 2005. This survey defines "current smokers" as those persons who have smoked at least 100 cigarettes in their lifetime and who smoked every day or some days at the time of the survey. Although the percentage of adults who smoke (incidence) declined from 42.4% in 1965 to 25.5% in 1990,9 the incidence rate declined relatively slowly through the following decade. The decline has accelerated since 2002, when the incidence rate was 22.5%. 7 Ibid. 8 Source: CDC. Morbidity and Mortality Weekly Report. “Cigarette Smoking Among Adults – United States, 2004”. November 11, 2005. 9 Source: CDC. Office on Smoking and Health. A - 7 Youth Smoking Certain studies have focused in whole or in part on youth cigarette consumption. Surveys of youth typically define a "current smoker" as a person who has smoked a cigarette on one or more of the 30 days preceding the survey. The CDC's Youth Risk Behavior Survey estimated that from 1991 to 1999 incidence among high school students (grades 9 through 12) rose from 27.5% to 34.8%, representing an increase of 26.5%. By 2003, the incidence had fallen to 21.9%, a decline of 37.1% over four years.10 In 2004, the CDC's National Youth Tobacco Survey, formerly done by the American Legacy Foundation, reported that the percentage of middle school students who were current users of cigarettes declined from 9.8% in 2002 to 8.1% in 2004. Among high school students there was no significant change, with 22.3% as current users.11 According to the Monitoring the Future Study, a school-based study of cigarette consumption and drug use conducted by the Institute for Social Research at the University of Michigan, smoking incidence over the prior 30 days among tenth and twelfth graders was lower in 2005 than in 2004, continuing trends that began in 1996. Among those students in eighth grade, incidence increased slightly in 2005 after declining for eight consecutive years. Smoking incidence in all grades is well below where it was in 1991, having fallen below that mark in 2001 for eighth graders and in 2002 for tenth and twelfth graders. Prevalence of Cigarette Use Among 8th, 10th, and 12th Graders Grade 1991 (%) 2004 (%) 2005 (%) ‘04-’05 Change (%) ‘91-’05 Change (%) 8th 14.3 9.2 9.3 +1.1 -35.0 10th 20.8 16.0 14.9 -6.9 -28.4 12th 28.3 25.0 23.2 -7.2 -18.0 A report from the New York City Youth Risk Behavior Survey finds that smoking among New York City high school students decreased by 52% from 1997 to 2005.12 Over this period new York City has raised excise taxes to the highest in the nation and instituted a comprehensive indoor smoking ban. The 2004 National Survey on Drug Abuse and Health (formerly called National Household Survey on Drug Abuse) conducted by the Substance Abuse and Mental Health Services Administration of the United States Department of Health and Human Services 10 Source: CDC. Morbidity and Mortality Weekly Report. “Trends in Cigarette Smoking Among High School Students ---United States, 1991-2003”. May 21, 2004. 11 CDC. Morbidity and Mortality Weekly Report. “Tobacco Use, Access, and Exposure to Tobacco in Media Among Middle and High School Students in the United States, 2004”. April 1, 2005. 12 New York City Department of Health and Mental Hygiene. "Smoking among New York City Public High School Students". NYC Vital Signs. February 2006. A - 8 estimated that approximately 59.9 million Americans age 12 and older were current cigarette smokers (defined by this survey to mean they had smoked cigarettes at least once during the 30 days prior to the interview). This estimate represents an incidence rate of 24.9%, which is a decrease from 25.4% in 2003 and 26.0% in 2002. The same survey found that an estimated 11.9% of youths age 12 to 17 were current cigarette smokers in 2004, down from 12.2% in 2003 and 13.0% in 2002. Price Elasticity of Cigarette Demand The price elasticity of demand reflects the impact of changes in price on the demand for a product. Cigarette price elasticities from recent conventional research studies have generally fallen between an interval of -0.3 to -0.5.13 (In other words, as the price of cigarettes increases by 1.0% the quantity demanded decreases by 0.3% to 0.5%.) A few researchers have estimated price elasticity as high as -1.23. Research focused on youth smoking has found price elasticity levels of up to -1.41. Two studies published by the National Bureau of Economic Research examine the price elasticity of youth smoking. In their study on youth smoking in the United States, Gruber and Zinman estimate an elasticity of smoking participation (defined as smoking any cigarettes in the past 30 days) of –0.67 for high school seniors in the period 1991 to 1997.14 That is, a 1% increase in cigarette prices would result in a decrease of 0.67% in the number of those seniors who smoked. The study’s findings state that the drop in cigarette prices in the early 1990’s can explain 26% of the upward trend in youth smoking during the same period. The study also found that price has little effect on the smoking habits of younger teens (8th grade through 11th grade), but that youth access restrictions have a significant impact on limiting the extent to which younger teens smoke. Tauras and Chaloupka also found an inverse relationship between price and cigarette consumption among high school seniors.15 The price elasticity of cessation for males averaged 1.12 and for females averaged 1.19 in this study. These estimates imply that a 1% increase in the real price of cigarettes will result in an increase in the probability of smoking cessation for high school senior males and females of 1.12% and 1.19%, respectively. A study utilizing more recent data, from 1975 to 2003, by Grossman, estimated an elasticity of smoking participation of just -0.12.16 Nevertheless it concludes that price increases subsequent to the 1998 MSA explain almost all of the 12% drop in youth smoking over that time. In another study, Czart et al. (2001) looked at several factors which they felt could influence smoking among college students. These factors included price, school policies regarding tobacco use on campus, parental education levels, student income, student 13 Chalpouka FJ,Warner KE:P.5. 14 Source: Gruber, Jonathon and Zinman, Jonathon. “Youth Smoking in the U.S.:Evidence and Implications”. Working Paper No. W7780. National Bureau of Economic Research. 2000. 15 Source: Tauras, John A. and Chaloupka, Frank, J.. “Determinants of Smoking Cessation: An Analysis of Young Adult Men and Women”. Working Paper No. W7262. National Bureau of Economic Research. 1999. 16 Michael Grossman. "Individual Behaviors and Substance Use: The Role of Price". Working Paper No. W10948. National Bureau of Economic Research. December 2004. A - 9 marital status, sorority/fraternity membership, and state policies regarding smoking. The authors considered two ways in which smoking behavior could be affected: (1) smoking participation; and (2) the amount of cigarettes consumed per smoker. The results of the study suggest that, (1) the average estimated price elasticity of smoking participation is –0.26, and (2), the average conditional demand elasticity is –0.62. These results indicate that a 10% increase in cigarette prices, will reduce smoking participation among college students by 2.6% and will reduce the level of smoking among current college students by 6.2%.17 Tauras et al. (2001) conducted a study that looked at the effects of price on teenage smoking initiation.18 The authors used data from the Monitoring the Future study which examines smoking habits, among other things, of 8th, 10th, and 12th graders. They defined smoking initiation in three different ways: smoking any cigarettes in the last 30 days, smoking at least 1-5 cigarettes per day on average, or smoking at least one-half pack per day on average. The results suggest that the estimated price elasticities of initiation are –0.27 for any smoking, -0.81 for smoking at least 1-5 cigarettes, and –0.96 for smoking at least one-half pack of cigarettes. These results above indicate that a 10% increase in the price of cigarettes will decrease the probability of smoking initiation between approximately 3% and 10% depending on how initiation is defined. In a related study, Powell et al. (2003) estimated a price elasticity of youth smoking participation of –0.46, implying that a 10% increase in price leads to a 4.6% reduction in smoking participation.19 In conclusion, economic research suggests the demand for cigarettes is price inelastic, with an elasticity generally found to be between –0.3 and -0.5. Nicotine Replacement Products Nicotine replacement products, such as Nicorette Gum and Nicoderm patches, are used to aid those who are attempting to quit smoking. Before 1996, these products were only available with a doctor’s prescription. Currently, they are available as over-the-counter products. One study, by Hu et al., examines the effects of nicotine replacement products on cigarette consumption in the United States.20 One of the results of the study found that, “a 0.076% reduction in cigarette consumption is associated with the availability of nicotine patches after 1992.” In October 2002, the FDA approved the Commit lozenge for over-the-counter sale. This product is similar to the gum and patch nicotine replacement products. It is unclear whether it offers a significant advantage over those 17 Czart et al. “The impact of prices and control policies on cigarette smoking among college students”. Contemporary Economic Policy. Western Economic Association. Copyright April 2001. 18 Tauras et al. “Effects of Price and Access Laws on Teenage Smoking Initiation: A National Longitudinal Analysis”. University of Chicago Press. Copyright 2001. 19 Powell et al. “Peer Effects, Tobacco Control Policies, and Youth Smoking Behavior”. Impacteen. February 2003. 20 Hu et al. “Cigarette consumption and sales of nicotine replacement products”. TC Online. Tobacco Control. http:\\tc.bmjjournals.com. A - 10 other products.21 NicoBloc, a liquid applied to cigarettes which blocks tar and nicotine from being inhaled, is another new cessation product on the market since 2003. Zyban is a non-nicotine drug that has been available since 2000. It has been shown to be effective when combined with intensive behavioral support.22 Several new drugs may also appear on the market in the near future. The Food and Drug Administration (FDA) has granted a priority review, implying an approval decision within six months, to Pfizer and its product varenicline, which is intended to satisfy nicotine cravings without being pleasurable or addictive. The drug binds to the same brain receptor as nicotine. On May 14, 2005, Cytos Biotechnology AG announced the successful completion of Phase II testing of a virus-based vaccine, genetically engineered to attract an immune system response against nicotine and its effects. The company now plans to begin Phase III trials. Nabi Biopharmaceuticals has been in Phase II clinical trials for NicVAX, a vaccine to prevent and treat nicotine addiction. It triggers antibodies that bind with Nicotine molecules. On March 9, 2006, NicVAX received Fast Track Designation from the FDA, which is intended to expedite its review process. And the Xenova Group is set to begin Phase II testing of its similar vaccine, Ta-Nic. It is expected that products such as these will continue to be developed and that their introduction and use will contribute to the trend decline in smoking. Our forecast includes a strong negative trend in smoking rates which incorporates the influence of these factors. Workplace Restrictions In their 1996 study on the effect of workplace smoking bans on cigarette consumption, Evans, Farrelly, and Montgomery found that between 1986 and 1993 smoking participation rates among workers fell 2.6% more than non-workers.23 Their results suggest that workplace smoking bans reduce smoking prevalence by 5 percentage points and reduce consumption by smokers nearly 10%. The authors also found a positive correlation between hours worked and the impact on smokers in workplaces that have smoking bans. The more hours per day that a smoker spends working in an environment where there are smoking restrictions, the greater is the decline in the quantity of cigarettes consumed by that smoker. Factors Affecting Cigarette Consumption Most empirical studies have found a common set of variables that are relevant in building a model of cigarette demand. These conventional analyses usually evaluate one or more of the following factors: (i) general population growth, (ii) price increases, (iii) changes 21 Niaura, Raymond and Abrams, David B. “Smoking Cessation: Progress, Priorities, and Prospectus”. Journal of Consulting and Clinical Psychology. June 2002. 22 Roddy, Elin. "Bupropion and Other Non-nicotine Pharmacotherapies". British Medical Journal. 28 February 2004. 23 Source: Evans, William N.; Farrelly, Matthew C. and Montgomery, Edward. “Do Workplace Smoking Bans Reduce Smoking?”. Working Paper No. W5567. National Bureau of Economic Research. 1996. A - 11 in disposable income, (iv) youth consumption, (v) trend over time, (vi) smoking bans in public places, (vii) nicotine dependence and (viii) health warnings. While some of these factors were not found to have a measurable impact on changes in demand for cigarettes, all of these factors are thought to affect smoking in some manner and to affect current levels of consumption. General Population Growth. Global Insight forecasts that the United States population will increase from 283 million in 2000 to approximately 380 million in 2034. This forecast is consistent with the Bureau of the Census forecast based on the 2000 Census. Price Elasticity of Demand & Price Increases. Cigarette price elasticities from recent conventional research studies have generally fallen between an interval of -0.3 to -0.5. Based on Global Insight’s multivariate regression analysis using data from 1965 to 2003, the long run price elasticity of consumption for the entire population is -0.33; a 1.0% increase in the price of cigarettes decreases consumption by 0.33%. In 1998, the average price of a pack of cigarettes in nominal terms was $2.20. This increased to $2.88 per pack in 1999, representing a nominal growth in the price of cigarettes of 30.9% from 1998. During 1999, consumption declined by 6.45%. This was primarily due to a $0.45 per pack increase in November 1998 which was intended to offset the costs of the MSA and agreements with previously settled states. The cigarette manufacturers then increased wholesale prices on seven occasions between August 1999 and April 2002, with the total change aggregating to $0.82. In addition to the wholesale price increases, in 1999 New York and California each increased its state excise tax by $0.50 per pack. In 2001, five states followed suit, and in January 2002, a scheduled increase in the federal excise tax of $0.05 per pack went into effect. By June 2002 the average price per pack had reached $3.73. Severe budget shortfalls following the 2001 recession led at least 30 states to consider cigarette excise tax increases in 2002. Ultimately 20 states and New York City imposed excise tax increases that year. These increases range from $0.07 per pack in Tennessee to $1.42 per pack in New York City. They averaged $0.47 per pack, and, when weighted by the state population boosted the nationwide average retail price by $0.18. This increased the population-weighted average state excise tax to over $0.60 per pack. The trend continued in 2003, as state fiscal difficulties persisted. Excise tax increases were enacted in 13 states, pushing the average price per pack to over $3.80. This was followed by eleven state tax increases in 2004 and eight in 2005. As a result the population-weighted average state excise tax is now $0.913 per pack In 2006 at least ten states are considering proposed excise tax increases, including increases of $1.00 in New York and of up to $2.60 in California. During this period, the major manufacturers refrained from wholesale price increases, and also actively pursued extensive promotional and dealer and retailer discounting programs which served to hold down retail prices. They did this in part due to the state tax increases, but primarily to maintain their market share from its erosion by a deep discount segment which grew rapidly following the MSA. The major manufacturers were A - 12 finally successful in stemming the increase in the deep discount market share, which has been stable since 2003. As 2004 came to a close, the manufacturers raised list prices for the first time since 2002. Reynolds American announced selected increases and a reduction in discounts on most brands of 10 cents per pack. In June 2005 Philip Morris reduced its retail buydown by 5 cents per pack for its lead brands, and Reynolds American announced price increases, effective January 2006, of up to $0.10 per pack on many of its brands. The average price in February 2006 was $4.14 per pack. Over the longer term our forecast expects price increases to continue to exceed the general rate of inflation due to increases in the manufacturers' prices as well as further increases in excise taxes. Premium brands are typically $0.50 to $1.00 more expensive per pack than discount brands, allowing a margin for consumers to switch to less costly discount brands in the event of price increases. The increasing availability of cigarette outlets on Indian reservations, where sales are exempt from taxes, provides another opportunity for consumers to reduce the cost of smoking. Similarly, Internet sales of cigarettes are growing rapidly, though a recent decision by credit card companies that they would not handle cigarette sales has started to have an impact and will dampen this growth. While these sales are not technically exempt from taxation, states are currently having a difficult time enforcing existing statutes and collecting excise taxes on these sales.24 Under the MSA, volume adjustments to payments are based on the quantity (and not the price or type) of cigarettes shipped. The availability of lower price alternatives lessens the negative impact of price increases on cigarette volume. Changes in Disposable Income. Analyses from many conventional models also include the effect of real personal disposable income. Most studies have found cigarette consumption in the United States increases as disposable income increases.25 However, a few studies found cigarette consumption decreases as disposable income increases.26 Based on our multivariate regression analysis the income elasticity of consumption is 0.27; a 1.0% increase in real disposable income per capita increases per capita cigarette consumption by 0.27%. Youth Consumption. The number of teenagers who smoke is another likely determinant of future adult consumption. While this variable has been largely ignored in empirical studies of cigarette consumption,27 almost all adult smokers first use cigarettes by high school, and very little first use occurs after age 20.28 One study examines the effects of youth smoking on future adult smoking.29 The study found that between 25% and 50% of any increase or decrease in youth smoking would persist into adulthood. According to the study, several factors may alter future correlation between youth and adult smoking: there 24 Source: United States General Accounting Office. “Internet Cigarette Sales”. GAO-02-743. August 2002. 25 Ippolito, et al.; Fuji. 26 Wasserman, et al.; Townsend et al. 27 Except for those such as Wasserman, et al. that studied the price elasticity for different age groups. 28 Source: Surgeon General’s 1994 Report, “Preventing Tobacco Use Among Young People.” 29 Source: Gruber, Jonathon and Zinman, Jonathon. “Youth Smoking in the U.S.:Evidence and Implications”. Working Paper No. W7780. National Bureau of Economic Research. 2000. A - 13 are better means for quitting smoking than in the past, and there are more workplace bans in effect that those who are currently in their teen years will face as they age. We have compiled data from the CDC which measures the incidence of smoking in the 12-17 age group as the percentage of the population in this category that first become daily smokers. This percentage, after falling since the early 1970s, began to increase in 1990 and increased through the decade. We assume that this recent trend peaked in the late 1990s and youth smoking has resumed its longer-term decline. Trend Over Time. Since 1964 there has been a significant decline in U.S. adult per capita cigarette consumption. The Surgeon General’s health warning (1964) and numerous subsequent health warnings, together with the increased health awareness of the population over the past thirty years, may have contributed to decreases in cigarette consumption levels. If, as we assume, the awareness of the adult population continues to change in this way, overall consumption of cigarettes will decline gradually over time. In order to capture the impact of these changing health trends and the effects of other such variables which are difficult to quantify, our analysis includes a time trend variable. Health Warnings. Categorical variables also have been used to capture the effect of different time periods on cigarette consumption. For example, some researchers have identified the United States Surgeon General's Report in 1964 and subsequent mandatory health warnings on cigarette packages as turning points in public attitudes and knowledge of the health effects of smoking. The Cigarette Labeling and Advertising Act of 1965 required a health warning to be placed on all cigarette packages sold in the United States beginning January 1, 1966. The Public Health Smoking Act of 1969 required all cigarette packages sold in the United States to carry an updated version of the warning, stating that it was a Surgeon General’s warning, beginning November 1, 1970. The Comprehensive Smoking Education Act of 1984 led to even more specific health warnings on cigarette packages. The dangers of cigarette smoking have been generally known to the public for years. Part of the negative trend in smoking identified in our model may represent the cumulative effect of various health warnings since 1966. Smoking Bans in Public Places. Beginning in the 1970s numerous states have passed laws banning smoking in public places as well as private workplaces. In September 2003 Alabama joined the other forty-nine states and the District of Columbia in requiring smoke-free indoor air to some degree or in some public places.30 The most comprehensive bans have been enacted since 1998 in ten states and a few large cities. On March 26, 2003, New York State enacted legislation banning smoking in indoor workplaces, including restaurants and bars. Delaware had banned smoking in all indoor public areas in 2002. These states joined California in imposing comprehensive statewide smoking bans. The California ban has been in place since 1998. Also in 2003, Connecticut, Maine, and Florida passed laws which ban smoking in restaurants and bars. Similarly comprehensive bans took effect in March 2003 in New York City and Dallas and in Boston in May 2003. Since then Massachusetts, Montana, Rhode Island, and 30 Source: American Lung Association. “State Legislated Actions on Tobacco Issues”. 2002. A - 14 Vermont have established similar bans. Voters in Washington State passed a ballot initiative in November 2005 which bans smoking in all public places effective January 2006. The restrictions are stronger than those in other states as they include a ban on outdoor smoking within 25 feet of the entrances of restaurants and other public places. In January 2006, New Jersey adopted a comprehensive ban which will go into effect in April 2006. At the same time New Jersey increased the minimum legal age to purchase cigarettes from 18 to 19 years. Three states, Alabama, Alaska, and Utah, also set the minimum age at 19. In December 2005 Chicago passed a smoking ban which also applies within 15 feet of entrances. It went into effect in January 2006, with an exemption for bars until July 2008. And in January the District of Columbia enacted an extensive ban which will be fully in effect in January 2007. In March Colorado, Utah, and Puerto Rico enacted similar legislation. It is expected that these restrictions will continue to proliferate. In 2006 at least four additional states, Alabama, Arkansas, Iowa, and New Hampshire, are considering comprehensive bans. California, effective July 1, 2005, has banned smoking in its prisons. On January 26, 2006 the California Environmental Protection Agency Air Resources Board declared environmental tobacco smoke to be a toxic air contaminant. The American Nonsmokers’ Rights Foundation documents clean indoor air ordinances by local governments throughout the U.S. As of January 3, 2006, there were 2,129 municipalities with indoor smoking restrictions. Of these, 441 local governments required workplaces to be 100% smoke-free, and 100% smoke-free conditions were required for restaurants by 278 governments, and for bars by 205. The number of such ordinances grew rapidly beginning in the 1980s, from less than 200 in 1985 to over 1,000 by 1993, and 1,500 by 2001. The ordinances completely restricting smoking in restaurants and bars have generally appeared in the past decade. In 1993 only 13 municipalities prohibited all smoking in restaurants, and 6 in bars. These numbers grew to 49 for restaurants and 32 for bars in 1998, and doubled again by 2001, to 100 and 74, respectively.31 The first extensive outdoor smoking restrictions were instituted on March 17, 2006 in Calabasas, California. Based on the regression analysis using data from 1965 to 2003, the restrictions on public smoking appear to have an independent effect on per capita cigarette consumption. We estimate that the restrictions instituted beginning in the late 1970’s have reduced smoking by about 2%. However, the timing of the restrictions within and across states makes such statistical identification difficult. Bauer, et al. estimate that U.S. workers in smoke-free workplaces from 1993 to 2001 decreased their average daily consumption by 2.6 cigarettes.32 Research in Canada, by the Ontario Tobacco Research Unit, concludes that consumption drops in workplaces where smoking is banned, by almost 5 cigarettes per person per day. Tauras, in a study based on a large survey of smokers, found that the more restrictive smoke-free air laws decrease average smoking, but have little influence 31 Source: American Nonsmokers’ Rights Foundation. http://www.no-smoke.org. January 2006. 32 Bauer, Hyland, Li, Steger, and Cummings. "A Longitudinal Assessment of the Impact of Smoke-Free Worksite Policies on Tobacco Use". American Journal of Public Health. June 2005 A - 15 on prevalence.33 The study predicts that moving from no smoking restrictions at all to to the most restrictive bans reduces average smoking by from 5% to 8%. The trend variable included in our econometric analysis is likely to incorporate some part of the cumulative impact of the various smoking bans and restrictions. Our forecast assumes that the factors, which have contributed to the negative trend in smoking in the U.S. population, continue to contribute to further declines in smoking rates throughout the forecast horizon. Nicotine Dependence. Nicotine is widely believed to be an addictive substance. The Surgeon General34 and the American Medical Association35 (AMA) both conclude that nicotine is an addictive drug which produces dependence. The American Psychiatric Association has determined that cigarette smoking causes nicotine dependence in smokers and nicotine withdrawal in those who stop smoking. The American Medical Association Council on Scientific Affairs found that one-third to one-half of all people who experiment with smoking become smokers. Other Considerations. In August 1999, the CDC published Best Practices for Comprehensive Tobacco Control Programs. Citing the success of programs in California and Massachusetts, the CDC recommends comprehensive tobacco control programs to the states. On August 9, 2000, the Surgeon General issued a report, Reducing Tobacco Use (“Surgeon General’s Report”), that comprehensively assesses the value and efficacy of the major approaches that have been used to reduce tobacco use. The report concludes that a comprehensive program of educational strategies, treatment of nicotine addiction, regulation of advertising, clean air regulations, restriction of minors’ access to tobacco, and increased excise taxation can significantly reduce the prevalence of smoking. The Surgeon General called for increased spending on anti-smoking initiatives by states, up to 25% of their annual settlement proceeds, which is far higher than the approximately 9% allocated from the first year’s settlement payments. The Surgeon General’s Report documents evidence of the effectiveness of five major modalities for reducing tobacco use. Educational strategies are shown to be effective in postponing or preventing adolescent smoking. Pharmacologic treatment of nicotine addiction, combined with behavioral support, can enhance abstinence efforts. Regulation of advertising and promotional activities of manufacturers can reduce smoking, particularly among youth. Clean air regulations and restricted minor’s access contribute to lessening smoking prevalence. And excise tax increases will reduce cigarette consumption. Further support for the efficacy of such programs is provided in an analysis by Farrelly, Pechacek, and Chaloupka.36 They estimate that tobacco control program expenditures between 1988 and 1998 resulted in a decline in cigarette sales of 3%. 33 Tauras, John A. "Smoke-Free Air Laws, Cigarette Prices, and Adult Cigarette Demand" Economic Inquiry, April 2006. 34 Source: Surgeon General’s 1988 Report. “The Health Consequences of Smoking – Nicotine Addiction”. 35 Source: Council on Scientific Affairs. “Reducing the Addictiveness of Cigarettes". Report to the AMA House of Delegates. June 1998. 36 “The Impact of Tobacco Control Program Expenditures on Aggregate Cigarette Sales: 1981-1998.” Working Paper No. 8691,. National Bureau of Economic Research, 2001. A - 16 Tauras, et al. estimate that, had state tobacco control spending been maintained at the levels recommended by the CDC, youth smoking rates would have been from 3.3% to 13.5% lower.37 Also, Farrelly et al. estimate that 22% of the decline in youth smoking from 1999 to 2002 was due to the national "truth" mass media campaign.38 In 2002, New York City implemented a strategy which sharply increased excise taxes, banned smoking in bars and restaurants, distributed free nicotine patches, and expanded educational efforts. Research by Frieden et al. estimates that smoking prevalence in the City declines by 11% as a result of these measures, an effect consistent with the conclusions of the Surgeon General's Report.39 In May 2001 a Commission established by President Clinton in September 2000 released its final report on how to improve economic conditions in tobacco dependent economies while making sure that public health does not suffer in the process.40 The Commission recommended moving from the current quota system to what would be called a Tobacco Equity Reduction Program (TERP). TERP would allow compensation to be rendered to quota owners for the loss in value of their quota assets as a result of a restructuring to a production permit system where permits would be issued annually to tobacco growers. Also created would be a Center for Tobacco-Dependent Communities, which would address any challenges faced during this period. Three public health proposals that were suggested by the Commission were: that states increase funding on tobacco cessation and prevention programs; that the FDA be allowed to regulate tobacco products in a “fair and equitable” manner; and that funding be included in Medicaid and Medicare coverage for smoking cessation. To be able to fund these recommendations, the Commission called for a 17-cent increase in the excise tax on all packs of cigarettes sold in the United States. The increased revenues would then be deposited into a fund and earmarked for the recommended programs. On February 13, 2003, the Interagency Committee on Smoking and Health, which reports to the U.S. Department of Health and Human Services, issued recommendations, which included raising the federal excise tax on cigarettes from $0.39 to $2.39 per pack. The purpose of the tax increase would be to discourage smoking and to fund anti-tobacco efforts. Neither the Surgeon General’s nor the Presidential Commission’s report have resulted in a concerted nationwide program to implement their recommendations, though legislation to establish FDA regulation was re-introduced in 2005. Research has indicated, and our model incorporates, a negative impact on cigarette consumption due to tobacco tax increases, and a negative trend decline in levels of smoking since the Surgeon General’s 37 Tauras, Chaloupka, Farrelly, Giovino, Wakefield, Johnston, O'Malley, Kloska, and Pechacek. "State Tobacco Control Spending and Youth Smoking", American Journal of Public Health, February 2005. 38 Farrelly, Davis, Haviland, Messeri, and Healton."Evidence of a Dose-Response Relationship Between "truth" Antismoking Ads and Youth Smoking Prevalence". American Journal of Public Health. March 2005. 39 Frieden, Mostashari, Kerker, Miller, Hajat, and Frankel. "Adult Tobacco Use Levels After Intensive Tobacco Control Measures: New York City, 2002-2003". American Journal of Public Health. June 2005. 40 “Tobacco at a Crossroad: A Call for Action”. President’s Commission on Improving Economic Opportunity in Communities Dependent on Tobacco Production While Protecting Public Health. May 14, 2001. A - 17 1964 warning, subsequent anti-smoking initiatives, and regulations which restrict smoking. Our model and forecast acknowledges the efficacy of these activities in reducing smoking and assumes that the effectiveness of such anti-smoking efforts will continue. For instance, in 2001, Canada required cigarette labels to include large graphic depictions of adverse health consequences of smoking. Recent research suggests that these warnings have some effectiveness, as one-fifth of the participants in a survey reported smoking less as a result of the labels.41 Similarly, the Justice Department has indicated that, as part of a lawsuit against the tobacco companies, it may seek to require graphic health warnings covering 50 percent of cigarette packs. In addition, it would prohibit in-store promotions and require that all advertising and packaging be black-and- white. A similar proposal is part of the World Health Organization’s Framework Convention on Tobacco Control, which the U.S. may sign. As the prevalence of smoking declines, it is likely that the achievement of further declines will require either greater levels of spending, or more effective programs. This is the common economic principle of diminishing returns. New York State, in 2000, mandated that manufacturers provide, beginning in 2003, only cigarettes that self-extinguish. These standards went into effect in 2004. In June 2005, Vermont enacted similar legislation which goes into effect May 1, 2006. And in October 2005 California enacted a similar law which will take effect January 1, 2007. We do not believe that these statutes or a nationwide agreement on such standards will affect consumption noticeably. It will probably raise the cost of manufacture slightly, but we view it as a continuation of a long series of government actions that contribute to the trend decline in consumption, which has been incorporated into our model. The expense and availability of technology required in the manufacture of self-extinguishing cigarettes may put the smaller manufacturers at a slight competitive disadvantage, as their cost per pack would increase more relative to the cost per pack increase for the larger manufacturers. Similarly, in January 2001, Vector Group Ltd. announced plans for a virtually nicotine- free cigarette. The product, Quest, was introduced on January 27, 2003. This non- addictive product might be used as a tool to quit or reduce smoking. We view this as a continuation of efforts to provide products, such as the nicotine patch, that are supposed to reduce smoking addiction. These products have likely contributed to the trend decline in consumption incorporated into our model. In our forecast, we expect such efforts to continue to reduce per capita cigarette consumption. An Empirical Model of Cigarette Consumption An econometric model is a set of mathematical equations which statistically best describes the available historical data. It can be applied, with assumptions on the projected path of independent explanatory variables, to predict the future path of the dependent variable being studied, in this case adult per capita cigarette consumption (CPC). After extensive analysis of available data measuring all of the above-mentioned 41 Hammond, Fong, McDonald, Brown, and Cameron. "Graphic Canadian Warning Labels and Adverse Outcomes: Evidence from Canadian Smokers. American Journal of Public Health. August 2004. A - 18 factors which influence smoking, we found the following variables to be effective in building an empirical model of adult per capita cigarette consumption for the United States: 1) the real price of cigarettes (cigprice) 2) the level of real disposable income per capita (ydp96pc) 3) the impact of restrictions on smoking in public places (smokeban) 4) the trend over time in individual behavior and preferences (trend) We used the tools of standard multivariate regression analysis to determine the nature of the economic relationship between these variables and adult per capita cigarette consumption in the U.S. Then, using that relationship, along with Global Insight’s standard adult population growth, and adjustment for non-adult smoking, we projected actual cigarette consumption (in billions of cigarettes) out to 2034. It should also be noted that since our entire dataset incorporates the effect of the Surgeon General’s health warning (1964), the impact of that variable too is accounted for in the forecast. Similarly the effect of nicotine dependence is incorporated into our entire dataset and influences the trend decline. Using U.S. data from 1965 through 2003 on the variables described above, we developed the following regression equation. All of the data sources are detailed in Appendix 1 of this Report. log (cpc) = 57.7 - 0.024 * trend - 0.223 * log (cigprice) - 0.106 * log (cigprice)(-1) + 0.270 * log (ydp96pc) - 0.020 * smokeban The model is estimated in logarithmic form, since that allows the easy computation of the responsiveness (or elasticity) of the dependent variable (adult per capita cigarette consumption) to changes in the various explanatory (or the right hand side) variables. This model has an R-square in excess of 0.99, meaning that it explains more than 99 percent of the variation in U.S. adult per capita cigarette consumption over the 1965 to 2003 period. In terms of explanatory power this indicates a very strong model with a high level of statistical significance. Our model is completed with two other equations: (1) Total adult cigarette consumption = cpc * U.S. adult population. (2) Total cigarette consumption = total adult cigarette consumption + total youth cigarette consumption. A - 19 We have measured the consumption level of cigarettes in the 12-17 age group by examining the difference between total consumption and total adult consumption. We then use the expected trend of youth smoking incidence to adjust for the volume of cigarette consumption in this age group. Youth incidence is expected to gradually decline, and our estimated consumption levels will fall to 3.1 billion in 2034. Dependent Variable Adult Per Capita Cigarette Consumption (CPC) CPC measures the average annual cigarette consumption of the American adult. It is calculated by dividing total adult cigarette consumption by the size of the population 18 and above. Of the different measures of cigarette consumption available, this is considered to be the most reliable. It also directly reflects the changing behavior of individual smokers over the historical period. Data were obtained from the U.S. Department of Agriculture’s (USDA) Economic Research Service. Explanatory Variables The Real Price of Cigarettes (CIGPRICE) Reliable data on retail cigarette prices from the consumer price index (CPI) are only available since 1997, an inadequate time frame to build our model. However, tobacco CPI, which is available for the entire period of analysis, closely follows cigarette prices, since cigarettes constitute over 95 percent of tobacco products. We have, therefore, used the tobacco CPI in our model, as is standard. Further, we have deflated this price of cigarettes (tobacco) by the overall price level to ensure that any change in cigarette consumption is correctly attributed to a change in the price of cigarettes relative to other goods, rather than an overall change in the price level. The overall, as well as tobacco CPI, were obtained from the Bureau of Labor Statistics (BLS). The coefficient on CIGPRICE in the regression equation measures the elasticity of cigarette consumption with respect to price. In our model this effect consists of two parts. The coefficient of –0.223 measures the short-run elasticity of cigarette demand. That is, a 1% increase in price reduces consumption by 0.223% in the current year. The second coefficient, -0.106 relates to prices in the previous year. It indicates that, following a 1% increase, an additional decrease in cigarette consumption of 0.106% will occur. Thus, according to the data, a one percent increase in price decreases cigarette consumption by 0.329 percent in the long term. The low value of the elasticity indicates that cigarette consumption is price inelastic, or relatively unresponsive to changes in price. This coefficient is estimated such that a statistical confidence interval of 95% places its value between -0.25 and -0.41. This implies that there is a probability of 5% that the price elasticity is outside this range. A - 20 Real Disposable Income Per Capita (YDP96PC) Real disposable income per capita measures the average income per person after tax in constant 1996 dollars. Data used were collected by the Bureau of Economic Analysis (BEA). For goods considered “normal”, consumption increases as incomes rise. Hence the coefficient is positive. On the other hand if the coefficient is negative, it indicates that the good is “inferior” and less is purchased as incomes rise. Our analysis indicates that the income elasticity of cigarettes, given by the regression coefficient on YDP96PC, is 0.27. The positive sign on the coefficient indicates that cigarettes are a normal good. Specifically, every percent increase in real disposable income per capita has raised adult per capita cigarette consumption by 0.27%. However, the low value of the elasticity indicates that the demand for cigarettes is income inelastic, or relatively unresponsive to changes in income. This coefficient (0.27) is estimated such that a statistical confidence interval of 95% places its value between 0.03 and 0.52. This implies that there is a probability of 5% that the income elasticity is outside this range. Qualitative Variable The qualitative variable that we have explicitly included in our model relates to the restrictions on public smoking since the 1980s (SMOKEBAN). The negative coefficient on the variable implies that smoking decreases as a result of smoking bans. The coefficient on SMOKEBAN is estimated such that a statistical confidence interval of 95% for its value is from 0 to -0.53. This implies that there is a probability of 5% that the coefficient is outside this range. Trend and Constant Term According to the regression equation specified above, adult cigarette consumption per capita (CPC) displays a trend decline of 2.40 percent per year. The trend reflects the impact of a systematic change in the underlying data that is not explained by the included explanatory variables. In the case of cigarette consumption, the systematic change is in public attitudes toward smoking. The trend may also reflect the cumulative impact of health warnings, advertising restrictions, and other variables which are statistically insignificant when viewed in isolation. This trend, primarily due to an increase in the health-conscious proportion of the population averse to smoking, would by itself account for 90.3% of the variation in consumption. This coefficient is estimated such that a statistical confidence interval of 95% for its value is from 0.0195 to 0.0269 (1.95% to 2.69%). This implies that there is a probability of 5% that the trend rate of decline is outside this range. The constant term (57.7) also reflects the impact of excluded variables, those that stay fixed over time (e.g., the health warnings on cigarette packs). It should be noted that the actual decline in CPC in any given year could be above or below the trend, depending on the values of the other explanatory variables. A - 21 Forecast Assumptions Our forecast is based on assumptions regarding the future path of the explanatory variables in the regression equation. Projections of U.S. population and real per capita personal disposable income are standard Global Insight forecasts. Annual population growth is projected to average 0.8%, and real per capita personal disposable income is projected to increase over the long term at just over 2.1% per year. The projection of the real price of cigarettes is based upon its past behavior with an adjustment for the shock to prices due to the tobacco settlement. Cigarette prices increased dramatically in November 1998, as manufacturers raised prices by $0.45 per pack. Subsequent increases by the manufacturers and numerous federal and state hikes in excise taxes brought prices to an average of $3.84 per pack in 2004, and to $4.04 in 2005. After a long period of fighting to maintain market share, the large cigarette manufacturers are expected to reduce discounts and other promotions. In addition many states continue to discuss excise tax increases. We expect prices in 2006 to average $4.23 per pack. Our model, intended for long-term forecasting, uses annual data to describe changes in prices and other variables. When viewed over long intervals of time, the changes will appear to be gradual. The purpose of the model is to capture these broad changes and their influence on consumption. Because cigarette manufacturing is dominated by a few firms, price changes will typically be discrete events, with jumps such as occurred on August 1999 and December 2004, followed by plateaus, rather than small and continuous changes. The exact timing during the year of price changes influences only the short-term path of consumption. Our forecast assumptions have incorporated price increases in excess of general inflation in order to meet the requirements of the MSA and offset excise and other taxes. Based upon our general inflation and cost assumptions, we anticipate that the nominal price per pack of cigarettes will rise to $15.88 by 2034, which is $6.59 in 2000 dollars. Relative to other goods, cigarette prices will rise by an average of 2.1% per year over the long term. The average real increase over the 30 years ending 1998 was 1.48% per year. Prior to the MSA, only once, in 1983, have real cigarette prices appreciated at a double digit, or greater than 10%, rate. If a 10% rate of price increase were to continue, the annual rate of decline in cigarette consumption predicted by our model would increase to approximately 4%. Our Base Case Forecast assumes that the incidence of youth smoking will continue to decline. By 2034 we assume that youth smoking will have declined at an average annual rate of almost 2% since 2001, or by 47% overall. We believe the assumptions on which the Base Case Forecast are based to be reasonable. A - 22 Forecast of Cigarette Consumption After developing the regression equation specified above, we used it to project CPC for the period 2004 through 2034. Then using the standard adult population projections of Global Insight’s macroeconomic model, we converted per capita consumption to aggregate adult consumption. We then added our estimate of teenage smoking volume going forward. In using regression equations developed on the basis of historical data to project future values of the dependent variable, we must also assume that the underlying economic structure captured in the equation will remain essentially the same. While past performance is no guarantee of future patterns, it is still the best tool we have to make such projections. The graphs below display the projected time trend of U.S. cigarette consumption. The first graph illustrates total actual and projected cigarette consumption in the United States. The second graph illustrates actual and projected CPC in the United States. For the period 1965 through 2003 the forecast line on the second graph indicates the value of CPC our model would have projected for those years. 2030 2020 2010 2000 1990 550 500 450 400 350 300 250 200 Billions of Cigarettes Annual U.S. Cigarette Consumption: Base Case Forecast Actual Base Case Forecast A - 23 2030 2020 2010 2000 1990 1980 1970 4500 4000 3500 3000 2500 2000 1500 1000 500 Number of Cigarettes U.S. Adult Per Capita Cigarette Consumption: Base Case Forecast Actual Base Case Forecast In addition to the expected trend decline in cigarette consumption, the sharp upward shock to cigarette prices in late 1998 and 1999 contributed to a 6.45% reduction in consumption in 1999. The rate of decline has moderated considerably since that time, averaging -2.1% from 1999 to 2003. Total industry shipments for 2004 have been reported at 394.5 billion, a 1.7% decline from 2003. The deep discount share of the market has been reported by the manufacturers as having stabilized at about 12% for 2003 and 2004. These cigarettes are produced by a large number of manufacturers, including many who participate in the MSA. After significant gains earlier in the decade, imports to the U.S. have declined from a high of 23.1 billion sticks in 2003 to 18.1 billion in 2005. In 2005 industry shipments of 381 billion cigarettes were 3.4% lower than in 2004. Part of this decline can be attributed to two extra shipping days in the leap year 2004. On March 8 the National Association of Attorneys General and the American Legacy Foundation jointly announced that cigarette consumption in 2005 had fallen to 378 billion sticks. The estimate in this report, of 381 billion, is slightly higher. It is based on two sources. First, Reynolds American reported in February that the market research firm, MSAI, had estimated total industry shipments in 2005 of 381 billion. Second, the Alcohol and Tobacco Tax and Trade Bureau of the U.S. Department of Treasury reported on February 14, 2006, in their "Statistical Report – Tobacco", that U.S. manufacturers removed as taxable 362.96 billion cigarettes from production in 2005, and that imported cigarettes for consumption in 2005 totaled 18.13 billion. The total shipped for U.S. consumption is then 381.09 billion After 2005, the rate of decline of consumption is projected to moderate and average less than 2% per year. From 2004 through 2034 the average annual rate of decline is projected A - 24 to be 1.82%. On a per capita basis consumption is projected to fall at an average rate of 2.62% per year. Total consumption of cigarettes in the U.S. is projected to fall from an estimated 381 billion in 2005 to 373 billion in 2006, under 300 billion by 2018, and to under 226 billion by 2034. Statistical Confidence and Forecast Error In addition to potential forecast errors due to incorrect forecast assumptions, there also exists possible error in the statistical estimation. The estimation and development of an econometric model is a statistical exercise. Thus, our parameters are estimated with some degree of error. We have provided confidence intervals for the coefficient (elasticity) estimates. For instance, there is a 2.5% probability (5%/2) that the price elasticity exceeds 0.38. There is similarly a 2.5% chance that the income elasticity is less than 0.03. But if these events were independent, the probability of both would be .025 x .025 = .000625, or .0625%, less than one tenth of one percent. Comparison With Prior Forecasts In October 2001 Global Insight, then DRI•WEFA, Inc., presented a similar study, “A Forecast of U.S. Cigarette Consumption (1999-2030).” Its long run conclusions were quite similar to this study. The current forecast of consumption for the year 2030, 242.3 billion is 6 billion fewer than that of the original study, 248.2 billion. This forecast also differs from those we provided in similar studies in 2005 and 2006. In February 2006 full year data on industry shipments for 2005 were reported by the manufacturers and by the U.S. Bureau of Alcohol Tobacco and Firearms. From this data we estimate that consumption in 2005 was 381 billion cigarettes, 4 billion fewer than we had projected. This new data has been incorporated into this revised forecast. Its long term implications are that consumption levels in 2030 are forecast to be 242 billion, 4 billion fewer than the 246 billion in our forecasts of 2005. Alternative Forecasts Two sources of variance may appear in the forecast derived by our model. First, as detailed in the Explanatory Variables section, there is some degree of forecast error in the parameters of the model. Second, the time paths of the explanatory variables may differ from our Base Case Forecast assumptions. Alternative forecasts are included in order to provide an interval forecast that, in our opinion, encompasses all of the likely potential realizations over time. The high and low alternative forecasts are derived as follows. For the high scenario, we use a lower price forecast, under which prices are increasing at an annual rate 0.5% more slowly than our current base case forecast. Under this scenario, the rate of decline is A - 25 moderated slightly, from an average rate of 1.82% to 1.68%, resulting in consumption of 237 billion in 2034. In the low forecast, Low Case 1, we posit a sharper price elasticity of demand. Our estimate of the price elasticity, -0.33, is on the low end of the range when compared to that of certain other economic researchers. Recent economic research has forged a consensus that the elasticity lies between –0.3 and –0.5. We have, therefore, used a higher elasticity of –0.4, to generate the lowest consumption forecast which might be reasonably anticipated by our model. This increases the average rate of decline to 2.01% and results in cigarette consumption of 213 billion in 2034. 2030 2020 2010 2000 1990 550 500 450 400 350 300 250 200 150 Billions of Cigarettes Annual U.S. Cigarette Consumption Actual Base Case Forecast Low Forecast, with -0.4 Price Elasticity of Demand High Forecast,with 0.5% Lower Price Forecast Hypothetical Stress Scenarios The model was also tested under more extreme, and concurrently, less likely conditions. These exercises do not represent informed anticipation of possible future conditions. Rather, they are meant only to test the model under extreme conditions. First, we increased the negative response of consumer demand to recent price increases by assuming a much larger, -0.5, elasticity. This sharpens the fall in total consumption to an average annual rate of 2.21%, and results in demand of 200 billion cigarettes in 2034 (Low Case 2). This scenario would also be the result if, instead of a greater price sensitivity of smokers, we postulated an increased rate of cigarette price increase. Indeed, if cigarette prices, instead of averaging increases in real terms of 2.06% per year, accelerated to a pace of 3.60% annually, demand would also fall to 200 billion in 2034. A - 26 A second large negative stress is placed by postulating, in 2007, either an adverse federal government settlement, or tort claims of three times the size of this MSA. This would result in a real price increase of 57%, and a large decline, 18% over two years, in consumption. By 2034, consumption will have fallen to 185 billion cigarettes, an average annual rate of decline of 2.46% (Low Case 3). Alternative Forecasts 2034 Consumption Level (Bil.) Average Annual Decline (%) Base Case Forecast 226 1.82 Low Case 1 213 2.01 High Alternative 237 1.68 Low Case 2 200 2.21 Low Case 3 185 2.46 2030 2020 2010 2000 1990 550 500 450 400 350 300 250 200 150 Billions of Cigarettes Annual U.S. Cigarette Consumption Actual Base Case Forecast Low Case 2 Extreme Low Case 3 Extreme Finally, for comparative purposes we have calculated the volume of total cigarette consumption under four alternative annual rates of decline, 2.5%, 3%, 3.5% and 4%. Under these scenarios consumption in 2034 falls to 183 billion, 158 billion, 136 billion, and 117 billion respectively. These calculations are simple arithmetic examples, and are neither forecasts nor projections. A - 27 Base Case Forecast: Assumptions for Explanatory Variables Year Real Per Capita Personal Income Real Price of Cigarettes U.S. Adult Population Incidence of Smoking in 12-17 Age Group Youth Consumption Average Nominal Price Per Pack Growth Rate (%)Growth Rate (%)Growth Rate (%) Fraction Billions $ (Current) 1965 4.84 4.13 1.95 0.04 1966 4.06 0.92 1.28 0.04 1967 3.27 0.72 1.39 0.05 1968 3.50 1.89 1.56 0.05 1969 2.06 0.00 1.69 0.06 1970 3.02 2.24 2.00 0.05 1971 3.28 0.12 2.27 0.06 1972 3.66 2.08 2.85 0.06 1973 5.73 -3.29 2.03 0.07 1974 -1.62 -5.49 2.05 0.07 1975 1.30 -1.87 2.12 0.05 1976 2.92 -1.40 2.07 0.05 1977 2.46 -1.60 1.91 0.07 1978 3.58 -2.05 1.91 0.06 1979 1.35 -4.73 2.00 0.05 1980 0.06 -5.03 1.96 0.05 1981 1.63 -2.11 1.73 0.06 1982 1.20 4.80 1.64 0.05 1983 2.35 15.84 1.46 0.04 1984 6.63 2.10 1.48 0.05 1985 2.45 2.31 1.16 0.05 1986 2.21 4.84 1.38 0.06 1987 0.83 3.36 1.23 0.05 1988 3.32 4.83 1.26 0.05 1989 1.82 7.64 1.35 0.05 1990 0.72 4.71 0.89 0.06 7.96 1991 -0.81 7.16 0.96 0.06 7.72 1992 2.08 5.24 0.99 0.06 7.62 1993 -0.24 0.91 1.02 0.06 7.12 1994 1.48 -6.11 0.95 0.07 7.21 1995 1.58 -0.21 0.85 0.07 7.76 1996 1.77 0.18 0.89 0.08 7.54 1997 2.30 2.31 1.27 0.08 6.58 1998 4.63 11.03 1.15 0.08 6.30 2.20 1999 1.80 26.72 1.13 0.08 5.92 2.88 2000 3.71 7.47 1.14 0.08 5.92 3.20 2001 0.89 4.36 1.10 0.08 5.92 3.45 2002 2.06 5.76 1.02 0.08 5.91 3.71 2003 1.32 -0.64 0.96 0.08 5.87 3.77 2004 2.43 -0.75 0.96 0.08 5.84 3.84 2005 0.48 1.68 0.98 0.08 5.82 4.12 2006 2.24 2.59 0.99 0.08 5.80 4.27 2007 2.19 2.63 1.00 0.08 5.78 4.47 2008 2.22 2.71 1.00 0.08 5.77 4.68 2009 2.20 3.10 1.02 0.07 5.77 4.92 2010 2.17 2.61 1.00 0.07 5.62 5.17 2011 2.10 2.57 0.93 0.07 5.47 5.42 2012 2.02 2.52 0.88 0.07 5.32 5.71 2013 2.02 2.48 0.81 0.07 5.18 6.01 2014 2.02 2.84 0.80 0.07 5.18 6.35 2015 2.04 2.02 0.84 0.07 5.18 6.66 A - 28 Base Case Forecast: Assumptions for Explanatory Variables (Cont.) Year Real Per Capita Personal Income Real Price of Cigarettes U.S. Adult Population Incidence of Smoking in 12-17 Age Group Youth Consumption Average Nominal Price Per Pack Growth Rate (%)Growth Rate (%)Growth Rate (%) Fraction Billions $ (Current) 2016 2.04 2.37 0.82 0.07 5.18 7.00 2017 2.05 2.34 0.77 0.07 5.18 7.36 2018 2.05 2.31 0.76 0.07 5.18 7.74 2019 2.06 2.27 0.74 0.06 5.03 8.13 2020 2.08 1.89 0.76 0.06 4.88 8.52 2021 2.09 2.22 0.77 0.06 4.73 8.94 2022 2.10 1.85 0.77 0.06 4.59 9.36 2023 2.11 2.17 0.78 0.06 4.44 9.83 2024 2.11 1.81 0.78 0.06 4.44 10.28 2025 2.11 1.79 0.79 0.05 4.29 10.75 2026 2.11 1.78 0.79 0.05 4.14 11.24 2027 2.11 1.76 0.79 0.05 3.99 11.76 2028 2.11 1.75 0.80 0.05 3.85 12.29 2029 2.11 1.73 0.80 0.05 3.70 12.85 2030 2.11 2.02 0.80 0.05 3.70 13.47 2031 2.11 1.70 0.79 0.04 3.55 14.07 2032 2.11 1.68 0.77 0.04 3.40 14.70 2033 2.11 1.67 0.76 0.04 3.25 15.36 2034 2.11 1.66 0.75 0.04 3.11 16.04 A - 29 Historical / Base Case Forecast U.S. Adult Per Capita and Total Consumption of Cigarettes (1965 – 2034) Per Capita Consumption Growth Rate Total Consumption Total Consumption Growth Rate (%) (billions) (billions of packs) (%) 1965 4259 1.53 528.70 26.44 3.42 1966 4287 0.66 541.20 27.06 2.36 1967 4280 -0.16 549.20 27.46 1.48 1968 4186 -2.20 545.70 27.29 -0.64 1969 3993 -4.61 528.90 26.45 -3.08 1970 3985 -0.20 536.40 26.82 1.42 1971 4037 1.30 555.10 27.76 3.49 1972 4043 0.15 566.80 28.34 2.11 1973 4148 2.60 589.70 29.49 4.04 1974 4141 -0.17 599.00 29.95 1.58 1975 4123 -0.43 607.20 30.36 1.37 1976 4092 -0.75 613.50 30.68 1.04 1977 4051 -1.00 617.00 30.85 0.57 1978 3967 -2.07 616.00 30.80 -0.16 1979 3861 -2.67 621.50 31.08 0.89 1980 3849 -0.31 631.50 31.58 1.61 1981 3836 -0.34 640.00 32.00 1.35 1982 3739 -2.53 634.00 31.70 -0.94 1983 3488 -6.71 600.00 30.00 -5.36 1984 3446 -1.20 600.40 30.02 0.07 1985 3370 -2.21 594.00 29.70 -1.07 1986 3274 -2.85 583.80 29.19 -1.72 1987 3197 -2.35 575.00 28.75 -1.51 1988 3096 -3.16 562.50 28.13 -2.17 1989 2926 -5.49 540.00 27.00 -4.00 1990 2826 -3.14 525.00 26.25 -2.78 1991 2727 -3.50 510.00 25.50 -2.86 1992 2647 -2.93 500.00 25.00 -1.96 1993 2542 -3.97 485.00 24.25 -3.00 1994 2524 -0.71 486.00 24.30 0.21 1995 2505 -0.75 487.00 24.35 0.21 1996 2482 -0.84 487.00 24.35 0.00 1997 2423 -2.50 480.00 24.00 -1.44 1998 2320 -4.25 465.00 23.25 -3.13 1999 2136 -7.93 435.00 21.75 -6.45 2000 2056 -3.75 430.00 21.50 -1.15 2001 2026 -1.46 425.00 21.25 -1.16 2002 1979 -2.32 415.00 20.75 -2.35 2003 1837 -7.18 400.00 20.00 -3.61 2004 1791 -2.50 393.00 19.65 -1.75 2005 1719 -3.99 381.00 19.05 -3.05 2006 1670 -2.85 373.34 18.67 -2.01 2007 1625 -2.70 366.86 18.34 -1.73 2008 1581 -2.72 360.59 18.03 -1.71 2009 1537 -2.82 353.96 17.70 -1.84 2010 1494 -2.76 347.62 17.38 -1.79 2011 1454 -2.72 341.27 17.06 -1.83 2012 1414 -2.70 334.93 16.75 -1.86 2013 1376 -2.69 328.54 16.43 -1.91 2014 1338 -2.76 322.14 16.11 -1.95 2015 1303 -2.62 316.45 15.82 -1.77 A - 30 Historical / Base Case Forecast U.S. Adult Per Capita and Total Consumption of Cigarettes (1965 – 2034) (Cont.) Per Capita Consumption Growth Rate Total Consumption Total Consumption Growth Rate (%) (billions) (billions of packs) (%) 2016 1269 -2.61 310.82 15.54 -1.78 2017 1236 -2.63 305.06 15.25 -1.85 2018 1203 -2.62 299.41 14.97 -1.85 2019 1172 -2.61 293.71 14.69 -1.90 2020 1142 -2.53 288.43 14.42 -1.80 2021 1113 -2.56 283.17 14.16 -1.83 2022 1085 -2.51 278.11 13.91 -1.79 2023 1058 -2.54 273.09 13.65 -1.81 2024 1032 -2.49 268.43 13.42 -1.71 2025 1006 -2.45 263.84 13.19 -1.71 2026 982 -2.44 259.36 12.97 -1.70 2027 958 -2.44 254.97 12.75 -1.69 2028 934 -2.43 250.69 12.53 -1.68 2029 912 -2.43 246.48 12.32 -1.68 2030 889 -2.49 242.34 12.12 -1.68 2031 867 -2.45 238.16 11.91 -1.72 2032 846 -2.42 234.12 11.71 -1.70 2033 826 -2.41 230.14 11.51 -1.70 2034 806 -2.41 226.19 11.31 -1.72 A - 31 Base Case and Alternative Forecasts of Total U.S. Cigarette Consumption Year Base Case Forecast Low Case 1: -0.4 Price Elasticity of Demand High Forecast: Lower Price Assumption Cigarettes (billions) Packs (billions) Growth Rate (%) Cigarettes (billions) Packs (billions) Growth Rate (%) Cigarettes (billions) Packs (billions) Growth Rate (%) 2004 393.00 19.65 -1.75 393.00 19.65 -1.75 393.00 19.65 -1.75 2005 381.00 19.05 -3.05 381.00 19.05 -3.05 381.00 19.05 -3.05 2006 373.34 18.67 -2.01 372.50 18.62 -2.23 373.99 18.70 -1.84 2007 366.86 18.34 -1.73 365.11 18.26 -1.98 368.10 18.40 -1.57 2008 360.59 18.03 -1.71 357.81 17.89 -2.00 362.21 18.11 -1.60 2009 353.96 17.70 -1.84 350.22 17.51 -2.12 356.09 17.80 -1.69 2010 347.62 17.38 -1.79 343.12 17.16 -2.03 350.25 17.51 -1.64 2011 341.27 17.06 -1.83 336.05 16.80 -2.06 344.41 17.22 -1.67 2012 334.93 16.75 -1.86 329.04 16.45 -2.09 338.53 16.93 -1.71 2013 328.54 16.43 -1.91 322.01 16.10 -2.14 332.58 16.63 -1.76 2014 322.14 16.11 -1.95 314.92 15.75 -2.20 326.63 16.33 -1.79 2015 316.45 15.82 -1.77 308.80 15.44 -1.95 321.35 16.07 -1.62 2016 310.82 15.54 -1.78 302.65 15.13 -1.99 316.12 15.81 -1.63 2017 305.06 15.25 -1.85 296.41 14.82 -2.06 310.76 15.54 -1.69 2018 299.41 14.97 -1.85 290.33 14.52 -2.05 305.50 15.28 -1.69 2019 293.71 14.69 -1.90 284.19 14.21 -2.11 300.15 15.01 -1.75 2020 288.43 14.42 -1.80 278.57 13.93 -1.98 295.21 14.76 -1.65 2021 283.17 14.16 -1.83 272.93 13.65 -2.03 290.26 14.51 -1.68 2022 278.11 13.91 -1.79 267.62 13.38 -1.95 285.54 14.28 -1.63 2023 273.09 13.65 -1.81 262.28 13.11 -2.00 280.84 14.04 -1.65 2024 268.43 13.42 -1.71 257.39 12.87 -1.87 276.50 13.83 -1.55 2025 263.84 13.19 -1.71 252.57 12.63 -1.87 272.21 13.61 -1.55 2026 259.36 12.97 -1.70 247.88 12.39 -1.86 268.02 13.40 -1.54 2027 254.97 12.75 -1.69 243.29 12.16 -1.85 263.90 13.19 -1.54 2028 250.69 12.53 -1.68 238.81 11.94 -1.84 259.86 12.99 -1.53 2029 246.48 12.32 -1.68 234.45 11.72 -1.83 255.91 12.80 -1.52 2030 242.34 12.12 -1.68 230.06 11.50 -1.87 251.99 12.60 -1.53 2031 238.16 11.91 -1.72 225.75 11.29 -1.87 248.05 12.40 -1.56 2032 234.12 11.71 -1.70 221.58 11.08 -1.85 244.24 12.21 -1.54 2033 230.14 11.51 -1.70 217.49 10.87 -1.85 240.46 12.02 -1.55 2034 226.19 11.31 -1.72 213.42 10.67 -1.87 236.72 11.84 -1.56 A - 32 Base Case Forecast and Low Case Extreme Projections Year Base Case Forecast Low Case 2: -0.5 Price Elasticity of Demand Low Case 3: Large MSA in 2006 Cigarettes (billions) Packs (billions) Growth Rate (%) Cigarettes (billions) Packs (billions) Growth Rate (%) Cigarettes (billions) Packs (billions) Growth Rate (%) 2004 393.00 19.65 -1.75 393.00 19.65 -1.75 393.00 19.65 -1.75 2005 381.00 19.05 -3.05 381.00 19.05 -3.05 381.00 19.05 -3.05 2006 373.34 18.67 -2.01 371.51 18.58 -2.49 373.34 18.67 -2.01 2007 366.86 18.34 -1.73 363.10 18.15 -2.26 319.24 15.96 -14.49 2008 360.59 18.03 -1.71 354.86 17.74 -2.27 294.49 14.72 -7.75 2009 353.96 17.70 -1.84 346.24 17.31 -2.43 289.07 14.45 -1.84 2010 347.62 17.38 -1.79 338.31 16.92 -2.29 283.90 14.20 -1.79 2011 341.27 17.06 -1.83 330.47 16.52 -2.32 278.71 13.94 -1.83 2012 334.93 16.75 -1.86 322.74 16.14 -2.34 273.53 13.68 -1.86 2013 328.54 16.43 -1.91 315.07 15.75 -2.38 268.32 13.42 -1.91 2014 322.14 16.11 -1.95 307.22 15.36 -2.49 263.09 13.15 -1.95 2015 316.45 15.82 -1.77 300.63 15.03 -2.15 258.44 12.92 -1.77 2016 310.82 15.54 -1.78 293.93 14.70 -2.23 253.84 12.69 -1.78 2017 305.06 15.25 -1.85 287.19 14.36 -2.29 249.14 12.46 -1.85 2018 299.41 14.97 -1.85 280.63 14.03 -2.28 244.52 12.23 -1.85 2019 293.71 14.69 -1.90 274.06 13.70 -2.34 239.87 11.99 -1.90 2020 288.43 14.42 -1.80 268.15 13.41 -2.16 235.56 11.78 -1.80 2021 283.17 14.16 -1.83 262.13 13.11 -2.25 231.26 11.56 -1.83 2022 278.11 13.91 -1.79 256.53 12.83 -2.14 227.13 11.36 -1.79 2023 273.09 13.65 -1.81 250.85 12.54 -2.22 223.03 11.15 -1.81 2024 268.43 13.42 -1.71 245.72 12.29 -2.05 219.23 10.96 -1.71 2025 263.84 13.19 -1.71 240.68 12.03 -2.05 215.48 10.77 -1.71 2026 259.36 12.97 -1.70 235.77 11.79 -2.04 211.81 10.59 -1.70 2027 254.97 12.75 -1.69 230.98 11.55 -2.03 208.23 10.41 -1.69 2028 250.69 12.53 -1.68 226.34 11.32 -2.01 204.74 10.24 -1.68 2029 246.48 12.32 -1.68 221.79 11.09 -2.01 201.30 10.06 -1.68 2030 242.34 12.12 -1.68 217.20 10.86 -2.07 197.91 9.90 -1.68 2031 238.16 11.91 -1.72 212.76 10.64 -2.04 194.50 9.73 -1.72 2032 234.12 11.71 -1.70 208.47 10.42 -2.02 191.20 9.56 -1.70 2033 230.14 11.51 -1.70 204.26 10.21 -2.02 187.96 9.40 -1.70 2034 226.19 11.31 -1.72 200.12 10.01 -2.03 184.73 9.24 -1.72 A - 33 Alternative Constant Rate Decline Projections Year 2.5% 3.0% Cigarettes Packs (billions) Growth Rate Cigarettes Packs (billions) Growth Rate 2004 393.00 19.65 -1.75 393.00 19.65 -4.00 2005 381.00 19.05 -3.05 381.00 19.05 -3.05 2006 371.48 18.57 -2.50 369.57 18.48 -3.00 2007 362.19 18.11 -2.50 358.48 17.92 -3.00 2008 353.13 17.66 -2.50 347.73 17.39 -3.00 2009 344.31 17.22 -2.50 337.30 16.86 -3.00 2010 335.70 16.78 -2.50 327.18 16.36 -3.00 2011 327.31 16.37 -2.50 317.36 15.87 -3.00 2012 319.12 15.96 -2.50 307.84 15.39 -3.00 2013 311.14 15.56 -2.50 298.61 14.93 -3.00 2014 303.37 15.17 -2.50 289.65 14.48 -3.00 2015 295.78 14.79 -2.50 280.96 14.05 -3.00 2016 288.39 14.42 -2.50 272.53 13.63 -3.00 2017 281.18 14.06 -2.50 264.35 13.22 -3.00 2018 274.15 13.71 -2.50 256.42 12.82 -3.00 2019 267.29 13.36 -2.50 248.73 12.44 -3.00 2020 260.61 13.03 -2.50 241.27 12.06 -3.00 2021 254.10 12.70 -2.50 234.03 11.70 -3.00 2022 247.74 12.39 -2.50 227.01 11.35 -3.00 2023 241.55 12.08 -2.50 220.20 11.01 -3.00 2024 235.51 11.78 -2.50 213.59 10.68 -3.00 2025 229.62 11.48 -2.50 207.19 10.36 -3.00 2026 223.88 11.19 -2.50 200.97 10.05 -3.00 2027 218.29 10.91 -2.50 194.94 9.75 -3.00 2028 212.83 10.64 -2.50 189.09 9.45 -3.00 2029 207.51 10.38 -2.50 183.42 9.17 -3.00 2030 202.32 10.12 -2.50 177.92 8.90 -3.00 2031 197.26 9.86 -2.50 172.58 8.63 -3.00 2032 192.33 9.62 -2.50 167.40 8.37 -3.00 2033 187.52 9.38 -2.50 162.38 8.12 -3.00 2034 182.83 9.14 -2.50 157.51 7.88 -3.00 A - 34 Alternative Constant Rate Decline Projections (Cont) Year 3.5% 4.0% Cigarettes Packs (billions) Growth Rate Cigarettes Packs (billions) Growth Rate 2004 393.00 19.65 -1.75 393.00 19.65 -4.00 2005 381.00 19.05 -3.05 381.00 19.05 -3.05 2006 367.67 18.38 -3.50 365.76 18.29 -4.00 2007 354.80 17.74 -3.50 351.13 17.56 -4.00 2008 342.38 17.12 -3.50 337.08 16.85 -4.00 2009 330.40 16.52 -3.50 323.60 16.18 -4.00 2010 318.83 15.94 -3.50 310.66 15.53 -4.00 2011 307.67 15.38 -3.50 298.23 14.91 -4.00 2012 296.90 14.85 -3.50 286.30 14.32 -4.00 2013 286.51 14.33 -3.50 274.85 13.74 -4.00 2014 276.48 13.82 -3.50 263.86 13.19 -4.00 2015 266.81 13.34 -3.50 253.30 12.67 -4.00 2016 257.47 12.87 -3.50 243.17 12.16 -4.00 2017 248.46 12.42 -3.50 233.44 11.67 -4.00 2018 239.76 11.99 -3.50 224.10 11.21 -4.00 2019 231.37 11.57 -3.50 215.14 10.76 -4.00 2020 223.27 11.16 -3.50 206.53 10.33 -4.00 2021 215.46 10.77 -3.50 198.27 9.91 -4.00 2022 207.92 10.40 -3.50 190.34 9.52 -4.00 2023 200.64 10.03 -3.50 182.73 9.14 -4.00 2024 193.62 9.68 -3.50 175.42 8.77 -4.00 2025 186.84 9.34 -3.50 168.40 8.42 -4.00 2026 180.30 9.02 -3.50 161.67 8.08 -4.00 2027 173.99 8.70 -3.50 155.20 7.76 -4.00 2028 167.90 8.40 -3.50 148.99 7.45 -4.00 2029 162.02 8.10 -3.50 143.03 7.15 -4.00 2030 156.35 7.82 -3.50 137.31 6.87 -4.00 2031 150.88 7.54 -3.50 131.82 6.59 -4.00 2032 145.60 7.28 -3.50 126.55 6.33 -4.00 2033 140.50 7.03 -3.50 121.48 6.07 -4.00 2034 135.59 6.78 -3.50 116.62 5.83 -4.00 A - 35 Appendix : References American Lung Association. State Legislated Actions on Tobacco Issues, 2002. Baltagi BH, Goel RK. Quasi-experimental price elasticities of cigarette demand and the bootlegging effect. American Journal of Agricultural Economics 1987, 69(4):750-4. Bauer, Hyland, Li, Steger, and Cummings. "A Longitudinal Assessment of the Impact of Smoke- Free Worksite Policies on Tobacco Use". American Journal of Public Health. June 2005 Becker GS, Murphy KM. A theory of rational addiction. Journal of Political Economy 1988;96(4):675-700. Bitton, asaf; Fichtenberg, Caroline; Glantz, Stanton. “Reducing Smoking Prevalence to 10% in Five Years. Journal of the American Medical Association 2001, 286:2733-4. Borio, Gene. “Tobacco Timeline,” 1998. Capehart, T. U.S. Tobacco Farming Trends. Tobacco Situation & Outlook U.S. Department of Agriculture, Economic Research Service, TBS-243; April 1999. Chaloupka FJ, Warner KE. The Economics of Smoking. National Bureau of Economic Research, Cambridge, March 1999. Center for Disease Control, Morbidity and Mortality Weekly Report, “Tobacco Use Among Middle and High School Students-United States, 2002. November 14, 2003. Center for Disease Control, Morbidity and Mortality Weekly Report, “Trends in Cigarette Smoking Among High School Students-United States, 1991-2002”, May 17,2002. Center for Disease Control, Morbidity and Mortality Weekly Report, “Cigarette Smoking Among Adults--United States, 2004,” November 11, 2005. Center for Disease Control, Morbidity and Mortality Weekly Report, “Youth Risk Behavior Surveillance – United States, 1999”, June 9, 2000. Center for Disease Control, Morbidity and Mortality Weekly Report, “Cigarette Smoking Among Adults – United States, 1995,” December 26, 1997. Center for Disease Control, Morbidity and Mortality Weekly Report, “State Laws on Tobacco Control-United States, 1995,” November 3, 1995. Centers for Disease Control and Prevention. CDC Surveillance Summaries, November 2, 2001. MMWR 2001; 50 (No. SS-4). Center for Disease Control, Office on Smoking and Health, http://www.cdc.gov/tobacco. Chaloupka, Frank, Cummings, K M, Morley,CP, and Horan, JK. “Tax, price, and cigarette smoking: evidence from the tobacco documents and implications for tobacco company marketing strategies”. Tobacco Control 2002; 11(Supp I):i62-i71. A - 36 Chaloupka, Frank and Jha, Prabhat, editors. “Tobacco Control in Developing Countries”. Oxford University Press, New York, NY. Copyright 2000. Colman, Greg and Remler, Dahlia K., “Vertical Equity Consequences of Very High Cigarette Tax Increases: If the Poor are the Ones Smoking, How Could Cigarette Tax Increases be Progressive". Working Paper No. W10906, National Bureau of Economic Research, November 2004. Connolly, Alpert, Rees, Carpenter, Wayne, Vallone, and Kish, “Effect of the New York State Cigarette Fire Safety Standard on Ignition Propensity, Smoke Constituents, and the Consumer Market", Tobacco Control, 2005:14. Council on Scientific Affairs, “Reducing the Addictiveness of Cigarettes, “Report to the AMA House of Delegates, June 1998. Cummings, K. Michael and Hyland, Andrew, “Impact of Nicotine Replacement Therapy on Smoking Behavior", Annual Review of Public Health, 2005-03-16. Czart, Christina; Pacula, Rosalie Liccardo; Chaloupka, Frank; and Wechsler, Henry. “The impact of prices and control policies on cigarette smoking among college students”. Published in: Contemporary Economic Policy. Western Economic Association, Copyright April 2001. Economic Research Service. Tobacco Summary, U.S. Department of Agriculture, TBS-243; April 1999. Economic Research Service. Tobacco Summary, U.S. Department of Agriculture, TBS-244; September 1999. Economic Research Service. Tobacco, U.S. Department of Agriculture, TBS-254; April 2003. Economic Research Service. Tobacco Outlook, U.S. Department of Agriculture, TBS-258; April 2005. Elster J. Ulysses and the Sirens: Studies in Rationality and Irrationality. Cambridge: Cambridge University Press, 1979. Evans, William N.; Farrelly, Matthew C.; and Montgomery, Edward. “Do Workplace Smoking Bans Reduce Smoking?”. Working Paper No. W5567, National Bureau of Economic Research, 1996. Farrelly, Davis, Haviland, Messeri, and Healton, "Evidence of a Dose-Response Relationship Between "truth" Antismoking Ads and Youth Smoking Prevalence" American Journal of Public Health, March 2005. Farrelly, Matthew C.; Pechacek, Terry F.; Chaloupka, Frank A. “The Impact of Tobacco Control Program Expenditures on Aggregate Cigarette Sales: 1981-1998. Working Paper No. W8691, National Bureau of Economic Research, 2001. A - 37 Frieden, Mostashari, Kerker, Miller, Hajat, and Frankel. "Adult Tobacco Use Levels After Intensive Tobacco Control Measures: New York City, 2002-2003". American Journal of Public Health. June 2005 Fujii ET. “The Demand for Cigarettes: Further Empirical Evidence and its Implications for Public Policy.” Applied Economics 1980; 12:479-89. Gale, F. Tobacco Dollars and Jobs. Tobacco Situation & Outlook U.S. Department of Agriculture, Economic Research Service, TBS-239; Sept 1997:37-43. Grossman, Michael, "Individual Behaviors and Substance Use: The Role of Price" Working Paper No. W10948, National Bureau of Economic Research, December 2004. Gruber, Jonathan. “Tobacco At the Crossroads: The Past and Future of Smoking Regulation in the United States”. Journal of Economic Perspectives, Volume 15, Number 2, Spring 2001:193-212. Gruber, Jonathan, editor. “Risky Behavior Among Youths”. National Bureau of Economic Research, University of Chicago Press; Copyright 2001. Gruber, Jonathan and Koszegi, Botond, “Is Addiction “Rational”? Theory and Evidence”, Quarterly Journal of Economics, 2001; 116(4), 1261-1305. Gruber, Jonathan, Sen, Anindya, and Stabile, Mark, “Estimating Price Elasticities When There Is Smuggling: The Sensitivity of Smoking to Price in Canada”, Working Paper No. W8962, National Bureau of Economic Research, 2002. ` Gruber, Jonathan and Zinman, Jonathon. “Youth Smoking in the U.S.:Evidence and Implications”. Working Paper No. W7780, National Bureau of Economic Research, 2000. Guindon GE, Tobin S, Yach D. “Trends and Affordability of Cigarette Prices: Ample Room for Tax Increases and Related Health Gains”. Tobacco Control. 2002;11:35-43. Hammond, Fong, McDonald, Brown, and Cameron, "Graphic Canadian Warning Labels and Adverse Outcomes: Evidence from Canadian Smokers: American Journal of Public Health, August 2004. Harris, Jeffrey E. “A Working Model For Predicting the Consumption and Revenue Impacts of Large Increases in the U.S. Federal Cigarette Excise Tax” (July 1, 1994). Henningfield, Fant, Buchhalter, and Stitzer. "Pharmacology for Nicotine Dependence". A Cancer Journal for Clinicians. September/October 2005. Hu, The-wei; Sung, Hai-Yen; Keeler, Theodore E.; and Marciniak, Martin. “Cigarette Consumption and sales of Nicotine Replacement Products”. Tobacco Control, TC Online, Summer 2000. http://tc.bmjjournals.com/cgi/content/full/9/suppl_2/ii60. Hursh SR, Bauman RA. The behavioral analysis of demand. In: Green L, Kagel JH, editors. Advances in Behavioral Economics. Volume 1. Norwood (NJ): Ablex Publishing Corporation, 1987:117-65. A - 38 Institute for Social Research, University of Michigan. “Monitoring the Future Study,” December 2005. Ippolito RA, Murphy RD, Sant D. Staff Report on Consumer Responses to Cigarette Health Information. Washington: Federal Trade Commision, 1979. Lantz Paula M, Jacobson Peter D, Warner Kenneth E, Wasserman Jeffrey, Pollack Harold A, Berson Julie, Ahlstrom Alexis, “Investing in Youth Tobacco Control: A Review of Smoking Prevention and Control Strategies”. Tobacco Control 2000; 9:47-63. Levy, David T. and Friend, Karen. “A Computer Simulation Model of Mass Media Interventions Directed at Tobacco Use”. Preventive Medicine 200132: 284-294. Moore, Michael J. and Hughes, James W. “The Health Care Consequences of Smoking and its Regulation”. National Bureau of Economic Research, Copyright 2000. Niaura, Raymond and Abrams, David B. “Smoking Cessation: Progress, Priorities, and Prospectus”. Journal of Consulting and Clinical Psychology 2002; 70(3): 494-509. National Cancer Institute, “Changing Adolescent Smoking Prevalence”. Smoking and Tobacco Control Monograph 14, March 2002. New York City Department of Health and Mental Hygiene. "Smoking among New York City Public High School Students". NYC Vital Signs. February 2006. President’s Commission on Improving Economic Opportunity in Communities Dependent on Tobacco Production While Protecting Public Health. “Tobacco at a Crossroad: A Call for Action”. May 14, 2001. Rabin, Robert L. and Sugarman, Stephen D. eds. Regulating Tobacco. Oxford University Press 2001. Roddy, Elin, "Bupropion and Other Non-nicotine Pharmacotherapies", British Medical Journal, 28 February 2004. Ross, Hana and Chaloupka, Frank, J. “The Effect of Cigarette Prices on Youth Smoking”, Research Paper Series No. 7, ImpacTeen, February 2001. Schelling TC. “Self-Command in Practice, in Policy and in a Theory of Rational Choice.” American Economic Review 1984; 40 (1):141-59. Stillman, Frances A., Hartman, Anne M., Graubard, Barry I., Gilpin, Elizaberh A., Murray, David M., and Gibson, James T. “Evaluation of the American Stop Smoking Intervention Study (ASSIST): A Report of Outcomes” Journal of the National Cancer Institute. Vol.95, No 22, November 19, 2003. Substance Abuse and Mental Health Services Administration, National Survey on Drug Abuse and Health, September 5, 2003. Sumner DA, Alston JM. Removal of Price Supports and Supply Controls for U.S. Tobacco : An Economic Analysis of the Impact. Washington: National Planning Association, 1985. A - 39 Surgeon General’s 1994 Report, “Preventing Tobacco Use Among Young People.” Surgeon General's 1988 Report, "The Health Consequences of Smoking - Nicotine Addiction". Sweanor DT, Martial LR. The Smuggling of Tobacco Products: Lessons from Canada. Ottawa (Canada): Non-Smokers’ Rights Association/Smoking and Health Action Foundation, 1994. Tauras, John A. and Chaloupka, Frank, J.. “Determinants of Smoking Cessation: An Analysis of Young Adult Men and Women.” Working Paper No. W7262, National Bureau of Economic Research, 1999. Taurus, John A. and Chaloupka, Frank J.. “The Demand for Nicotine Replacement Therapies”. Working Paper No. 8332, National Bureau of Economic Research, June 2001. Tauras, Chaloupka, Farrelly, Giovino, Wakefield, Johnston, O'Malley, Kloska, and Pechacek, "State Tobacco Control Spending and Youth Smoking", American Journal of Public Health, February 2005. Tauras, John A.; O’Malley, Patrick M.; and Johnston, Lloyd D.. “Effects of Price and Access Laws on Teenage Smoking Initiation: A National Longitudinal Analysis”. University of Chicago Press, Copyright 2001. Tauras, John A. “Smoke-Free Air Laws, Cigarette Prices, and Adult Cigarette Demand” Economic Inquiry. April 2006. Tengs, Tommy; Osgood, Nathaniel D; Chen, Laurie L. The Cost-Effectiveness of Intensive National School=Based Anti-Tobacco Education: Results from the Tobacco Policy Model. Preventitive Medicine 2001: 33(6): 558-70. Tennant RB. The American Cigarette Industry: A Study in Economic Analysis and Public Policy. New Haven (CT): Yale University Press, 1950. Tobacco Institute. Tobacco Industry Profile 1997. Washington: Tobacco Institute, 1997. Townsend JL, Roderick P, Cooper J. “Cigarette Smoking by Socioeconomic Group, Sex, and Age: Effects of Price, Income, and Health Publicity.” British Medical Journal 1994; 309 (6959): 923-6. UK Department of Health. Effect of Tobacco Advertising on Tobacco Consumption : A Discussion Document Reviewing the Evidence. London: U.K. Department of Health, Economics and Operational Research Division, 1992. United States General Accounting Office, “Internet Cigarette Sales”, GAO-02-743, August 2002. Wasserman J, Manning WG, Newhouse JP, Winkler JD. “The Effects of Excise Taxes and Regulations on Cigarette Smoking.” Journal of Health Economics 1991; 10 (1): 43-64. Winston GC. “Addiction and Backsliding: a Theory of Compulsive Consumption.” Journal of Economic Behavior and Organization 1980; 1 (4): 295-324. [THIS PAGE INTENTIONALLY LEFT BLANK] APPENDIX B MASTER SETTLEMENT AGREEMENT [THIS PAGE INTENTIONALLY LEFT BLANK] MASTER SETTLEMENT AGREEMENT (AS AMENDED BY THE ADDENDUM OF CLARIFICATIONS) TABLE OF CONTENTS Page i MASTER SETTLEMENT AGREEMENT TABLE OF CONTENTS Page I. RECITALS.............................................................................................................................................................. 1 II. DEFINITIONS....................................................................................................................................................... 1 (a) “Account”................................................................................................................................................ 1 (b) “Adult”.................................................................................................................................................... 1 (c) “Adult-Only Facility”.............................................................................................................................. 1 (d) “Affiliate” ............................................................................................................................................... 1 (e) “Agreement” ........................................................................................................................................... 1 (f) “Allocable Share”.................................................................................................................................... 1 (g) “Allocated Payment” .............................................................................................................................. 2 (h) “Bankruptcy” .......................................................................................................................................... 2 (i) “Brand Name” ......................................................................................................................................... 2 (j) “Brand Name Sponsorship”..................................................................................................................... 2 (k) “Business Day”....................................................................................................................................... 2 (l) “Cartoon”................................................................................................................................................. 2 (m) “Cigarette”............................................................................................................................................. 2 (n) “Claims” ................................................................................................................................................. 2 (o) “Consent Decree” ................................................................................................................................... 3 (p) “Court”.................................................................................................................................................... 3 (q) “Escrow”................................................................................................................................................. 3 (r) “Escrow Agent”....................................................................................................................................... 3 (s) “Escrow Agreement”............................................................................................................................... 3 (t) “Federal Tobacco Legislation Offset” ..................................................................................................... 3 (u) “Final Approval”..................................................................................................................................... 3 (v) “Foundation”........................................................................................................................................... 3 (w) “Independent Auditor”........................................................................................................................... 3 (x) “Inflation Adjustment”............................................................................................................................ 3 (y) “Litigating Releasing Parties Offset”...................................................................................................... 3 (z) “Market Share” ....................................................................................................................................... 3 (aa) “MSA Execution Date”......................................................................................................................... 3 (bb) “NAAG” ............................................................................................................................................... 3 (cc) “Non-Participating Manufacturer” ........................................................................................................ 3 (dd) “Non-Settling States Reduction” .......................................................................................................... 3 (ee) “Notice Parties”..................................................................................................................................... 3 (ff) “NPM Adjustment”................................................................................................................................ 3 (gg) “NPM Adjustment Percentage” ............................................................................................................ 3 (hh) “Original Participating Manufacturers”................................................................................................ 3 (ii) “Outdoor Advertising”............................................................................................................................ 3 (jj) “Participating Manufacturer”.................................................................................................................. 4 (kk) “Previously Settled States Reduction”.................................................................................................. 4 (ll) “Prime Rate”........................................................................................................................................... 4 (mm) “Relative Market Share”..................................................................................................................... 4 (nn) “Released Claims” ................................................................................................................................ 4 (oo) “Released Parties”................................................................................................................................. 4 (pp) “Releasing Parties” ............................................................................................................................... 5 (qq) “Settling State” ..................................................................................................................................... 5 (rr) “State”.................................................................................................................................................... 5 (ss) “State-Specific Finality”........................................................................................................................ 5 (tt) “Subsequent Participating Manufacturer” .............................................................................................. 5 (uu) “Tobacco Product Manufacturer” ......................................................................................................... 5 (vv) “Tobacco Products” .............................................................................................................................. 5 (ww) “Tobacco-Related Organizations”....................................................................................................... 5 (xx) “Transit Advertisements”...................................................................................................................... 5 TABLE OF CONTENTS (continued) Page ii (yy) “Underage” ........................................................................................................................................... 6 (zz) “Video Game Arcade”........................................................................................................................... 6 (aaa) “Volume Adjustment” ......................................................................................................................... 6 (bbb) “Youth”............................................................................................................................................... 6 III. PERMANENT RELIEF ................................................................................................................................ 6 (a) Prohibition on Youth Targeting .............................................................................................................. 6 (b) Ban on Use of Cartoons.......................................................................................................................... 6 (c) Limitation of Tobacco Brand Name Sponsorships ................................................................................. 6 (d) Elimination of Outdoor Advertising and Transit Advertisements .......................................................... 7 (e) Prohibition on Payments Related to Tobacco Products and Media......................................................... 7 (f) Ban on Tobacco Brand Name Merchandise ............................................................................................ 7 (g) Ban on Youth Access to Free Samples ................................................................................................... 8 (h) Ban on Gifts to Underage Persons Based on Proofs of Purchase............................................................ 8 (i) Limitation on Third-Party Use of Brand Names...................................................................................... 8 (j) Ban on Non-Tobacco Brand Names ........................................................................................................ 8 (k) Minimum Pack Size of Twenty Cigarettes ............................................................................................. 8 (l) Corporate Culture Commitments Related to Youth Access and Consumption ....................................... 8 (m) Limitations on Lobbying ....................................................................................................................... 9 (n) Restriction on Advocacy Concerning Settlement Proceeds.................................................................... 9 (o) Dissolution of The Tobacco Institute, Inc., the Council for Tobacco Research-U.S.A., Inc. and the Center for Indoor Air Research, Inc................................................................................................ 9 (p) Regulation and Oversight of New Tobacco-Related Trade Associations............................................. 10 (q) Prohibition on Agreements to Suppress Research ................................................................................ 10 (r) Prohibition on Material Misrepresentations .......................................................................................... 10 IV. PUBLIC ACCESS TO DOCUMENTS...................................................................................................... 11 V. TOBACCO CONTROL AND UNDERAGE USE LAWS......................................................................... 12 VI. ESTABLISHMENT OF A NATIONAL FOUNDATION.......................................................................... 12 (a) Foundation Purposes............................................................................................................................. 12 (b) Base Foundation Payments................................................................................................................... 12 (c) National Public Education Fund Payments........................................................................................... 12 (d) Creation and Organization of the Foundation....................................................................................... 13 (e) Foundation Affiliation........................................................................................................................... 13 (f) Foundation Functions ............................................................................................................................ 13 (g) Foundation Grant-Making .................................................................................................................... 13 (h) Foundation Activities............................................................................................................................ 14 (i) Severance of this Section....................................................................................................................... 14 VII. ENFORCEMENT ....................................................................................................................................... 14 (a) Jurisdiction............................................................................................................................................ 14 (b) Enforcement of Consent Decree ........................................................................................................... 14 (c) Enforcement of this Agreement ............................................................................................................ 14 (d) Right of Review.................................................................................................................................... 15 (e) Applicability.......................................................................................................................................... 15 (f) Coordination of Enforcement ................................................................................................................ 15 (g) Inspection and Discovery Rights .......................................................................................................... 15 VIII. CERTAIN ONGOING RESPONSIBILITIES OF THE SETTLING STATES.......................................... 15 IX. PAYMENTS ............................................................................................................................................... 16 (a) All Payments Into Escrow..................................................................................................................... 16 (b) Initial Payments .................................................................................................................................... 16 (c) Annual Payments and Strategic Contribution Payments....................................................................... 16 (d) NPM Adjustment for Subsequent Participating Manufacturers............................................................ 17 (e) Supplemental Payments ........................................................................................................................ 21 (f) Payment Responsibility......................................................................................................................... 21 (g) Corporate Structures ............................................................................................................................. 21 (h) Accrual of Interest ................................................................................................................................ 21 (i) Payments by Subsequent Participating Manufacturers.......................................................................... 21 (j) Order of Application of Allocations, Offsets, Reductions and Adjustments ......................................... 22 X. EFFECT OF FEDERAL TOBACCO-RELATED LEGISLATION ........................................................... 23 TABLE OF CONTENTS (continued) Page iii XI. CALCULATION AND DISBURSEMENT OF PAYMENTS ................................................................... 24 (a) Independent Auditor to Make All Calculations..................................................................................... 24 (b) Identity of Independent Auditor............................................................................................................ 24 (c) Resolution of Disputes.......................................................................................................................... 24 (d) General Provisions as to Calculation of Payments................................................................................ 24 (e) General Treatment of Payments............................................................................................................ 26 (f) Disbursements and Charges Not Contingent on Final Approval........................................................... 26 (g) Payments to be Made Only After Final Approval................................................................................. 28 (h) Applicability to Section XVII Payments............................................................................................... 28 (i) Miscalculated or Disputed Payments..................................................................................................... 28 (j) Payments After Applicable Condition................................................................................................... 29 XII. SETTLING STATES’ RELEASE, DISCHARGE AND COVENANT ..................................................... 30 (a) Release.................................................................................................................................................. 30 (b) Released Claims Against Released Parties ........................................................................................... 31 XIII. CONSENT DECREES AND DISMISSAL OF CLAIMS .......................................................................... 32 XIV. PARTICIPATING MANUFACTURERS’ DISMISSAL OF RELATED LAWSUITS ............................. 33 XV. VOLUNTARY ACT OF THE PARTIES ................................................................................................... 33 XVI. CONSTRUCTION ...................................................................................................................................... 33 XVII. RECOVERY OF COSTS AND ATTORNEYS’ FEES .............................................................................. 33 XVIII. MISCELLANEOUS.................................................................................................................................... 34 (a) Effect of Current or Future Law............................................................................................................ 34 (b) Limited Most-Favored Nation Provision .............................................................................................. 34 (c) Transfer of Tobacco Brands.................................................................................................................. 35 (d) Payments in Settlement......................................................................................................................... 35 (e) No Determination or Admission ........................................................................................................... 35 (f) Non-Admissibility ................................................................................................................................. 35 (g) Representations of Parties..................................................................................................................... 35 (h) Obligations Several, Not Joint .............................................................................................................. 35 (i) Headings ................................................................................................................................................ 36 (j) Amendment and Waiver........................................................................................................................ 36 (k) Notices.................................................................................................................................................. 36 (l) Cooperation ........................................................................................................................................... 36 (m) Designees to Discuss Disputes............................................................................................................. 36 (n) Governing Law ..................................................................................................................................... 36 (o) Severability........................................................................................................................................... 36 (p) Intended Beneficiaries .......................................................................................................................... 37 (q) Counterparts.......................................................................................................................................... 37 (r) Applicability.......................................................................................................................................... 37 (s) Preservation of Privilege ....................................................................................................................... 37 (t) Non-Release........................................................................................................................................... 37 (u) Termination........................................................................................................................................... 37 (v) Freedom of Information Requests......................................................................................................... 37 (w) Bankruptcy........................................................................................................................................... 37 (x) Notice of Material Transfers................................................................................................................. 39 (y) Entire Agreement.................................................................................................................................. 39 (z) Business Days ....................................................................................................................................... 39 (aa) Subsequent Signatories........................................................................................................................ 39 (bb) Decimal Places.................................................................................................................................... 39 (cc) Regulatory Authority........................................................................................................................... 39 (dd) Successors........................................................................................................................................... 39 (ee) Export Packaging ................................................................................................................................ 39 (ff) Actions Within Geographic Boundaries of Settling States................................................................... 39 (gg) Notice to Affiliates.............................................................................................................................. 39 EXHIBIT A STATE ALLOCATION PERCENTAGES ....................................................................................A-1 EXHIBIT B FORM OF ESCROW AGREEMENT............................................................................................ B-1 EXHIBIT C FORMULA FOR CALCULATING INFLATION ADJUSTMENTS ........................................... C-1 EXHIBIT D LIST OF LAWSUITS.....................................................................................................................D-1 TABLE OF CONTENTS (continued) Page iv EXHIBIT E FORMULA FOR CALCULATING VOLUME ADJUSTMENTS................................................E-1 EXHIBIT F POTENTIAL LEGISLATION NOT TO BE OPPOSED ................................................................F-1 EXHIBIT G OBLIGATIONS OF THE TOBACCO INSTITUTE UNDER THE MASTER SETTLEMENT AGREEMENT................................................................................................................................G-1 EXHIBIT H DOCUMENT PRODUCTION.......................................................................................................H-1 EXHIBIT I INDEX AND SEARCH FEATURES FOR DOCUMENT WEBSITE............................................I-1 EXHIBIT J TOBACCO ENFORCEMENT FUND PROTOCOL...................................................................... J-1 EXHIBIT K MARKET CAPITALIZATION PERCENTAGES.........................................................................K-1 EXHIBIT L MODEL CONSENT DECREE .......................................................................................................L-1 EXHIBIT M LIST OF PARTICIPATING MANUFACTURERS’ LAWSUITS AGAINST THE SETTLING STATES......................................................................................................................................... M-1 EXHIBIT N LITIGATING POLITICAL SUBDIVISIONS ...............................................................................N-1 EXHIBIT O MODEL STATE FEE PAYMENT AGREEMENT.......................................................................O-1 EXHIBIT P NOTICES ........................................................................................................................................P-1 EXHIBIT Q 1996 AND 1997 DATA..................................................................................................................Q-1 EXHIBIT R EXCLUSION OF CERTAIN BRAND NAMES............................................................................ R-1 EXHIBIT S DESIGNATION OF OUTSIDE COUNSEL...................................................................................S-1 EXHIBIT T MODEL STATUTE ....................................................................................................................... T-1 EXHIBIT U STRATEGIC CONTRIBUTION FUND PROTOCOL..................................................................U-1 1 MASTER SETTLEMENT AGREEMENT This Master Settlement Agreement is made by the undersigned Settling State officials (on behalf of their respective Settling States) and the undersigned Participating Manufacturers to settle and resolve with finality all Released Claims against the Participating Manufacturers and related entities as set forth herein. This Agreement constitutes the documentation effecting this settlement with respect to each Settling State, and is intended to and shall be binding upon each Settling State and each Participating Manufacturer in accordance with the terms hereof. I. RECITALS WHEREAS, more than 40 States have commenced litigation asserting various claims for monetary, equitable and injunctive relief against certain tobacco product manufacturers and others as defendants, and the States that have not filed suit can potentially assert similar claims; WHEREAS, the Settling States that have commenced litigation have sought to obtain equitable relief and damages under state laws, including consumer protection and/or antitrust laws, in order to further the Settling States’ policies regarding public health, including policies adopted to achieve a significant reduction in smoking by Youth; WHEREAS, defendants have denied each and every one of the Settling States’ allegations of unlawful conduct or wrongdoing and have asserted a number of defenses to the Settling States’ claims, which defenses have been contested by the Settling States; WHEREAS, the Settling States and the Participating Manufacturers are committed to reducing underage tobacco use by discouraging such use and by preventing Youth access to Tobacco Products; WHEREAS, the Participating Manufacturers recognize the concern of the tobacco grower community that it may be adversely affected by the potential reduction in tobacco consumption resulting from this settlement, reaffirm their commitment to work cooperatively to address concerns about the potential adverse economic impact on such community, and will, within 30 days after the MSA Execution Date, meet with the political leadership of States with grower communities to address these economic concerns; WHEREAS, the undersigned Settling State officials believe that entry into this Agreement and uniform consent decrees with the tobacco industry is necessary in order to further the Settling States’ policies designed to reduce Youth smoking, to promote the public health and to secure monetary payments to the Settling States; and WHEREAS, the Settling States and the Participating Manufacturers wish to avoid the further expense, delay, inconvenience, burden and uncertainty of continued litigation (including appeals from any verdicts), and, therefore, have agreed to settle their respective lawsuits and potential claims pursuant to terms which will achieve for the Settling States and their citizens significant funding for the advancement of public health, the implementation of important tobacco-related public health measures, including the enforcement of the mandates and restrictions related to such measures, as well as funding for a national Foundation dedicated to significantly reducing the use of Tobacco Products by Youth; NOW, THEREFORE, BE IT KNOWN THAT, in consideration of the implementation of tobacco-related health measures and the payments to be made by the Participating Manufacturers, the release and discharge of all claims by the Settling States, and such other consideration as described herein, the sufficiency of which is hereby acknowledged, the Settling States and the Participating Manufacturers, acting by and through their authorized agents, memorialize and agree as follows: II. DEFINITIONS (a) “Account” has the meaning given in the Escrow Agreement. (b) “Adult” means any person or persons who are not Underage. (c) “Adult-Only Facility” means a facility or restricted area (whether open-air or enclosed) where the operator ensures or has a reasonable basis to believe (such as by checking identification as required under state law, or by checking the identification of any person appearing to be under the age of 27) that no Underage person is present. A facility or restricted area need not be permanently restricted to Adults in order to constitute an Adult-Only Facility, provided that the operator ensures or has a reasonable basis to believe that no Underage person is present during the event or time period in question. (d) “Affiliate” means a person who directly or indirectly owns or controls, is owned or controlled by, or is under common ownership or control with, another person. Solely for purposes of this definition, the terms “owns,” “is owned” and “ownership” mean ownership of an equity interest, or the equivalent thereof, of 10 percent or more, and the term “person” means an individual, partnership, committee, association, corporation or any other organization or group of persons. (e) “Agreement” means this Master Settlement Agreement, together with the exhibits hereto, as it may be amended pursuant to subsection XVIII(j). (f) “Allocable Share” means the percentage set forth for the State in question as listed in Exhibit A hereto, without regard to any subsequent alteration or modification of such State’s percentage share agreed to by or among any States; or, solely for the purpose of calculating payments under subsection IX(c)(2) (and corresponding payments under subsection 2 IX(i)), the percentage disclosed for the State in question pursuant to subsection IX(c)(2)(A) prior to June 30, 1999, without regard to any subsequent alteration or modification of such State’s percentage share agreed to by or among any States. (g) “Allocated Payment” means a particular Settling State’s Allocable Share of the sum of all of the payments to be made by the Original Participating Manufacturers in the year in question pursuant to subsections IX(c)(1) and IX(c)(2), as such payments have been adjusted, reduced and allocated pursuant to clause “First” through the first sentence of clause “Fifth” of subsection IX(j), but before application of the other offsets and adjustments described in clauses “Sixth” through “Thirteenth” of subsection IX(j). (h) “Bankruptcy” means, with respect to any entity, the commencement of a case or other proceeding (whether voluntary or involuntary) seeking any of (1) liquidation, reorganization, rehabilitation, receivership, conservatorship, or other relief with respect to such entity or its debts under any bankruptcy, insolvency or similar law now or hereafter in effect; (2) the appointment of a trustee, receiver, liquidator, custodian or similar official of such entity or any substantial part of its business or property; (3) the consent of such entity to any of the relief described in (1) above or to the appointment of any official described in (2) above in any such case or other proceeding involuntarily commenced against such entity; or (4) the entry of an order for relief as to such entity under the federal bankruptcy laws as now or hereafter in effect. Provided, however, that an involuntary case or proceeding otherwise within the foregoing definition shall not be a “Bankruptcy” if it is or was dismissed within 60 days of its commencement. (i) “Brand Name” means a brand name (alone or in conjunction with any other word), trademark, logo, symbol, motto, selling message, recognizable pattern of colors, or any other indicia of product identification identical or similar to, or identifiable with, those used for any domestic brand of Tobacco Products. Provided, however, that the term “Brand Name” shall not include the corporate name of any Tobacco Product Manufacturer that does not after the MSA Execution Date sell a brand of Tobacco Products in the States that includes such corporate name. (j) “Brand Name Sponsorship” means an athletic, musical, artistic, or other social or cultural event as to which payment is made (or other consideration is provided) in exchange for use of a Brand Name or Names (1) as part of the name of the event or (2) to identify, advertise, or promote such event or an entrant, participant or team in such event in any other way. Sponsorship of a single national or multi-state series or tour (for example, NASCAR (including any number of NASCAR races)), or of one or more events within a single national or multi-state series or tour, or of an entrant, participant, or team taking part in events sanctioned by a single approving organization (e.g., NASCAR or CART), constitutes one Brand Name Sponsorship. Sponsorship of an entrant, participant, or team by a Participating Manufacturer using a Brand Name or Names in an event that is part of a series or tour that is sponsored by such Participating Manufacturer or that is part of a series or tour in which any one or more events are sponsored by such Participating Manufacturer does not constitute a separate Brand Name Sponsorship. Sponsorship of an entrant, participant, or team by a Participating Manufacturer using a Brand Name or Names in any event (or series of events) not sponsored by such Participating Manufacturer constitutes a Brand Name Sponsorship. The term “Brand Name Sponsorship” shall not include an event in an Adult-Only Facility. (k) “Business Day” means a day which is not a Saturday or Sunday or legal holiday on which banks are authorized or required to close in New York, New York. (l) “Cartoon” means any drawing or other depiction of an object, person, animal, creature or any similar caricature that satisfies any of the following criteria: (1) the use of comically exaggerated features; (2) the attribution of human characteristics to animals, plants or other objects, or the similar use of anthropomorphic technique; or (3) the attribution of unnatural or extrahuman abilities, such as imperviousness to pain or injury, X-ray vision, tunneling at very high speeds or transformation. The term “Cartoon” includes “Joe Camel,” but does not include any drawing or other depiction that on July 1, 1998, was in use in any State in any Participating Manufacturer’s corporate logo or in any Participating Manufacturer’s Tobacco Product packaging. (m) “Cigarette” means any product that contains nicotine, is intended to be burned or heated under ordinary conditions of use, and consists of or contains (1) any roll of tobacco wrapped in paper or in any substance not containing tobacco; or (2) tobacco, in any form, that is functional in the product, which, because of its appearance, the type of tobacco used in the filler, or its packaging and labeling, is likely to be offered to, or purchased by, consumers as a cigarette; or (3) any roll of tobacco wrapped in any substance containing tobacco which, because of its appearance, the type of tobacco used in the filler, or its packaging and labeling, is likely to be offered to, or purchased by, consumers as a cigarette described in clause (1) of this definition. The term “Cigarette” includes “roll-your-own” (i.e., any tobacco which, because of its appearance, type, packaging, or labeling is suitable for use and likely to be offered to, or purchased by, consumers as tobacco for making cigarettes). Except as provided in subsections II(z) and II(mm), 0.0325 ounces of “roll-your-own” tobacco shall constitute one individual “Cigarette.” (n) “Claims” means any and all manner of civil (i.e., non-criminal): claims, demands, actions, suits, causes of action, damages (whenever incurred), liabilities of any nature including civil penalties and punitive damages, as well as costs, expenses and attorneys’ fees (except as to the Original Participating Manufacturers’ obligations under section XVII), known or unknown, suspected or unsuspected, accrued or unaccrued, whether legal, equitable, or statutory. 3 (o) “Consent Decree” means a state-specific consent decree as described in subsection XIII(b)(1)(B) of this Agreement. (p) “Court” means the respective court in each Settling State to which this Agreement and the Consent Decree are presented for approval and/or entry as to that Settling State. (q) “Escrow” has the meaning given in the Escrow Agreement. (r) “Escrow Agent” means the escrow agent under the Escrow Agreement. (s) “Escrow Agreement” means an escrow agreement substantially in the form of Exhibit B. (t) “Federal Tobacco Legislation Offset” means the offset described in section X. (u) “Final Approval” means the earlier of: (1) the date by which State-Specific Finality in a sufficient number of Settling States has occurred; or (2) June 30, 2000. For the purposes of this subsection (u), “State-Specific Finality in a sufficient number of Settling States” means that State-Specific Finality has occurred in both: (A) a number of Settling States equal to at least 80% of the total number of Settling States; and (B) Settling States having aggregate Allocable Shares equal to at least 80% of the total aggregate Allocable Shares assigned to all Settling States. Notwithstanding the foregoing, the Original Participating Manufacturers may, by unanimous written agreement, waive any requirement for Final Approval set forth in subsections (A) or (B) hereof. (v) “Foundation” means the foundation described in section VI. (w) “Independent Auditor” means the firm described in subsection XI(b). (x) “Inflation Adjustment” means an adjustment in accordance with the formulas for inflation adjustments set forth in Exhibit C. (y) “Litigating Releasing Parties Offset” means the offset described in subsection XII(b). (z) “Market Share” means a Tobacco Product Manufacturer’s respective share (expressed as a percentage) of the total number of individual Cigarettes sold in the fifty United States, the District of Columbia and Puerto Rico during the applicable calendar year, as measured by excise taxes collected by the federal government and, in the case of sales in Puerto Rico, arbitrios de cigarillos collected by the Puerto Rico taxing authority. For purposes of the definition and determination of “Market Share” with respect to calculations under subsection IX(i), 0.09 ounces of “roll your own” tobacco shall constitute one individual Cigarette; for purposes of the definition and determination of “Market Share” with respect to all other calculations, 0.0325 ounces of “roll your own” tobacco shall constitute one individual Cigarette. (aa) “MSA Execution Date” means November 23, 1998. (bb) “NAAG” means the National Association of Attorneys General, or its successor organization that is directed by the Attorneys General to perform certain functions under this Agreement. (cc) “Non-Participating Manufacturer” means any Tobacco Product Manufacturer that is not a Participating Manufacturer. (dd) “Non-Settling States Reduction” means a reduction determined by multiplying the amount to which such reduction applies by the aggregate Allocable Shares of those States that are not Settling States on the date 15 days before such payment is due. (ee) “Notice Parties” means each Participating Manufacturer, each Settling State, the Escrow Agent, the Independent Auditor and NAAG. (ff) “NPM Adjustment” means the adjustment specified in subsection IX(d). (gg) “NPM Adjustment Percentage” means the percentage determined pursuant to subsection IX(d). (hh) “Original Participating Manufacturers” means the following: Brown & Williamson Tobacco Corporation, Lorillard Tobacco Company, Philip Morris Incorporated and R.J. Reynolds Tobacco Company, and the respective successors of each of the foregoing. Except as expressly provided in this Agreement, once an entity becomes an Original Participating Manufacturer, such entity shall permanently retain the status of Original Participating Manufacturer. (ii) “Outdoor Advertising” means (1) billboards, (2) signs and placards in arenas, stadiums, shopping malls and Video Game Arcades (whether any of the foregoing are open air or enclosed) (but not including any such sign or placard located in an Adult-Only Facility), and (3) any other advertisements placed (A) outdoors, or (B) on the inside surface of a window facing outward. Provided, however, that the term “Outdoor Advertising” does not mean (1) an advertisement on the outside of a Tobacco Product manufacturing facility; (2) an individual advertisement that does not occupy an area larger than 14 square feet (and that neither is placed in such proximity to any other such advertisement so as to create a single “mosaic”- type advertisement larger than 14 square feet, nor functions solely as a segment of a larger advertising unit or series), and that is placed (A) on the outside of any retail establishment that sells Tobacco Products (other than solely through a vending machine), (B) outside (but on the property of) any such establishment, or (C) on the inside surface of a window facing 4 outward in any such establishment; (3) an advertisement inside a retail establishment that sells Tobacco Products (other than solely through a vending machine) that is not placed on the inside surface of a window facing outward; or (4) an outdoor advertisement at the site of an event to be held at an Adult-Only Facility that is placed at such site during the period the facility or enclosed area constitutes an Adult-Only Facility, but in no event more than 14 days before the event, and that does not advertise any Tobacco Product (other than by using a Brand Name to identify the event). (jj) “Participating Manufacturer” means a Tobacco Product Manufacturer that is or becomes a signatory to this Agreement, provided that (1) in the case of a Tobacco Product Manufacturer that is not an Original Participating Manufacturer, such Tobacco Product Manufacturer is bound by this Agreement and the Consent Decree (or, in any Settling State that does not permit amendment of the Consent Decree, a consent decree containing terms identical to those set forth in the Consent Decree) in all Settling States in which this Agreement and the Consent Decree binds Original Participating Manufacturers (provided, however, that such Tobacco Product Manufacturer need only become bound by the Consent Decree in those Settling States in which the Settling State has filed a Released Claim against it), and (2) in the case of a Tobacco Product Manufacturer that signs this Agreement after the MSA Execution Date, such Tobacco Product Manufacturer, within a reasonable period of time after signing this Agreement, makes any payments (including interest thereon at the Prime Rate) that it would have been obligated to make in the intervening period had it been a signatory as of the MSA Execution Date. “Participating Manufacturer” shall also include the successor of a Participating Manufacturer. Except as expressly provided in this Agreement, once an entity becomes a Participating Manufacturer such entity shall permanently retain the status of Participating Manufacturer. Each Participating Manufacturer shall regularly report its shipments of Cigarettes in or to the fifty United States, the District of Columbia and Puerto Rico to Management Science Associates, Inc. (or a successor entity as set forth in subsection (mm)). Solely for purposes of calculations pursuant to subsection IX(d), a Tobacco Product Manufacturer that is not a signatory to this Agreement shall be deemed to be a “Participating Manufacturer” if the Original Participating Manufacturers unanimously consent in writing. (kk) “Previously Settled States Reduction” means a reduction determined by multiplying the amount to which such reduction applies by 12.4500000%, in the case of payments due in or prior to 2007; 12.2373756%, in the case of payments due after 2007 but before 2018; and 11.0666667%, in the case of payments due in or after 2018. (ll) “Prime Rate” shall mean the prime rate as published from time to time by the Wall Street Journal or, in the event the Wall Street Journal is no longer published or no longer publishes such rate, an equivalent successor reference rate determined by the Independent Auditor. (mm) “Relative Market Share” means an Original Participating Manufacturer’s respective share (expressed as a percentage) of the total number of individual Cigarettes shipped in or to the fifty United States, the District of Columbia and Puerto Rico by all the Original Participating Manufacturers during the calendar year immediately preceding the year in which the payment at issue is due (regardless of when such payment is made), as measured by the Original Participating Manufacturers’ reports of shipments of Cigarettes to Management Science Associates, Inc. (or a successor entity acceptable to both the Original Participating Manufacturers and a majority of those Attorneys General who are both the Attorney General of a Settling State and a member of the NAAG executive committee at the time in question). A Cigarette shipped by more than one Participating Manufacturer shall be deemed to have been shipped solely by the first Participating Manufacturer to do so. For purposes of the definition and determination of “Relative Market Share,” 0.09 ounces of “roll your own” tobacco shall constitute one individual Cigarette. (nn) “Released Claims” means: (1) for past conduct, acts or omissions (including any damages incurred in the future arising from such past conduct, acts or omissions), those Claims directly or indirectly based on, arising out of or in any way related, in whole or in part, to (A) the use, sale, distribution, manufacture, development, advertising, marketing or health effects of, (B) the exposure to, or (C) research, statements, or warnings regarding, Tobacco Products (including, but not limited to, the Claims asserted in the actions identified in Exhibit D, or any comparable Claims that were, could be or could have been asserted now or in the future in those actions or in any comparable action in federal, state or local court brought by a Settling State or a Releasing Party (whether or not such Settling State or Releasing Party has brought such action)), except for claims not asserted in the actions identified in Exhibit D for outstanding liability under existing licensing (or similar) fee laws or existing tax laws (but not excepting claims for any tax liability of the Tobacco-Related Organizations or of any Released Party with respect to such Tobacco-Related Organizations, which claims are covered by the release and covenants set forth in this Agreement); (2) for future conduct, acts or omissions, only those monetary Claims directly or indirectly based on, arising out of or in any way related to, in whole or in part, the use of or exposure to Tobacco Products manufactured in the ordinary course of business, including without limitation any future Claims for reimbursement of health care costs allegedly associated with the use of or exposure to Tobacco Products. (oo) “Released Parties” means all Participating Manufacturers, their past, present and future Affiliates, and the respective divisions, officers, directors, employees, representatives, insurers, lenders, underwriters, Tobacco-Related Organizations, trade associations, suppliers, agents, auditors, advertising agencies, public relations entities, attorneys, retailers and distributors of any Participating Manufacturer or of any such Affiliate (and the predecessors, heirs, executors, administrators, successors and assigns of each of the foregoing). Provided, however, that “Released Parties” does not include any person or entity (including, but not limited to, an Affiliate) that is itself a Non-Participating Manufacturer at any time after the MSA Execution Date, unless such person or entity becomes a Participating Manufacturer. 5 (pp) “Releasing Parties” means each Settling State and any of its past, present and future agents, officials acting in their official capacities, legal representatives, agencies, departments, commissions and divisions; and also means, to the full extent of the power of the signatories hereto to release past, present and future claims, the following: (1) any Settling State’s subdivisions (political or otherwise, including, but not limited to, municipalities, counties, parishes, villages, unincorporated districts and hospital districts), public entities, public instrumentalities and public educational institutions; and (2) persons or entities acting in a parens patriae, sovereign, quasi-sovereign, private attorney general, qui tam, taxpayer, or any other capacity, whether or not any of them participate in this settlement, (A) to the extent that any such person or entity is seeking relief on behalf of or generally applicable to the general public in such Settling State or the people of the State, as opposed solely to private or individual relief for separate and distinct injuries, or (B) to the extent that any such entity (as opposed to an individual) is seeking recovery of health-care expenses (other than premium or capitation payments for the benefit of present or retired state employees) paid or reimbursed, directly or indirectly, by a Settling State. (qq) “Settling State” means any State that signs this Agreement on or before the MSA Execution Date. Provided, however, that the term “Settling State” shall not include (1) the States of Mississippi, Florida, Texas and Minnesota; and (2) any State as to which this Agreement has been terminated. (rr) “State” means any state of the United States, the District of Columbia, the Commonwealth of Puerto Rico, Guam, the Virgin Islands, American Samoa, and the Northern Marianas. (ss) “State-Specific Finality” means, with respect to the Settling State in question: (1) this Agreement and the Consent Decree have been approved and entered by the Court as to all Original Participating Manufacturers, or, in the event of an appeal from or review of a decision of the Court to withhold its approval and entry of this Agreement and the Consent Decree, by the court hearing such appeal or conducting such review; (2) entry by the Court has been made of an order dismissing with prejudice all claims against Released Parties in the action as provided herein; and (3) the time for appeal or to seek review of or permission to appeal (“Appeal”) from the approval and entry as described in subsection (1) hereof and entry of such order described in subsection (2) hereof has expired; or, in the event of an Appeal from such approval and entry, the Appeal has been dismissed, or the approval and entry described in (1) hereof and the order described in subsection (2) hereof have been affirmed in all material respects by the court of last resort to which such Appeal has been taken and such dismissal or affirmance has become no longer subject to further Appeal (including, without limitation, review by the United States Supreme Court). (tt) “Subsequent Participating Manufacturer” means a Tobacco Product Manufacturer (other than an Original Participating Manufacturer) that: (1) is a Participating Manufacturer, and (2) is a signatory to this Agreement, regardless of when such Tobacco Product Manufacturer became a signatory to this Agreement. “Subsequent Participating Manufacturer” shall also include the successors of a Subsequent Participating Manufacturer. Except as expressly provided in this Agreement, once an entity becomes a Subsequent Participating Manufacturer such entity shall permanently retain the status of Subsequent Participating Manufacturer, unless it agrees to assume the obligations of an Original Participating Manufacturer as provided in subsection XVIII(c). (uu) “Tobacco Product Manufacturer” means an entity that after the MSA Execution Date directly (and not exclusively through any Affiliate): (1) manufactures Cigarettes anywhere that such manufacturer intends to be sold in the States, including Cigarettes intended to be sold in the States through an importer (except where such importer is an Original Participating Manufacturer that will be responsible for the payments under this Agreement with respect to such Cigarettes as a result of the provisions of subsections II(mm) and that pays the taxes specified in subsection II(z) on such Cigarettes, and provided that the manufacturer of such Cigarettes does not market or advertise such Cigarettes in the States); (2) is the first purchaser anywhere for resale in the States of Cigarettes manufactured anywhere that the manufacturer does not intend to be sold in the States; or (3) becomes a successor of an entity described in subsection (1) or (2) above. The term “Tobacco Product Manufacturer” shall not include an Affiliate of a Tobacco Product Manufacturer unless such Affiliate itself falls within any of subsections (1) - (3) above. (vv) “Tobacco Products” means Cigarettes and smokeless tobacco products. (ww) “Tobacco-Related Organizations” means the Council for Tobacco Research-U.S.A., Inc., The Tobacco Institute, Inc. (“TI”), and the Center for Indoor Air Research, Inc. (“CIAR”) and the successors, if any, of TI or CIAR. (xx) “Transit Advertisements” means advertising on or within private or public vehicles and all advertisements placed at, on or within any bus stop, taxi stand, transportation waiting area, train station, airport or any similar location. Notwithstanding the foregoing, the term “Transit Advertisements” does not include (1) any advertisement placed in, on or outside the premises of any retail establishment that sells Tobacco Products (other than solely through a vending machine) (except if such individual advertisement (A) occupies an area larger than 14 square feet; (B) is placed in such proximity to any other such advertisement so as to create a single “mosaic”-type advertisement larger than 14 square feet; or (C) functions solely as a segment of a larger advertising unit or series); or (2) advertising at the site of an event to be held at an Adult-Only Facility that is placed at such site during the period the facility or enclosed area constitutes an Adult-Only Facility, but in no 6 event more than 14 days before the event, and that does not advertise any Tobacco Product (other than by using a Brand Name to identify the event). (yy) “Underage” means younger than the minimum age at which it is legal to purchase or possess (whichever minimum age is older) Cigarettes in the applicable Settling State. (zz) “Video Game Arcade” means an entertainment establishment primarily consisting of video games (other than video games intended primarily for use by persons 18 years of age or older) and/or pinball machines. (aaa) “Volume Adjustment” means an upward or downward adjustment in accordance with the formula for volume adjustments set forth in Exhibit E. (bbb) “Youth” means any person or persons under 18 years of age. III. PERMANENT RELIEF (a) Prohibition on Youth Targeting. No Participating Manufacturer may take any action, directly or indirectly, to target Youth within any Settling State in the advertising, promotion or marketing of Tobacco Products, or take any action the primary purpose of which is to initiate, maintain or increase the incidence of Youth smoking within any Settling State. (b) Ban on Use of Cartoons. Beginning 180 days after the MSA Execution Date, no Participating Manufacturer may use or cause to be used any Cartoon in the advertising, promoting, packaging or labeling of Tobacco Products. (c) Limitation of Tobacco Brand Name Sponsorships. (1) Prohibited Sponsorships. After the MSA Execution Date, no Participating Manufacturer may engage in any Brand Name Sponsorship in any State consisting of: (A) concerts; or (B) events in which the intended audience is comprised of a significant percentage of Youth; or (C) events in which any paid participants or contestants are Youth; or (D) any athletic event between opposing teams in any football, basketball, baseball, soccer or hockey league. (2) Limited Sponsorships. (A) No Participating Manufacturer may engage in more than one Brand Name Sponsorship in the States in any twelve-month period (such period measured from the date of the initial sponsored event). (B) Provided, however, that (i) nothing contained in subsection (2)(A) above shall require a Participating Manufacturer to breach or terminate any sponsorship contract in existence as of August 1, 1998 (until the earlier of (x) the current term of any existing contract, without regard to any renewal or option that may be exercised by such Participating Manufacturer or (y) three years after the MSA Execution Date); and (ii) notwithstanding subsection (1)(A) above, Brown & Williamson Tobacco Corporation may sponsor either the GPC country music festival or the Kool jazz festival as its one annual Brand Name Sponsorship permitted pursuant to subsection (2)(A) as well as one Brand Name Sponsorship permitted pursuant to subsection (2)(B)(i). (3) Related Sponsorship Restrictions. With respect to any Brand Name Sponsorship permitted under this subsection (c): (A) advertising of the Brand Name Sponsorship event shall not advertise any Tobacco Product (other than by using the Brand Name to identify such Brand Name Sponsorship event); (B) no Participating Manufacturer may refer to a Brand Name Sponsorship event or to a celebrity or other person in such an event in its advertising of a Tobacco Product; (C) nothing contained in the provisions of subsection III(e) of this Agreement shall apply to actions taken by any Participating Manufacturer in connection with a Brand Name Sponsorship permitted pursuant to the provisions of subsections (2)(A) and (2)(B)(i); the Brand Name Sponsorship permitted by subsection (2)(B)(ii) shall be subject to the restrictions of subsection III(e) except that such restrictions shall not prohibit use of the Brand Name to identify the Brand Name Sponsorship; (D) nothing contained in the provisions of subsections III(f) and III(i) shall apply to apparel or other merchandise: (i) marketed, distributed, offered, sold, or licensed at the site of a Brand Name Sponsorship permitted pursuant to subsections (2)(A) or (2)(B)(i) by the person to which the relevant Participating Manufacturer has provided payment in exchange for the use of the relevant Brand Name in the Brand Name Sponsorship or a third-party that does not receive payment from the relevant Participating Manufacturer (or any Affiliate of such Participating Manufacturer) in connection with the marketing, distribution, offer, sale or license of such apparel or other merchandise; or (ii) used at the site of a Brand Name Sponsorship permitted pursuant to subsection (2)(A) or (2)(B)(i) (during such event) that are not distributed (by sale or otherwise) to any member of the general public; and (E) nothing contained in the provisions of subsection III(d) shall: (i) apply to the use of a Brand Name on a vehicle used in a Brand Name Sponsorship; or (ii) apply to Outdoor Advertising advertising the Brand Name 7 Sponsorship, to the extent that such Outdoor Advertising is placed at the site of a Brand Name Sponsorship no more than 90 days before the start of the initial sponsored event, is removed within 10 days after the end of the last sponsored event, and is not prohibited by subsection (3)(A) above. (4) Corporate Name Sponsorships. Nothing in this subsection (c) shall prevent a Participating Manufacturer from sponsoring or causing to be sponsored any athletic, musical, artistic, or other social or cultural event, or any entrant, participant or team in such event (or series of events) in the name of the corporation which manufactures Tobacco Products, provided that the corporate name does not include any Brand Name of domestic Tobacco Products. (5) Naming Rights Prohibition. No Participating Manufacturer may enter into any agreement for the naming rights of any stadium or arena located within a Settling State using a Brand Name, and shall not otherwise cause a stadium or arena located within a Settling State to be named with a Brand Name. (6) Prohibition on Sponsoring Teams and Leagues. No Participating Manufacturer may enter into any agreement pursuant to which payment is made (or other consideration is provided) by such Participating Manufacturer to any football, basketball, baseball, soccer or hockey league (or any team involved in any such league) in exchange for use of a Brand Name. (d) Elimination of Outdoor Advertising and Transit Advertisements. Each Participating Manufacturer shall discontinue Outdoor Advertising and Transit Advertisements advertising Tobacco Products within the Settling States as set forth herein. (1) Removal. Except as otherwise provided in this section, each Participating Manufacturer shall remove from within the Settling States within 150 days after the MSA Execution Date all of its (A) billboards (to the extent that such billboards constitute Outdoor Advertising) advertising Tobacco Products; (B) signs and placards (to the extent that such signs and placards constitute Outdoor Advertising) advertising Tobacco Products in arenas, stadiums, shopping malls and Video Game Arcades; and (C) Transit Advertisements advertising Tobacco Products. (2) Prohibition on New Outdoor Advertising and Transit Advertisements. No Participating Manufacturer may, after the MSA Execution Date, place or cause to be placed any new Outdoor Advertising advertising Tobacco Products or new Transit Advertisements advertising Tobacco Products within any Settling State. (3) Alternative Advertising. With respect to those billboards required to be removed under subsection (1) that are leased (as opposed to owned) by any Participating Manufacturer, the Participating Manufacturer will allow the Attorney General of the Settling State within which such billboards are located to substitute, at the Settling State’s option, alternative advertising intended to discourage the use of Tobacco Products by Youth and their exposure to second-hand smoke for the remaining term of the applicable contract (without regard to any renewal or option term that may be exercised by such Participating Manufacturer). The Participating Manufacturer will bear the cost of the lease through the end of such remaining term. Any other costs associated with such alternative advertising will be borne by the Settling State. (4) Ban on Agreements Inhibiting Anti-Tobacco Advertising. Each Participating Manufacturer agrees that it will not enter into any agreement that prohibits a third party from selling, purchasing or displaying advertising discouraging the use of Tobacco Products or exposure to second-hand smoke. In the event and to the extent that any Participating Manufacturer has entered into an agreement containing any such prohibition, such Participating Manufacturer agrees to waive such prohibition in such agreement. (5) Designation of Contact Person. Each Participating Manufacturer that has Outdoor Advertising or Transit Advertisements advertising Tobacco Products within a Settling State shall, within 10 days after the MSA Execution Date, provide the Attorney General of such Settling State with the name of a contact person to whom the Settling State may direct inquiries during the time such Outdoor Advertising and Transit Advertisements are being eliminated, and from whom the Settling State may obtain periodic reports as to the progress of their elimination. (6) Adult-Only Facilities. To the extent that any advertisement advertising Tobacco Products located within an Adult-Only Facility constitutes Outdoor Advertising or a Transit Advertisement, this subsection (d) shall not apply to such advertisement, provided such advertisement is not visible to persons outside such Adult-Only Facility. (e) Prohibition on Payments Related to Tobacco Products and Media. No Participating Manufacturer may, beginning 30 days after the MSA Execution Date, make, or cause to be made, any payment or other consideration to any other person or entity to use, display, make reference to or use as a prop any Tobacco Product, Tobacco Product package, advertisement for a Tobacco Product, or any other item bearing a Brand Name in any motion picture, television show, theatrical production or other live performance, live or recorded performance of music, commercial film or video, or video game (“Media”); provided, however, that the foregoing prohibition shall not apply to (1) Media where the audience or viewers are within an Adult-Only Facility (provided such Media are not visible to persons outside such Adult-Only Facility); (2) Media not intended for distribution or display to the public; or (3) instructional Media concerning non-conventional cigarettes viewed only by or provided only to smokers who are Adults. (f) Ban on Tobacco Brand Name Merchandise. Beginning July 1, 1999, no Participating Manufacturer may, within any Settling State, market, distribute, offer, sell, license or cause to be marketed, distributed, offered, sold or licensed (including, without limitation, by catalogue or direct mail), any apparel or other merchandise (other than Tobacco Products, items the sole function of which is to advertise Tobacco Products, or written or electronic publications) which bears a Brand Name. Provided, however, that nothing in this subsection shall (1) require any Participating Manufacturer to breach or 8 terminate any licensing agreement or other contract in existence as of June 20, 1997 (this exception shall not apply beyond the current term of any existing contract, without regard to any renewal or option term that may be exercised by such Participating Manufacturer); (2) prohibit the distribution to any Participating Manufacturer’s employee who is not Underage of any item described above that is intended for the personal use of such an employee; (3) require any Participating Manufacturer to retrieve, collect or otherwise recover any item that prior to the MSA Execution Date was marketed, distributed, offered, sold, licensed, or caused to be marketed, distributed, offered, sold or licensed by such Participating Manufacturer; (4) apply to coupons or other items used by Adults solely in connection with the purchase of Tobacco Products; or (5) apply to apparel or other merchandise used within an Adult-Only Facility that is not distributed (by sale or otherwise) to any member of the general public. (g) Ban on Youth Access to Free Samples. After the MSA Execution Date, no Participating Manufacturer may, within any Settling State, distribute or cause to be distributed any free samples of Tobacco Products except in an Adult-Only Facility. For purposes of this Agreement, a “free sample” does not include a Tobacco Product that is provided to an Adult in connection with (1) the purchase, exchange or redemption for proof of purchase of any Tobacco Products (including, but not limited to, a free offer in connection with the purchase of Tobacco Products, such as a “two-for-one” offer), or (2) the conducting of consumer testing or evaluation of Tobacco Products with persons who certify that they are Adults. (h) Ban on Gifts to Underage Persons Based on Proofs of Purchase. Beginning one year after the MSA Execution Date, no Participating Manufacturer may provide or cause to be provided to any person without sufficient proof that such person is an Adult any item in exchange for the purchase of Tobacco Products, or the furnishing of credits, proofs-of- purchase, or coupons with respect to such a purchase. For purposes of the preceding sentence only, (1) a driver’s license or other government-issued identification (or legible photocopy thereof), the validity of which is certified by the person to whom the item is provided, shall by itself be deemed to be a sufficient form of proof of age; and (2) in the case of items provided (or to be redeemed) at retail establishments, a Participating Manufacturer shall be entitled to rely on verification of proof of age by the retailer, where such retailer is required to obtain verification under applicable federal, state or local law. (i) Limitation on Third-Party Use of Brand Names. After the MSA Execution Date, no Participating Manufacturer may license or otherwise expressly authorize any third party to use or advertise within any Settling State any Brand Name in a manner prohibited by this Agreement if done by such Participating Manufacturer itself. Each Participating Manufacturer shall, within 10 days after the MSA Execution Date, designate a person (and provide written notice to NAAG of such designation) to whom the Attorney General of any Settling State may provide written notice of any such third-party activity that would be prohibited by this Agreement if done by such Participating Manufacturer itself. Following such written notice, the Participating Manufacturer will promptly take commercially reasonable steps against any such non-de minimis third-party activity. Provided, however, that nothing in this subsection shall require any Participating Manufacturer to (1) breach or terminate any licensing agreement or other contract in existence as of July 1, 1998 (this exception shall not apply beyond the current term of any existing contract, without regard to any renewal or option term that may be exercised by such Participating Manufacturer); or (2) retrieve, collect or otherwise recover any item that prior to the MSA Execution Date was marketed, distributed, offered, sold, licensed or caused to be marketed, distributed, offered, sold or licensed by such Participating Manufacturer. (j) Ban on Non-Tobacco Brand Names. No Participating Manufacturer may, pursuant to any agreement requiring the payment of money or other valuable consideration, use or cause to be used as a brand name of any Tobacco Product any nationally recognized or nationally established brand name or trade name of any non-tobacco item or service or any nationally recognized or nationally established sports team, entertainment group or individual celebrity. Provided, however, that the preceding sentence shall not apply to any Tobacco Product brand name in existence as of July 1, 1998. For the purposes of this subsection, the term “other valuable consideration” shall not include an agreement between two entities who enter into such agreement for the sole purpose of avoiding infringement claims. (k) Minimum Pack Size of Twenty Cigarettes. No Participating Manufacturer may, beginning 60 days after the MSA Execution Date and through and including December 31, 2001, manufacture or cause to be manufactured for sale in any Settling State any pack or other container of Cigarettes containing fewer than 20 Cigarettes (or, in the case of roll-your- own tobacco, any package of roll-your-own tobacco containing less than 0.60 ounces of tobacco). No Participating Manufacturer may, beginning 150 days after the MSA Execution Date and through and including December 31, 2001, sell or distribute in any Settling State any pack or other container of Cigarettes containing fewer than 20 Cigarettes (or, in the case of roll-your-own tobacco, any package of roll-your-own tobacco containing less than 0.60 ounces of tobacco). Each Participating Manufacturer further agrees that following the MSA Execution Date it shall not oppose, or cause to be opposed (including through any third party or Affiliate), the passage by any Settling State of any legislative proposal or administrative rule applicable to all Tobacco Product Manufacturers and all retailers of Tobacco Products prohibiting the manufacture and sale of any pack or other container of Cigarettes containing fewer than 20 Cigarettes (or, in the case of roll-your-own tobacco, any package of roll-your-own tobacco containing less than 0.60 ounces of tobacco). (l) Corporate Culture Commitments Related to Youth Access and Consumption. Beginning 180 days after the MSA Execution Date each Participating Manufacturer shall: promulgate or reaffirm corporate principles that express and explain its commitment to comply with the provisions of this Agreement and the reduction of use of Tobacco Products by Youth, and clearly and regularly communicate to its employees and customers its commitment to assist in the reduction of Youth use of Tobacco Products; 9 designate an executive level manager (and provide written notice to NAAG of such designation) to identify methods to reduce Youth access to, and the incidence of Youth consumption of, Tobacco Products; and encourage its employees to identify additional methods to reduce Youth access to, and the incidence of Youth consumption of, Tobacco Products. (m) Limitations on Lobbying. Following State-Specific Finality in a Settling State: (1) No Participating Manufacturer may oppose, or cause to be opposed (including through any third party or Affiliate), the passage by such Settling State (or any political subdivision thereof) of those state or local legislative proposals or administrative rules described in Exhibit F hereto intended by their terms to reduce Youth access to, and the incidence of Youth consumption of, Tobacco Products. Provided, however, that the foregoing does not prohibit any Participating Manufacturer from (A) challenging enforcement of, or suing for declaratory or injunctive relief with respect to, any such legislation or rule on any grounds; (B) continuing, after State-Specific Finality in such Settling State, to oppose or cause to be opposed, the passage during the legislative session in which State-Specific Finality in such Settling State occurs of any specific state or local legislative proposals or administrative rules introduced prior to the time of State-Specific Finality in such Settling State; (C) opposing, or causing to be opposed, any excise tax or income tax provision or user fee or other payments relating to Tobacco Products or Tobacco Product Manufacturers; or (D) opposing, or causing to be opposed, any state or local legislative proposal or administrative rule that also includes measures other than those described in Exhibit F. (2) Each Participating Manufacturer shall require all of its officers and employees engaged in lobbying activities in such Settling State after State-Specific Finality, contract lobbyists engaged in lobbying activities in such Settling State after State-Specific Finality, and any other third parties who engage in lobbying activities in such Settling State after State-Specific Finality on behalf of such Participating Manufacturer (“lobbyist” and “lobbying activities” having the meaning such terms have under the law of the Settling State in question) to certify in writing to the Participating Manufacturer that they: (A) will not support or oppose any state, local or federal legislation, or seek or oppose any governmental action, on behalf of the Participating Manufacturer without the Participating Manufacturer’s express authorization (except where such advance express authorization is not reasonably practicable); (B) are aware of and will fully comply with this Agreement and all laws and regulations applicable to their lobbying activities, including, without limitation, those related to disclosure of financial contributions. Provided, however, that if the Settling State in question has in existence no laws or regulations relating to disclosure of financial contributions regarding lobbying activities, then each Participating Manufacturer shall, upon request of the Attorney General of such Settling State, disclose to such Attorney General any payment to a lobbyist that the Participating Manufacturer knows or has reason to know will be used to influence legislative or administrative actions of the state or local government relating to Tobacco Products or their use. Disclosures made pursuant to the preceding sentence shall be filed in writing with the Office of the Attorney General on the first day of February and the first day of August of each year for any and all payments made during the six month period ending on the last day of the preceding December and June, respectively, with the following information: (1) the name, address, telephone number and e-mail address (if any) of the recipient; (2) the amount of each payment; and (3) the aggregate amount of all payments described in this subsection (2)(B) to the recipient in the calendar year; and (C) have reviewed and will fully abide by the Participating Manufacturer’s corporate principles promulgated pursuant to this Agreement when acting on behalf of the Participating Manufacturer. (3) No Participating Manufacturer may support or cause to be supported (including through any third party or Affiliate) in Congress or any other forum legislation or rules that would preempt, override, abrogate or diminish such Settling State’s rights or recoveries under this Agreement. Except as specifically provided in this Agreement, nothing herein shall be deemed to restrain any Settling State or Participating Manufacturer from advocating terms of any national settlement or taking any other positions on issues relating to tobacco. (n) Restriction on Advocacy Concerning Settlement Proceeds. After the MSA Execution Date, no Participating Manufacturer may support or cause to be supported (including through any third party or Affiliate) the diversion of any proceeds of this settlement to any program or use that is neither tobacco-related nor health-related in connection with the approval of this Agreement or in any subsequent legislative appropriation of settlement proceeds. (o) Dissolution of The Tobacco Institute, Inc., the Council for Tobacco Research-U.S.A., Inc. and the Center for Indoor Air Research, Inc. (1) The Council for Tobacco Research-U.S.A., Inc. (“CTR”) (a not-for-profit corporation formed under the laws of the State of New York) shall, pursuant to the plan of dissolution previously negotiated and agreed to between the Attorney General of the State of New York and CTR, cease all operations and be dissolved in accordance with the laws of the State of New York (and with the preservation of all applicable privileges held by any member company of CTR). (2) The Tobacco Institute, Inc. (“TI”) (a not-for-profit corporation formed under the laws of the State of New York) shall, pursuant to a plan of dissolution to be negotiated by the Attorney General of the State of New York and the Original Participating Manufacturers in accordance with Exhibit G hereto, cease all operations and be dissolved in 10 accordance with the laws of the State of New York and under the authority of the Attorney General of the State of New York (and with the preservation of all applicable privileges held by any member company of TI). (3) Within 45 days after Final Approval, the Center for Indoor Air Research, Inc. (“CIAR”) shall cease all operations and be dissolved in a manner consistent with applicable law and with the preservation of all applicable privileges (including, without limitation, privileges held by any member company of CIAR). (4) The Participating Manufacturers shall direct the Tobacco-Related Organizations to preserve all records that relate in any way to issues raised in smoking-related health litigation. (5) The Participating Manufacturers may not reconstitute CTR or its function in any form. (6) The Participating Manufacturers represent that they have the authority to and will effectuate subsections (1) through (5) hereof. (p) Regulation and Oversight of New Tobacco-Related Trade Associations. (1) A Participating Manufacturer may form or participate in new tobacco-related trade associations (subject to all applicable laws), provided such associations agree in writing not to act in any manner contrary to any provision of this Agreement. Each Participating Manufacturer agrees that if any new tobacco-related trade association fails to so agree, such Participating Manufacturer will not participate in or support such association. (2) Any tobacco-related trade association that is formed or controlled by one or more of the Participating Manufacturers after the MSA Execution Date shall adopt by-laws governing the association’s procedures and the activities of its members, board, employees, agents and other representatives with respect to the tobacco-related trade association. Such by-laws shall include, among other things, provisions that: (A) each officer of the association shall be appointed by the board of the association, shall be an employee of such association, and during such officer’s term shall not be a director of or employed by any member of the association or by an Affiliate of any member of the association; (B) legal counsel for the association shall be independent, and neither counsel nor any member or employee of counsel’s law firm shall serve as legal counsel to any member of the association or to a manufacturer of Tobacco Products that is an Affiliate of any member of the association during the time that it is serving as legal counsel to the association; and (C) minutes describing the substance of the meetings of the board of directors of the association shall be prepared and shall be maintained by the association for a period of at least five years following their preparation. (3) Without limitation on whatever other rights to access they may be permitted by law, for a period of seven years from the date any new tobacco-related trade association is formed by any of the Participating Manufacturers after the MSA Execution Date the antitrust authorities of any Settling State may, for the purpose of enforcing this Agreement, upon reasonable cause to believe that a violation of this Agreement has occurred, and upon reasonable prior written notice (but in no event less than 10 Business Days): (A) have access during regular office hours to inspect and copy all relevant non-privileged, non- work-product books, records, meeting agenda and minutes, and other documents (whether in hard copy form or stored electronically) of such association insofar as they pertain to such believed violation; and (B) interview the association’s directors, officers and employees (who shall be entitled to have counsel present) with respect to relevant, non-privileged, non-work-product matters pertaining to such believed violation. Documents and information provided to Settling State antitrust authorities shall be kept confidential by and among such authorities, and shall be utilized only by the Settling States and only for the purpose of enforcing this Agreement or the criminal law. The inspection and discovery rights provided to the Settling States pursuant to this subsection shall be coordinated so as to avoid repetitive and excessive inspection and discovery. (q) Prohibition on Agreements to Suppress Research. No Participating Manufacturer may enter into any contract, combination or conspiracy with any other Tobacco Product Manufacturer that has the purpose or effect of: (1) limiting competition in the production or distribution of information about health hazards or other consequences of the use of their products; (2) limiting or suppressing research into smoking and health; or (3) limiting or suppressing research into the marketing or development of new products. Provided, however, that nothing in this subsection shall be deemed to (1) require any Participating Manufacturer to produce, distribute or otherwise disclose any information that is subject to any privilege or protection; (2) preclude any Participating Manufacturer from entering into any joint defense or joint legal interest agreement or arrangement (whether or not in writing), or from asserting any privilege pursuant thereto; or (3) impose any affirmative obligation on any Participating Manufacturer to conduct any research. (r) Prohibition on Material Misrepresentations. No Participating Manufacturer may make any material misrepresentation of fact regarding the health consequences of using any Tobacco Product, including any tobacco additives, filters, paper or other ingredients. Nothing in this subsection shall limit the exercise of any First Amendment right or the assertion of any defense or position in any judicial, legislative or regulatory forum. 11 IV. PUBLIC ACCESS TO DOCUMENTS (a) After the MSA Execution Date, the Original Participating Manufacturers and the Tobacco-Related Organizations will support an application for the dissolution of any protective orders entered in each Settling State’s lawsuit identified in Exhibit D with respect only to those documents, indices and privilege logs that have been produced as of the MSA Execution Date to such Settling State and (1) as to which defendants have made no claim, or have withdrawn any claim, of attorney-client privilege, attorney work-product protection, common interest/joint defense privilege (collectively, “privilege”), trade-secret protection, or confidential or proprietary business information; and (2) that are not inappropriate for public disclosure because of personal privacy interests or contractual rights of third parties that may not be abrogated by the Original Participating Manufacturers or the Tobacco-Related Organizations. (b) Notwithstanding State-Specific Finality, if any order, ruling or recommendation was issued prior to September 17, 1998 rejecting a claim of privilege or trade-secret protection with respect to any document or documents in a lawsuit identified in Exhibit D, the Settling State in which such order, ruling or recommendation was made may, no later than 45 days after the occurrence of State-Specific Finality in such Settling State, seek public disclosure of such document or documents by application to the court that issued such order, ruling or recommendation and the court shall retain jurisdiction for such purposes. The Original Participating Manufacturers and Tobacco-Related Organizations do not consent to, and may object to, appeal from or otherwise oppose any such application for disclosure. The Original Participating Manufacturers and Tobacco-Related Organizations will not assert that the settlement of such lawsuit has divested the court of jurisdiction or that such Settling State lacks standing to seek public disclosure on any applicable ground. (c) The Original Participating Manufacturers will maintain at their expense their Internet document websites accessible through “TobaccoResolution.com” or a similar website until June 30, 2010. The Original Participating Manufacturers will maintain the documents that currently appear on their respective websites and will add additional documents to their websites as provided in this section IV. (d) Within 180 days after the MSA Execution Date, each Original Participating Manufacturer and Tobacco-Related Organization will place on its website copies of the following documents, except as provided in subsections IV(e) and IV(f) below: (1) all documents produced by such Original Participating Manufacturer or Tobacco-Related Organization as of the MSA Execution Date in any action identified in Exhibit D or any action identified in section 2 of Exhibit H that was filed by an Attorney General. Among these documents, each Original Participating Manufacturer and Tobacco-Related Organization will give the highest priority to (A) the documents that were listed by the State of Washington as trial exhibits in the State of Washington v. American Tobacco Co., et al., No. 96-2-15056-8 SEA (Wash. Super. Ct., County of King); and (B) the documents as to which such Original Participating Manufacturer or Tobacco-Related Organization withdrew any claim of privilege as a result of the re-examination of privilege claims pursuant to court order in State of Oklahoma v. R.J. Reynolds Tobacco Company, et al., CJ-96-2499-L (Dist. Ct., Cleveland County); (2) all documents that can be identified as having been produced by, and copies of transcripts of depositions given by, such Original Participating Manufacturer or Tobacco-Related Organization as of the MSA Execution Date in the litigation matters specified in section 1 of Exhibit H; and (3) all documents produced by such Original Participating Manufacturer or Tobacco-Related Organization as of the MSA Execution Date and listed by the plaintiffs as trial exhibits in the litigation matters specified in section 2 of Exhibit H. (e) Unless copies of such documents are already on its website, each Original Participating Manufacturer and Tobacco-Related Organization will place on its website copies of documents produced in any production of documents that takes place on or after the date 30 days before the MSA Execution Date in any federal or state court civil action concerning smoking and health. Copies of any documents required to be placed on a website pursuant to this subsection will be placed on such website within the later of 45 days after the MSA Execution Date or within 45 days after the production of such documents in any federal or state court action concerning smoking and health. This obligation will continue until June 30, 2010. In placing such newly produced documents on its website, each Original Participating Manufacturer or Tobacco- Related Organization will identify, as part of its index to be created pursuant to subsection IV(h), the action in which it produced such documents and the date on which such documents were added to its website. (f) Nothing in this section IV shall require any Original Participating Manufacturer or Tobacco-Related Organization to place on its website or otherwise disclose documents that: (1) it continues to claim to be privileged, a trade secret, confidential or proprietary business information, or that contain other information not appropriate for public disclosure because of personal privacy interests or contractual rights of third parties; or (2) continue to be subject to any protective order, sealing order or other order or ruling that prevents or limits a litigant from disclosing such documents. (g) Oversized or multimedia records will not be required to be placed on the Website, but each Original Participating Manufacturers and Tobacco-Related Organizations will make any such records available to the public by placing copies of them in the document depository established in The State of Minnesota, et al. v. Philip Morris Incorporated, et al., C1-94-8565 (County of Ramsey, District Court, 2d Judicial Cir.). 12 (h) Each Original Participating Manufacturer will establish an index and other features to improve searchable access to the document images on its website, as set forth in Exhibit I. (i) Within 90 days after the MSA Execution Date, the Original Participating Manufacturers will furnish NAAG with a project plan for completing the Original Participating Manufacturers’ obligations under subsection IV(h) with respect to documents currently on their websites and documents being placed on their websites pursuant to subsection IV(d). NAAG may engage a computer consultant at the Original Participating Manufacturers’ expense for a period not to exceed two years and at a cost not to exceed $100,000. NAAG’s computer consultant may review such plan and make recommendations consistent with this Agreement. In addition, within 120 days after the completion of the Original Participating Manufacturers’ obligations under subsection IV(d), NAAG’s computer consultant may make final recommendations with respect to the websites consistent with this Agreement. In preparing these recommendations, NAAG’s computer consultant may seek input from Settling State officials, public health organizations and other users of the websites. (j) The expenses incurred pursuant to subsection IV(i), and the expenses related to documents of the Tobacco- Related Organizations, will be severally shared among the Original Participating Manufacturers (allocated among them according to their Relative Market Shares). All other expenses incurred under this section will be borne by the Original Participating Manufacturer that incurs such expense. V. TOBACCO CONTROL AND UNDERAGE USE LAWS Each Participating Manufacturer agrees that following State-Specific Finality in a Settling State it will not initiate, or cause to be initiated, a facial challenge against the enforceability or constitutionality of such Settling State’s (or such Settling State’s political subdivisions’) statutes, ordinances and administrative rules relating to tobacco control enacted prior to June 1, 1998 (other than a statute, ordinance or rule challenged in any lawsuit listed in Exhibit M). VI. ESTABLISHMENT OF A NATIONAL FOUNDATION (a) Foundation Purposes. The Settling States believe that a comprehensive, coordinated program of public education and study is important to further the remedial goals of this Agreement. Accordingly, as part of the settlement of claims described herein, the payments specified in subsections VI(b), VI(c), and IX(e) shall be made to a charitable foundation, trust or similar organization (the “Foundation”) and/or to a program to be operated within the Foundation (the “National Public Education Fund”). The purposes of the Foundation will be to support (1) the study of and programs to reduce Youth Tobacco Product usage and Youth substance abuse in the States, and (2) the study of and educational programs to prevent diseases associated with the use of Tobacco Products in the States. (b) Base Foundation Payments. On March 31, 1999, and on March 31 of each subsequent year for a period of nine years thereafter, each Original Participating Manufacturer shall severally pay its Relative Market Share of $25,000,000 to fund the Foundation. The payments to be made by each of the Original Participating Manufacturers pursuant to this subsection (b) shall be subject to no adjustments, reductions, or offsets, and shall be paid to the Escrow Agent (to be credited to the Subsection VI(b) Account), who shall disburse such payments to the Foundation only upon the occurrence of State- Specific Finality in at least one Settling State. (c) National Public Education Fund Payments. (1) Each Original Participating Manufacturer shall severally pay its Relative Market Share of the following base amounts on the following dates to the Escrow Agent for the benefit of the Foundation’s National Public Education Fund to be used for the purposes and as described in subsections VI(f)(1), VI(g) and VI(h) below: $250,000,000 on March 31, 1999; $300,000,000 on March 31, 2000; $300,000,000 on March 31, 2001; $300,000,000 on March 31, 2002; and $300,000,000 on March 31, 2003, as such amounts are modified in accordance with this subsection (c). The payment due on March 31, 1999 pursuant to this subsection (c)(1) is to be credited to the Subsection VI(c) Account (First). The payments due on or after March 31, 2000 pursuant to this subsection VI(c)(1) are to be credited to the Subsection VI(c) Account (Subsequent). (2) The payments to be made by the Original Participating Manufacturers pursuant to this subsection (c), other than the payment due on March 31, 1999, shall be subject to the Inflation Adjustment, the Volume Adjustment and the offset for miscalculated or disputed payments described in subsection XI(i). (3) The payment made pursuant to this subsection (c) on March 31, 1999 shall be disbursed by the Escrow Agent to the Foundation only upon the occurrence of State-Specific Finality in at least one Settling State. Each remaining payment pursuant to this subsection (c) shall be disbursed by the Escrow Agent to the Foundation only when State-Specific Finality has occurred in Settling States having aggregate Allocable Shares equal to at least 80% of the total aggregate Allocable Shares assigned to all States that were Settling States as of the MSA Execution Date. (4) In addition to the payments made pursuant to this subsection (c), the National Public Education Fund will be funded (A) in accordance with subsection IX(e), and (B) through monies contributed by other entities directly to the Foundation and designated for the National Public Education Fund (“National Public Education Fund Contributions”). (5) The payments made by the Original Participating Manufacturers pursuant to this subsection (c) and/or subsection IX(e) and monies received from all National Public Education Fund Contributions will be deposited and invested in accordance with the laws of the state of incorporation of the Foundation. 13 (d) Creation and Organization of the Foundation. NAAG, through its executive committee, will provide for the creation of the Foundation. The Foundation shall be organized exclusively for charitable, scientific, and educational purposes within the meaning of Internal Revenue Code section 501(c)(3). The organizational documents of the Foundation shall specifically incorporate the provisions of this Agreement relating to the Foundation, and will provide for payment of the Foundation’s administrative expenses from the funds paid pursuant to subsection VI(b) or VI(c). The Foundation shall be governed by a board of directors. The board of directors shall be comprised of eleven directors. NAAG, the National Governors’ Association (“NGA”), and the National Conference of State Legislatures (“NCSL”) shall each select from its membership two directors. These six directors shall select the five additional directors. One of these five additional directors shall have expertise in public health issues. Four of these five additional directors shall have expertise in medical, child psychology, or public health disciplines. The board of directors shall be nationally geographically diverse. (e) Foundation Affiliation. The Foundation shall be formally affiliated with an educational or medical institution selected by the board of directors. (f) Foundation Functions. The functions of the Foundation shall be: (1) carrying out a nationwide sustained advertising and education program to (A) counter the use by Youth of Tobacco Products, and (B) educate consumers about the cause and prevention of diseases associated with the use of Tobacco Products; (2) developing and disseminating model advertising and education programs to counter the use by Youth of substances that are unlawful for use or purchase by Youth, with an emphasis on reducing Youth smoking; monitoring and testing the effectiveness of such model programs; and, based on the information received from such monitoring and testing, continuing to develop and disseminate revised versions of such model programs, as appropriate; (3) developing and disseminating model classroom education programs and curriculum ideas about smoking and substance abuse in the K-12 school system, including specific target programs for special at-risk populations; monitoring and testing the effectiveness of such model programs and ideas; and, based on the information received from such monitoring and testing, continuing to develop and disseminate revised versions of such model programs or ideas, as appropriate; (4) developing and disseminating criteria for effective cessation programs; monitoring and testing the effectiveness of such criteria; and continuing to develop and disseminate revised versions of such criteria, as appropriate; (5) commissioning studies, funding research, and publishing reports on factors that influence Youth smoking and substance abuse and developing strategies to address the conclusions of such studies and research; (6) developing other innovative Youth smoking and substance abuse prevention programs; (7) providing targeted training and information for parents; (8) maintaining a library open to the public of Foundation-funded studies, reports and other publications related to the cause and prevention of Youth smoking and substance abuse; (9) tracking and monitoring Youth smoking and substance abuse, with a focus on the reasons for any increases or failures to decrease Youth smoking and substance abuse and what actions can be taken to reduce Youth smoking and substance abuse; (10) receiving, controlling, and managing contributions from other entities to further the purposes described in this Agreement; and (11) receiving, controlling, and managing such funds paid by the Participating Manufacturers pursuant to subsections VI(b) and VI(c) above. (g) Foundation Grant-Making. The Foundation is authorized to make grants from the National Public Education Fund to Settling States and their political subdivisions to carry out sustained advertising and education programs to (1) counter the use by Youth of Tobacco Products, and (2) educate consumers about the cause and prevention of diseases associated with the use of Tobacco Products. In making such grants, the Foundation shall consider whether the Settling State or political subdivision applying for such grant: (1) demonstrates the extent of the problem regarding Youth smoking in such Settling State or political subdivision; (2) either seeks the grant to implement a model program developed by the Foundation or provides the Foundation with a specific plan for such applicant’s intended use of the grant monies, including demonstrating such applicant’s ability to develop an effective advertising/education campaign and to assess the effectiveness of such advertising/education campaign; (3) has other funds readily available to carry out a sustained advertising and education program to (A) counter the use by Youth of Tobacco Products, and (B) educate consumers about the cause and prevention of diseases associated with the use of Tobacco Products; and (4) is a Settling State that has not severed this section VI from its settlement with the Participating Manufacturers pursuant to subsection VI(i) below, or is a political subdivision in such a Settling State. 14 (h) Foundation Activities. The Foundation shall not engage in, nor shall any of the Foundation’s money be used to engage in, any political activities or lobbying, including, but not limited to, support of or opposition to candidates, ballot initiatives, referenda or other similar activities. The National Public Education Fund shall be used only for public education and advertising regarding the addictiveness, health effects, and social costs related to the use of tobacco products and shall not be used for any personal attack on, or vilification of, any person (whether by name or business affiliation), company, or governmental agency, whether individually or collectively. The Foundation shall work to ensure that its activities are carried out in a culturally and linguistically appropriate manner. The Foundation’s activities (including the National Public Education Fund) shall be carried out solely within the States. The payments described in subsections VI(b) and VI(c) above are made at the direction and on behalf of Settling States. By making such payments in such manner, the Participating Manufacturers do not undertake and expressly disclaim any responsibility with respect to the creation, operation, liabilities, or tax status of the Foundation or the National Public Education Fund. (i) Severance of this Section. If the Attorney General of a Settling State determines that such Settling State may not lawfully enter into this section VI as a matter of applicable state law, such Attorney General may sever this section VI from its settlement with the Participating Manufacturers by giving written notice of such severance to each Participating Manufacturer and NAAG pursuant to subsection XVIII(k) hereof. If any Settling State exercises its right to sever this section VI, this section VI shall not be considered a part of the specific settlement between such Settling State and the Participating Manufacturers, and this section VI shall not be enforceable by or in such Settling State. The payment obligation of subsections VI(b) and VI(c) hereof shall apply regardless of a determination by one or more Settling States to sever section VI hereof; provided, however, that if all Settling States sever section VI hereof, the payment obligations of subsections (b) and (c) hereof shall be null and void. If the Attorney General of a Settling State that severed this section VI subsequently determines that such Settling State may lawfully enter into this section VI as a matter of applicable state law, such Attorney General may rescind such Settling State’s previous severance of this section VI by giving written notice of such rescission to each Participating Manufacturer and NAAG pursuant to subsection XVIII(k). If any Settling State rescinds such severance, this section VI shall be considered a part of the specific settlement between such Settling State and the Participating Manufacturers (including for purposes of subsection (g)(4)), and this section VI shall be enforceable by and in such Settling State. VII. ENFORCEMENT (a) Jurisdiction. Each Participating Manufacturer and each Settling State acknowledge that the Court: (1) has jurisdiction over the subject matter of the action identified in Exhibit D in such Settling State and over each Participating Manufacturer; (2) shall retain exclusive jurisdiction for the purposes of implementing and enforcing this Agreement and the Consent Decree as to such Settling State; and (3) except as provided in subsections IX(d), XI(c) and XVII(d) and Exhibit O, shall be the only court to which disputes under this Agreement or the Consent Decree are presented as to such Settling State. Provided, however, that notwithstanding the foregoing, the Escrow Court (as defined in the Escrow Agreement) shall have exclusive jurisdiction, as provided in section 15 of the Escrow Agreement, over any suit, action or proceeding seeking to interpret or enforce any provision of, or based on any right arising out of, the Escrow Agreement. (b) Enforcement of Consent Decree. Except as expressly provided in the Consent Decree, any Settling State or Released Party may apply to the Court to enforce the terms of the Consent Decree (or for a declaration construing any such term) with respect to alleged violations within such Settling State. A Settling State may not seek to enforce the Consent Decree of another Settling State; provided, however, that nothing contained herein shall affect the ability of any Settling State to (1) coordinate state enforcement actions or proceedings, or (2) file or join any amicus brief. In the event that the Court determines that any Participating Manufacturer or Settling State has violated the Consent Decree within such Settling State, the party that initiated the proceedings may request any and all relief available within such Settling State pursuant to the Consent Decree. (c) Enforcement of this Agreement. (1) Except as provided in subsections IX(d), XI(c), XVII(d) and Exhibit O, any Settling State or Participating Manufacturer may bring an action in the Court to enforce the terms of this Agreement (or for a declaration construing any such term (“Declaratory Order”)) with respect to disputes, alleged violations or alleged breaches within such Settling State. (2) Before initiating such proceedings, a party shall provide 30 days’ written notice to the Attorney General of each Settling State, to NAAG, and to each Participating Manufacturer of its intent to initiate proceedings pursuant to this subsection. The 30-day notice period may be shortened in the event that the relevant Attorney General reasonably determines that a compelling time-sensitive public health and safety concern requires more immediate action. (3) In the event that the Court determines that any Participating Manufacturer or Settling State has violated or breached this Agreement, the party that initiated the proceedings may request an order restraining such violation or breach, and/or ordering compliance within such Settling State (an “Enforcement Order”). (4) If an issue arises as to whether a Participating Manufacturer has failed to comply with an Enforcement Order, the Attorney General for the Settling State in question may seek an order for interpretation or for monetary, civil contempt or criminal sanctions to enforce compliance with such Enforcement Order. (5) If the Court finds that a good-faith dispute exists as to the meaning of the terms of this Agreement or a Declaratory Order, the Court may in its discretion determine to enter a Declaratory Order rather than an Enforcement Order. 15 (6) Whenever possible, the parties shall seek to resolve an alleged violation of this Agreement by discussion pursuant to subsection XVIII(m) of this Agreement. In addition, in determining whether to seek an Enforcement Order, or in determining whether to seek an order for monetary, civil contempt or criminal sanctions for any claimed violation of an Enforcement Order, the Attorney General shall give good-faith consideration to whether the Participating Manufacturer that is claimed to have violated this Agreement has taken appropriate and reasonable steps to cause the claimed violation to be cured, unless such party has been guilty of a pattern of violations of like nature. (d) Right of Review. All orders and other judicial determinations made by any court in connection with this Agreement or any Consent Decree shall be subject to all available appellate review, and nothing in this Agreement or any Consent Decree shall be deemed to constitute a waiver of any right to any such review. (e) Applicability. This Agreement and the Consent Decree apply only to the Participating Manufacturers in their corporate capacity acting through their respective successors and assigns, directors, officers, employees, agents, subsidiaries, divisions, or other internal organizational units of any kind or any other entities acting in concert or participation with them. The remedies, penalties and sanctions that may be imposed or assessed in connection with a breach or violation of this Agreement or the Consent Decree (or any Declaratory Order or Enforcement Order issued in connection with this Agreement or the Consent Decree ) shall only apply to the Participating Manufacturers, and shall not be imposed or assessed against any employee, officer or director of any Participating Manufacturer, or against any other person or entity as a consequence of such breach or violation, and the Court shall have no jurisdiction to do so. (f) Coordination of Enforcement. The Attorneys General of the Settling States (through NAAG) shall monitor potential conflicting interpretations by courts of different States of this Agreement and the Consent Decrees. The Settling States shall use their best efforts, in cooperation with the Participating Manufacturers, to coordinate and resolve the effects of such conflicting interpretations as to matters that are not exclusively local in nature. (g) Inspection and Discovery Rights. Without limitation on whatever other rights to access they may be permitted by law, following State-Specific Finality in a Settling State and for seven years thereafter, representatives of the Attorney General of such Settling State may, for the purpose of enforcing this Agreement and the Consent Decree, upon reasonable cause to believe that a violation of this Agreement or the Consent Decree has occurred, and upon reasonable prior written notice (but in no event less than 10 Business Days): (1) have access during regular office hours to inspect and copy all relevant non-privileged, non-work-product books, records, meeting agenda and minutes, and other documents (whether in hard copy form or stored electronically) of each Participating Manufacturer insofar as they pertain to such believed violation; and (2) interview each Participating Manufacturer’s directors, officers and employees (who shall be entitled to have counsel present) with respect to relevant, non-privileged, non-work-product matters pertaining to such believed violation. Documents and information provided to representatives of the Attorney General of such Settling State pursuant to this section VII shall be kept confidential by the Settling States, and shall be utilized only by the Settling States and only for purposes of enforcing this Agreement, the Consent Decree and the criminal law. The inspection and discovery rights provided to such Settling State pursuant to this subsection shall be coordinated through NAAG so as to avoid repetitive and excessive inspection and discovery. VIII. CERTAIN ONGOING RESPONSIBILITIES OF THE SETTLING STATES (a) Upon approval of the NAAG executive committee, NAAG will provide coordination and facilitation for the implementation and enforcement of this Agreement on behalf of the Attorneys General of the Settling States, including the following: (1) NAAG will assist in coordinating the inspection and discovery activities referred to in subsections III(p)(3) and VII(g) regarding compliance with this Agreement by the Participating Manufacturers and any new tobacco- related trade associations. (2) NAAG will convene at least two meetings per year and one major national conference every three years for the Attorneys General of the Settling States, the directors of the Foundation and three persons designated by each Participating Manufacturer. The purpose of the meetings and conference is to evaluate the success of this Agreement and coordinate efforts by the Attorneys General and the Participating Manufacturers to continue to reduce Youth smoking. (3) NAAG will periodically inform NGA, NCSL, the National Association of Counties and the National League of Cities of the results of the meetings and conferences referred to in subsection (a)(2) above. (4) NAAG will support and coordinate the efforts of the Attorneys General of the Settling States in carrying out their responsibilities under this Agreement. (5) NAAG will perform the other functions specified for it in this Agreement, including the functions specified in section IV. (b) Upon approval by the NAAG executive committee to assume the responsibilities outlined in subsection VIII(a) hereof, each Original Participating Manufacturer shall cause to be paid, beginning on December 31, 1998, and on December 31 of each year thereafter through and including December 31, 2007, its Relative Market Share of $150,000 per year to the Escrow Agent (to be credited to the Subsection VIII(b) Account), who shall disburse such monies to NAAG within 10 Business Days, to fund the activities described in subsection VIII(a). (c) The Attorneys General of the Settling States, acting through NAAG, shall establish a fund (“The States’ Antitrust/Consumer Protection Tobacco Enforcement Fund”) in the form attached as Exhibit J, which will be maintained by 16 such Attorneys General to supplement the Settling States’ (1) enforcement and implementation of the terms of this Agreement and the Consent Decrees, and (2) investigation and litigation of potential violations of laws with respect to Tobacco Products, as set forth in Exhibit J. Each Original Participating Manufacturer shall on March 31, 1999, severally pay its Relative Market Share of $50,000,000 to the Escrow Agent (to be credited to the Subsection VIII(c) Account), who shall disburse such monies to NAAG upon the occurrence of State-Specific Finality in at least one Settling State. Such funds will be used in accordance with the provisions of Exhibit J. IX. PAYMENTS (a) All Payments Into Escrow. All payments made pursuant to this Agreement (except those payments made pursuant to section XVII) shall be made into escrow pursuant to the Escrow Agreement, and shall be credited to the appropriate Account established pursuant to the Escrow Agreement. Such payments shall be disbursed to the beneficiaries or returned to the Participating Manufacturers only as provided in section XI and the Escrow Agreement. No payment obligation under this Agreement shall arise (1) unless and until the Escrow Court has approved and retained jurisdiction over the Escrow Agreement or (2) if such approval is reversed (unless and until such reversal is itself reversed). The parties agree to proceed as expeditiously as possible to resolve any issues that prevent approval of the Escrow Agreement. If any payment (other than the first initial payment under subsection IX(b)) is delayed because the Escrow Agreement has not been approved, such payment shall be due and payable (together with interest at the Prime Rate) within 10 Business Days after approval of the Escrow Agreement by the Escrow Court. (b) Initial Payments. On the second Business Day after the Escrow Court approves and retains jurisdiction over the Escrow Agreement, each Original Participating Manufacturer shall severally pay to the Escrow Agent (to be credited to the Subsection IX(b) Account (First)) its Market Capitalization Percentage (as set forth in Exhibit K) of the base amount of $2,400,000,000. On January 10, 2000, each Original Participating Manufacturer shall severally pay to the Escrow Agent its Relative Market Share of the base amount of $2,472,000,000. On January 10, 2001, each Original Participating Manufacturer shall severally pay to the Escrow Agent its Relative Market Share of the base amount of $2,546,160,000. On January 10, 2002, each Original Participating Manufacturer shall severally pay to the Escrow Agent its Relative Market Share of the base amount of $2,622,544,800. On January 10, 2003, each Original Participating Manufacturer shall severally pay to the Escrow Agent its Relative Market Share of the base amount of $2,701,221,144. The payments pursuant to this subsection (b) due on or after January 10, 2000 shall be credited to the Subsection IX(b) Account (Subsequent). The foregoing payments shall be modified in accordance with this subsection (b). The payments made by the Original Participating Manufacturers pursuant to this subsection (b) (other than the first such payment) shall be subject to the Volume Adjustment, the Non-Settling States Reduction and the offset for miscalculated or disputed payments described in subsection XI(i). The first payment due under this subsection (b) shall be subject to the Non-Settling States Reduction, but such reduction shall be determined as of the date one day before such payment is due (rather than the date 15 days before). (c) Annual Payments and Strategic Contribution Payments. (1) On April 15, 2000 and on April 15 of each year thereafter in perpetuity, each Original Participating Manufacturer shall severally pay to the Escrow Agent (to be credited to the Subsection IX(c)(1) Account) its Relative Market Share of the base amounts specified below, as such payments are modified in accordance with this subsection (c)(1): Year Base Amount 2000 $4,500,000,000 2001 $5,000,000,000 2002 $6,500,000,000 2003 $6,500,000,000 2004 $8,000,000,000 2005 $8,000,000,000 2006 $8,000,000,000 2007 $8,000,000,000 2008 $8,139,000,000 2009 $8,139,000,000 2010 $8,139,000,000 2011 $8,139,000,000 2012 $8,139,000,000 2013 $8,139,000,000 2014 $8,139,000,000 2015 $8,139,000,000 2016 $8,139,000,000 2017 $8,139,000,000 2018 and each year thereafter $9,000,000,000 The payments made by the Original Participating Manufacturers pursuant to this subsection (c)(1) shall be subject to the Inflation Adjustment, the Volume Adjustment, the Previously Settled States Reduction, the Non-Settling States Reduction, the NPM Adjustment, the offset for miscalculated or disputed payments described in subsection XI(i), the Federal 17 Tobacco Legislation Offset, the Litigating Releasing Parties Offset, and the offsets for claims over described in subsections XII(a)(4)(B) and XII(a)(8). (2) On April 15, 2008 and on April 15 of each year thereafter through 2017, each Original Participating Manufacturer shall severally pay to the Escrow Agent (to be credited to the Subsection IX(c)(2) Account) its Relative Market Share of the base amount of $861,000,000, as such payments are modified in accordance with this subsection (c)(2). The payments made by the Original Participating Manufacturers pursuant to this subsection (c)(2) shall be subject to the Inflation Adjustment, the Volume Adjustment, the NPM Adjustment, the offset for miscalculated or disputed payments described in subsection XI(i), the Federal Tobacco Legislation Offset, the Litigating Releasing Parties Offset, and the offsets for claims over described in subsections XII(a)(4)(B) and XII(a)(8). Such payments shall also be subject to the Non-Settling States Reduction; provided, however, that for purposes of payments due pursuant to this subsection (c)(2) (and corresponding payments by Subsequent Participating Manufacturers under subsection IX(i)), the Non-Settling States Reduction shall be derived as follows: (A) the payments made by the Original Participating Manufacturers pursuant to this subsection (c)(2) shall be allocated among the Settling States on a percentage basis to be determined by the Settling States pursuant to the procedures set forth in Exhibit U, and the resulting allocation percentages disclosed to the Escrow Agent, the Independent Auditor and the Original Participating Manufacturers not later than June 30, 1999; and (B) the Non-Settling States Reduction shall be based on the sum of the Allocable Shares so established pursuant to subsection (c)(2)(A) for those States that were Settling States as of the MSA Execution Date and as to which this Agreement has terminated as of the date 15 days before the payment in question is due. (d) Non-Participating Manufacturer Adjustment. (1) Calculation of NPM Adjustment for Original Participating Manufacturers. To protect the public health gains achieved by this Agreement, certain payments made pursuant to this Agreement shall be subject to an NPM Adjustment. Payments by the Original Participating Manufacturers to which the NPM Adjustment applies shall be adjusted as provided below: (A) Subject to the provisions of subsections (d)(1)(C), (d)(1)(D) and (d)(2) below, each Allocated Payment shall be adjusted by subtracting from such Allocated Payment the product of such Allocated Payment amount multiplied by the NPM Adjustment Percentage. The “NPM Adjustment Percentage” shall be calculated as follows: (i) If the Market Share Loss for the year immediately preceding the year in which the payment in question is due is less than or equal to 0 (zero), then the NPM Adjustment Percentage shall equal zero. (ii) If the Market Share Loss for the year immediately preceding the year in which the payment in question is due is greater than 0 (zero) and less than or equal to 16 2/3 percentage points, then the NPM Adjustment Percentage shall be equal to the product of (x) such Market Share Loss and (y) 3 (three). (iii) If the Market Share Loss for the year immediately preceding the year in which the payment in question is due is greater than 16 2/3 percentage points, then the NPM Adjustment Percentage shall be equal to the sum of (x) 50 percentage points and (y) the product of (1) the Variable Multiplier and (2) the result of such Market Share Loss minus 16 2/3 percentage points. (B) Definitions: (i) “Base Aggregate Participating Manufacturer Market Share” means the result of (x) the sum of the applicable Market Shares (the applicable Market Share to be that for 1997) of all present and former Tobacco Product Manufacturers that were Participating Manufacturers during the entire calendar year immediately preceding the year in which the payment in question is due minus (y) 2 (two) percentage points. (ii) “Actual Aggregate Participating Manufacturer Market Share” means the sum of the applicable Market Shares of all present and former Tobacco Product Manufacturers that were Participating Manufacturers during the entire calendar year immediately preceding the year in which the payment in question is due (the applicable Market Share to be that for the calendar year immediately preceding the year in which the payment in question is due). (iii) “Market Share Loss” means the result of (x) the Base Aggregate Participating Manufacturer Market Share minus (y) the Actual Aggregate Participating Manufacturer Market Share. (iv) “Variable Multiplier” equals 50 percentage points divided by the result of (x) the Base Aggregate Participating Manufacturer Market Share minus (y) 16 2/3 percentage points. (C) On or before February 2 of each year following a year in which there was a Market Share Loss greater than zero, a nationally recognized firm of economic consultants (the “Firm”) shall determine whether the disadvantages experienced as a result of the provisions of this Agreement were a significant factor contributing to the Market Share Loss for the year in question. If the Firm determines that the disadvantages experienced as a result of the provisions of this Agreement were a significant factor contributing to the Market Share Loss for the year in question, the NPM Adjustment described in subsection IX(d)(1) shall apply. If the Firm determines that the disadvantages experienced as a result of the provisions of this Agreement were not a significant factor contributing to the Market Share Loss for the year in question, the NPM Adjustment described in subsection IX(d)(1) shall not apply. The Original Participating Manufacturers, the Settling States, and the Attorneys General for the Settling States shall cooperate to ensure that the determination described in this subsection (1)(C) is timely made. The Firm shall be acceptable to (and the principals responsible for this assignment shall be acceptable to) both the Original Participating Manufacturers and a majority of those Attorneys General who are both the 18 Attorney General of a Settling State and a member of the NAAG executive committee at the time in question (or in the event no such firm or no such principals shall be acceptable to such parties, National Economic Research Associates, Inc., or its successors by merger, acquisition or otherwise (“NERA”), acting through a principal or principals acceptable to such parties, if such a person can be identified and, if not, acting through a principal or principals identified by NERA, or a successor firm selected by the CPR Institute for Dispute Resolution). As soon as practicable after the MSA Execution Date, the Firm shall be jointly retained by the Settling States and the Original Participating Manufacturers for the purpose of making the foregoing determination, and the Firm shall provide written notice to each Settling State, to NAAG, to the Independent Auditor and to each Participating Manufacturer of such determination. The determination of the Firm with respect to this issue shall be conclusive and binding upon all parties, and shall be final and non-appealable. The reasonable fees and expenses of the Firm shall be paid by the Original Participating Manufacturers according to their Relative Market Shares. Only the Participating Manufacturers and the Settling States, and their respective counsel, shall be entitled to communicate with the Firm with respect to the Firm’s activities pursuant to this subsection (1)(C). (D) No NPM Adjustment shall be made with respect to a payment if the aggregate number of Cigarettes shipped in or to the fifty United States, the District of Columbia and Puerto Rico in the year immediately preceding the year in which the payment in question is due by those Participating Manufacturers that had become Participating Manufacturers prior to 14 days after the MSA Execution Date is greater than the aggregate number of Cigarettes shipped in or to the fifty United States, the District of Columbia, and Puerto Rico in 1997 by such Participating Manufacturers (and any of their Affiliates that made such shipments in 1997, as demonstrated by certified audited statements of such Affiliates’ shipments, and that do not continue to make such shipments after the MSA Execution Date because the responsibility for such shipments has been transferred to one of such Participating Manufacturers). Measurements of shipments for purposes of this subsection (D) shall be made in the manner prescribed in subsection II(mm); in the event that such shipment data is unavailable for any Participating Manufacturer for 1997, such Participating Manufacturer’s shipment volume for such year shall be measured in the manner prescribed in subsection II(z). (2) Allocation among Settling States of NPM Adjustment for Original Participating Manufacturers. (A) The NPM Adjustment set forth in subsection (d)(1) shall apply to the Allocated Payments of all Settling States, except as set forth below. (B) A Settling State’s Allocated Payment shall not be subject to an NPM Adjustment: (i) if such Settling State continuously had a Qualifying Statute (as defined in subsection (2)(E) below) in full force and effect during the entire 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; or (ii) if such Settling State enacted the Model Statute (as defined in subsection (2)(E) below) for the first time during the calendar year immediately preceding the year in which the payment in question is due, continuously had the Model Statute in full force and effect during the last six months of such calendar year, and diligently enforced the provisions of such statute during the period in which it was in full force and effect. (C) The aggregate amount of the NPM Adjustments that would have applied to the Allocated Payments of those Settling States that are not subject to an NPM Adjustment pursuant to subsection (2)(B) shall be reallocated among all other Settling States pro rata in proportion to their respective Allocable Shares (the applicable Allocable Shares being those listed in Exhibit A), and such other Settling States’ Allocated Payments shall be further reduced accordingly. (D) This subsection (2)(D) shall apply if the amount of the NPM Adjustment applied pursuant to subsection (2)(A) to any Settling State plus the amount of the NPM Adjustments reallocated to such Settling State pursuant to subsection (2)(C) in any individual year would either (i) exceed such Settling State’s Allocated Payment in that year, or (ii) if subsection (2)(F) applies to the Settling State in question, exceed 65% of such Settling State’s Allocated Payment in that year. For each Settling State that has an excess as described in the preceding sentence, the excess amount of NPM Adjustment shall be further reallocated among all other Settling States whose Allocated Payments are subject to an NPM Adjustment and that do not have such an excess, pro rata in proportion to their respective Allocable Shares, and such other Settling States’ Allocated Payments shall be further reduced accordingly. The provisions of this subsection (2)(D) shall be repeatedly applied in any individual year until either (i) the aggregate amount of NPM Adjustments has been fully reallocated or (ii) the full amount of the NPM Adjustments subject to reallocation under subsection (2)(C) or (2)(D) cannot be fully reallocated in any individual year as described in those subsections because (x) the Allocated Payment in that year of each Settling State that is subject to an NPM Adjustment and to which subsection (2)(F) does not apply has been reduced to zero, and (y) the Allocated Payment in that year of each Settling State to which subsection (2)(F) applies has been reduced to 35% of such Allocated Payment. (E) A “Qualifying Statute” means a Settling State’s statute, regulation, law and/or rule (applicable everywhere the Settling State has authority to legislate) that effectively and fully neutralizes the cost disadvantages that the Participating Manufacturers experience vis-à-vis Non-Participating Manufacturers within such Settling State as a result of the provisions of this Agreement. Each Participating Manufacturer and each Settling State agree that the model statute in the form set forth in Exhibit T (the “Model Statute”), if enacted without modification or addition (except for particularized state procedural or technical requirements) and not in conjunction with any other legislative or regulatory proposal, shall constitute a Qualifying Statute. Each Participating Manufacturer agrees to support the enactment of such Model Statute if such Model 19 Statute is introduced or proposed (i) without modification or addition (except for particularized procedural or technical requirements), and (ii) not in conjunction with any other legislative proposal. (F) If a Settling State (i) enacts the Model Statute without any modification or addition (except for particularized state procedural or technical requirements) and not in conjunction with any other legislative or regulatory proposal, (ii) uses its best efforts to keep the Model Statute in full force and effect by, among other things, defending the Model Statute fully in any litigation brought in state or federal court within such Settling State (including litigating all available appeals that may affect the effectiveness of the Model Statute), and (iii) otherwise complies with subsection (2)(B), but a court of competent jurisdiction nevertheless invalidates or renders unenforceable the Model Statute with respect to such Settling State, and but for such ruling the Settling State would have been exempt from an NPM Adjustment under subsection (2)(B), then the NPM Adjustment (including reallocations pursuant to subsections (2)(C) and (2)(D)) shall still apply to such Settling State’s Allocated Payments but in any individual year shall not exceed 65% of the amount of such Allocated Payments. (G) In the event a Settling State proposes and/or enacts a statute, regulation, law and/or rule (applicable everywhere the Settling State has authority to legislate) that is not the Model Statute and asserts that such statute, regulation, law and/or rule is a Qualifying Statute, the Firm shall be jointly retained by the Settling States and the Original Participating Manufacturers for the purpose of determining whether or not such statute, regulation, law and/or rule constitutes a Qualifying Statute. The Firm shall make the foregoing determination within 90 days of a written request to it from the relevant Settling State (copies of which request the Settling State shall also provide to all Participating Manufacturers and the Independent Auditor), and the Firm shall promptly thereafter provide written notice of such determination to the relevant Settling State, NAAG, all Participating Manufacturers and the Independent Auditor. The determination of the Firm with respect to this issue shall be conclusive and binding upon all parties, and shall be final and non-appealable; provided, however, (i) that such determination shall be of no force and effect with respect to a proposed statute, regulation, law and/or rule that is thereafter enacted with any modification or addition; and (ii) that the Settling State in which the Qualifying Statute was enacted and any Participating Manufacturer may at any time request that the Firm reconsider its determination as to this issue in light of subsequent events (including, without limitation, subsequent judicial review, interpretation, modification and/or disapproval of a Settling State’s Qualifying Statute, and the manner and/or the effect of enforcement of such Qualifying Statute). The Original Participating Manufacturers shall severally pay their Relative Market Shares of the reasonable fees and expenses of the Firm. Only the Participating Manufacturers and Settling States, and their respective counsel, shall be entitled to communicate with the Firm with respect to the Firm’s activities pursuant to this subsection (2)(G). (H) Except as provided in subsection (2)(F), in the event a Qualifying Statute is enacted within a Settling State and is thereafter invalidated or declared unenforceable by a court of competent jurisdiction, otherwise rendered not in full force and effect, or, upon reconsideration by the Firm pursuant to subsection (2)(G) determined not to constitute a Qualifying Statute, then such Settling State’s Allocated Payments shall be fully subject to an NPM Adjustment unless and until the requirements of subsection (2)(B) have been once again satisfied. (3) Allocation of NPM Adjustment among Original Participating Manufacturers. The portion of the total amount of the NPM Adjustment to which the Original Participating Manufacturers are entitled in any year that can be applied in such year consistent with subsection IX(d)(2) (the “Available NPM Adjustment”) shall be allocated among them as provided in this subsection IX(d)(3). (A) The “Base NPM Adjustment” shall be determined for each Original Participating Manufacturer in such year as follows: (i) For those Original Participating Manufacturers whose Relative Market Shares in the year immediately preceding the year in which the NPM Adjustment in question is applied exceed or are equal to their respective 1997 Relative Market Shares, the Base NPM Adjustment shall equal 0 (zero). (ii) For those Original Participating Manufacturers whose Relative Market Shares in the year immediately preceding the year in which the NPM Adjustment in question is applied are less than their respective 1997 Relative Market Shares, the Base NPM Adjustment shall equal the result of (x) the difference between such Original Participating Manufacturer’s Relative Market Share in such preceding year and its 1997 Relative Market Share multiplied by both (y) the number of individual Cigarettes (expressed in thousands of units) shipped in or to the United States, the District of Columbia and Puerto Rico by all the Original Participating Manufacturers in such preceding year (determined in accordance with subsection II(mm)) and (z) $20 per each thousand units of Cigarettes (as this number is adjusted pursuant to subsection IX(d)(3)(C) below). (iii) For those Original Participating Manufacturers whose Base NPM Adjustment, if calculated pursuant to subsection (ii) above, would exceed $300 million (as this number is adjusted pursuant to subsection IX(d)(3)(C) below), the Base NPM Adjustment shall equal $300 million (or such adjusted number, as provided in subsection IX(d)(3)(C) below). (B) The share of the Available NPM Adjustment each Original Participating Manufacturer is entitled to shall be calculated as follows: (i) If the Available NPM Adjustment the Original Participating Manufacturers are entitled to in any year is less than or equal to the sum of the Base NPM Adjustments of all Original Participating 20 Manufacturers in such year, then such Available NPM Adjustment shall be allocated among those Original Participating Manufacturers whose Base NPM Adjustment is not equal to 0 (zero) pro rata in proportion to their respective Base NPM Adjustments. (ii) If the Available NPM Adjustment the Original Participating Manufacturers are entitled to in any year exceeds the sum of the Base NPM Adjustments of all Original Participating Manufacturers in such year, then (x) the difference between such Available NPM Adjustment and such sum of the Base NPM Adjustments shall be allocated among the Original Participating Manufacturers pro rata in proportion to their Relative Market Shares (the applicable Relative Market Shares to be those in the year immediately preceding such year), and (y) each Original Participating Manufacturer’s share of such Available NPM Adjustment shall equal the sum of (1) its Base NPM Adjustment for such year, and (2) the amount allocated to such Original Participating Manufacturer pursuant to clause (x). (iii) If an Original Participating Manufacturer’s share of the Available NPM Adjustment calculated pursuant to subsection IX(d)(3)(B)(i) or IX(d)(3)(B)(ii) exceeds such Original Participating Manufacturer’s payment amount to which such NPM Adjustment applies (as such payment amount has been determined pursuant to step B of clause “Seventh” of subsection IX(j)), then (1) such Original Participating Manufacturer’s share of the Available NPM Adjustment shall equal such payment amount, and (2) such excess shall be reallocated among the other Original Participating Manufacturers pro rata in proportion to their Relative Market Shares. (C) Adjustments: (i) For calculations made pursuant to this subsection IX(d)(3) (if any) with respect to payments due in the year 2000, the number used in subsection IX(d)(3)(A)(ii)(z) shall be $20 and the number used in subsection IX(d)(3)(A)(iii) shall be $300 million. Each year thereafter, both these numbers shall be adjusted upward or downward by multiplying each of them by the quotient produced by dividing (x) the average revenue per Cigarette of all the Original Participating Manufacturers in the year immediately preceding such year, by (y) the average revenue per Cigarette of all the Original Participating Manufacturers in the year immediately preceding such immediately preceding year. (ii) For purposes of this subsection, the average revenue per Cigarette of all the Original Participating Manufacturers in any year shall equal (x) the aggregate revenues of all the Original Participating Manufacturers from sales of Cigarettes in the fifty United States, the District of Columbia and Puerto Rico after Federal excise taxes and after payments pursuant to this Agreement and the tobacco litigation Settlement Agreements with the States of Florida, Mississippi, Minnesota and Texas (as such revenues are reported to the United States Securities and Exchange Commission (“SEC”) for such year (either independently by the Original Participating Manufacturer or as part of consolidated financial statements reported to the SEC by an Affiliate of the Original Participating Manufacturers) or, in the case of an Original Participating Manufacturer that does not report income to the SEC, as reported in financial statements prepared in accordance with United States generally accepted accounting principles and audited by a nationally recognized accounting firm), divided by (y) the aggregate number of the individual Cigarettes shipped in or to the United States, the District of Columbia and Puerto Rico by all the Original Participating Manufacturers in such year (determined in accordance with subsection II(mm)). (D) In the event that in the year immediately preceding the year in which the NPM Adjustment in question is applied both (x) the Relative Market Share of Lorillard Tobacco Company (or of its successor) (“Lorillard”) was less than or equal to 20.0000000%, and (y) the number of individual Cigarettes shipped in or to the United States, the District of Columbia and Puerto Rico by Lorillard (determined in accordance with subsection II(mm)) (for purposes of this subsection (D), “Volume”) was less than or equal to 70 billion, Lorillard’s and Philip Morris Incorporated’s (or its successor’s) (“Philip Morris”) shares of the Available NPM Adjustment calculated pursuant to subsections (3)(A)-(C) above shall be further reallocated between Lorillard and Philip Morris as follows (this subsection (3)(D) shall not apply in the year in which either of the two conditions specified in this sentence is not satisfied): (i) Notwithstanding subsections (A)-(C) of this subsection (d)(3), but subject to further adjustment pursuant to subsections (D)(ii) and (D)(iii) below, Lorillard’s share of the Available NPM Adjustment shall equal its Relative Market Share of such Available NPM Adjustment (the applicable Relative Market Share to be that in the year immediately preceding the year in which such NPM Adjustment is applied). The dollar amount of the difference between the share of the Available NPM Adjustment Lorillard is entitled to pursuant to the preceding sentence and the share of the Available NPM Adjustment it would be entitled to in the same year pursuant to subsections (d)(3)(A)-(C) shall be reallocated to Philip Morris and used to decrease or increase, as the case may be, Philip Morris’s share of the Available NPM Adjustment in such year calculated pursuant to subsections (d)(3)(A)-(C). (ii) In the event that in the year immediately preceding the year in which the NPM Adjustment in question is applied either (x) Lorillard’s Relative Market Share was greater than 15.0000000% (but did not exceed 20.0000000%), or (y) Lorillard’s Volume was greater than 50 billion (but did not exceed 70 billion), or both, Lorillard’s share of the Available NPM Adjustment calculated pursuant to subsection (d)(3)(D)(i) shall be reduced by a percentage equal to the greater of (1) 10.0000000% for each percentage point (or fraction thereof) of excess of such Relative Market Share over 15.0000000% (if any), or (2) 2.5000000% for each billion (or fraction thereof) of excess of such Volume over 50 billion (if any). The dollar amount by which Lorillard’s share of the Available NPM Adjustment is reduced in any year pursuant to this subsection (D)(ii) shall be reallocated to Philip Morris and used to increase Philip Morris’s share of the Available NPM Adjustment in such year. 21 In the event that in any year a reallocation of the shares of the Available NPM Adjustment between Lorillard and Philip Morris pursuant to this subsection (d)(3)(D) results in Philip Morris’s share of the Available NPM Adjustment in such year exceeding the greater of (x) Philip Morris’s Relative Market Share of such Available NPM Adjustment (the applicable Relative Market Share to be that in the year immediately preceding such year), or (y) Philip Morris’s share of the Available NPM Adjustment in such year calculated pursuant to subsections (d)(3)(A)-(C), Philip Morris’s share of the Available NPM Adjustment in such year shall be reduced to equal the greater of (x) or (y) above. In such instance, the dollar amount by which Philip Morris’s share of the Available NPM Adjustment is reduced pursuant to the preceding sentence shall be reallocated to Lorillard and used to increase Lorillard’s share of the Available NPM Adjustment in such year. (iv) In the event that either Philip Morris or Lorillard is treated as a Non-Participating Manufacturer for purposes of this subsection IX(d)(3) pursuant to subsection XVIII(w)(2)(A), this subsection (3)(D) shall not be applied, and the Original Participating Manufacturers’ shares of the Available NPM Adjustment shall be determined solely as described in subsections (3)(A)-(C). (4) NPM Adjustment for Subsequent Participating Manufacturers. Subject to the provisions of subsection IX(i)(3), a Subsequent Participating Manufacturer shall be entitled to an NPM Adjustment with respect to payments due from such Subsequent Participating Manufacturer in any year during which an NPM Adjustment is applicable under subsection (d)(1) above to payments due from the Original Participating Manufacturers. The amount of such NPM Adjustment shall equal the product of (A) the NPM Adjustment Percentage for such year multiplied by (B) the sum of the payments due in the year in question from such Subsequent Participating Manufacturer that correspond to payments due from Original Participating Manufacturers pursuant to subsection IX(c) (as such payment amounts due from such Subsequent Participating Manufacturer have been adjusted and allocated pursuant to clauses “First” through “Fifth” of subsection IX(j)). The NPM Adjustment to payments by each Subsequent Participating Manufacturer shall be allocated and reallocated among the Settling States in a manner consistent with subsection (d)(2) above. (e) Supplemental Payments. Beginning on April 15, 2004, and on April 15 of each year thereafter in perpetuity, in the event that the sum of the Market Shares of the Participating Manufacturers that were Participating Manufacturers during the entire calendar year immediately preceding the year in which the payment in question would be due (the applicable Market Share to be that for the calendar year immediately preceding the year in which the payment in question would be due) equals or exceeds 99.0500000%, each Original Participating Manufacturer shall severally pay to the Escrow Agent (to be credited to the Subsection IX(e) Account) for the benefit of the Foundation its Relative Market Share of the base amount of $300,000,000, as such payments are modified in accordance with this subsection (e). Such payments shall be utilized by the Foundation to fund the national public education functions of the Foundation described in subsection VI(f)(1), in the manner described in and subject to the provisions of subsections VI(g) and VI(h). The payments made by the Original Participating Manufacturers pursuant to this subsection shall be subject to the Inflation Adjustment, the Volume Adjustment, the Non- Settling States Reduction, and the offset for miscalculated or disputed payments described in subsection XI(i). (f) Payment Responsibility. The payment obligations of each Participating Manufacturer pursuant to this Agreement shall be the several responsibility only of that Participating Manufacturer. The payment obligations of a Participating Manufacturer shall not be the obligation or responsibility of any Affiliate of such Participating Manufacturer. The payment obligations of a Participating Manufacturer shall not be the obligation or responsibility of any other Participating Manufacturer. Provided, however, that no provision of this Agreement shall waive or excuse liability under any state or federal fraudulent conveyance or fraudulent transfer law. Any Participating Manufacturer whose Market Share (or Relative Market Share) in any given year equals zero shall have no payment obligations under this Agreement in the succeeding year. (g) Corporate Structures. Due to the particular corporate structures of R.J. Reynolds Tobacco Company (“Reynolds”) and Brown & Williamson Tobacco Corporation (“B&W”) with respect to their non-domestic tobacco operations, Reynolds and B&W shall be severally liable for their respective shares of each payment due pursuant to this Agreement up to (and their liability hereunder shall not exceed) the full extent of their assets used in and earnings derived from, the manufacture and/or sale in the States of Tobacco Products intended for domestic consumption, and no recourse shall be had against any of their other assets or earnings to satisfy such obligations. (h) Accrual of Interest. Except as expressly provided otherwise in this Agreement, any payment due hereunder and not paid when due (or payments requiring the accrual of interest under subsection XI(d)) shall accrue interest from and including the date such payment is due until (but not including) the date paid at the Prime Rate plus three percentage points. (i) Payments by Subsequent Participating Manufacturers. (1) A Subsequent Participating Manufacturer shall have payment obligations under this Agreement only in the event that its Market Share in any calendar year exceeds the greater of (1) its 1998 Market Share or (2) 125 percent of its 1997 Market Share (subject to the provisions of subsection (i)(4)). In the year following any such calendar year, such Subsequent Participating Manufacturer shall make payments corresponding to those due in that same following year from the Original Participating Manufacturers pursuant to subsections VI(c) (except for the payment due on March 31, 1999), IX(c)(1), IX(c)(2) and IX(e). The amounts of such corresponding payments by a Subsequent Participating Manufacturer are in addition to the corresponding payments that are due from the Original Participating Manufacturers and shall be determined as described in subsections (2) and (3) below. Such payments by a Subsequent Participating Manufacturer shall (A) be due on the same dates as the corresponding payments are due from Original Participating Manufacturers; (B) be for the same 22 purpose as such corresponding payments; and (C) be paid, allocated and distributed in the same manner as such corresponding payments. (2) The base amount due from a Subsequent Participating Manufacturer on any given date shall be determined by multiplying (A) the corresponding base amount due on the same date from all of the Original Participating Manufacturers (as such base amount is specified in the corresponding subsection of this Agreement and is adjusted by the Volume Adjustment (except for the provisions of subsection (B)(ii) of Exhibit E), but before such base amount is modified by any other adjustments, reductions or offsets) by (B) the quotient produced by dividing (i) the result of (x) such Subsequent Participating Manufacturer’s applicable Market Share (the applicable Market Share being that for the calendar year immediately preceding the year in which the payment in question is due) minus (y) the greater of (1) its 1998 Market Share or (2) 125 percent of its 1997 Market Share, by (ii) the aggregate Market Shares of the Original Participating Manufacturers (the applicable Market Shares being those for the calendar year immediately preceding the year in which the payment in question is due). (3) Any payment due from a Subsequent Participating Manufacturer under subsections (1) and (2) above shall be subject (up to the full amount of such payment) to the Inflation Adjustment, the Non-Settling States Reduction, the NPM Adjustment, the offset for miscalculated or disputed payments described in subsection XI(i), the Federal Tobacco Legislation Offset, the Litigating Releasing Parties Offset and the offsets for claims over described in subsections XII(a)(4)(B) and XII(a)(8), to the extent that such adjustments, reductions or offsets would apply to the corresponding payment due from the Original Participating Manufacturers. Provided, however, that all adjustments and offsets to which a Subsequent Participating Manufacturer is entitled may only be applied against payments by such Subsequent Participating Manufacturer, if any, that are due within 12 months after the date on which the Subsequent Participating Manufacturer becomes entitled to such adjustment or makes the payment that entitles it to such offset, and shall not be carried forward beyond that time even if not fully used. (4) For purposes of this subsection (i), the 1997 (or 1998, as applicable) Market Share (and 125 percent thereof) of those Subsequent Participating Manufacturers that either (A) became a signatory to this Agreement more than 60 days after the MSA Execution Date or (B) had no Market Share in 1997 (or 1998, as applicable), shall equal zero. (j) Order of Application of Allocations, Offsets, Reductions and Adjustments. The payments due under this Agreement shall be calculated as set forth below. The “base amount” referred to in clause “First” below shall mean (1) in the case of payments due from Original Participating Manufacturers, the base amount referred to in the subsection establishing the payment obligation in question; and (2) in the case of payments due from a Subsequent Participating Manufacturer, the base amount referred to in subsection (i)(2) for such Subsequent Participating Manufacturer. In the event that a particular adjustment, reduction or offset referred to in a clause below does not apply to the payment being calculated, the result of the clause in question shall be deemed to be equal to the result of the immediately preceding clause. (If clause “First” is inapplicable, the result of clause “First” will be the base amount of the payment in question prior to any offsets, reductions or adjustments.) First: the Inflation Adjustment shall be applied to the base amount of the payment being calculated; Second: the Volume Adjustment (other than the provisions of subsection (B)(iii) of Exhibit E) shall be applied to the result of clause “First”; Third: the result of clause “Second” shall be reduced by the Previously Settled States Reduction; Fourth: the result of clause “Third” shall be reduced by the Non-Settling States Reduction; Fifth: in the case of payments due under subsections IX(c)(1) and IX(c)(2), the results of clause “Fourth” for each such payment due in the calendar year in question shall be apportioned among the Settling States pro rata in proportion to their respective Allocable Shares, and the resulting amounts for each particular Settling State shall then be added together to form such Settling State’s Allocated Payment. In the case of payments due under subsection IX(i) that correspond to payments due under subsections IX(c)(1) or IX(c)(2), the results of clause “Fourth” for all such payments due from a particular Subsequent Participating Manufacturer in the calendar year in question shall be apportioned among the Settling States pro rata in proportion to their respective Allocable Shares, and the resulting amounts for each particular Settling State shall then be added together. (In the case of all other payments made pursuant to this Agreement, this clause “Fifth” is inapplicable.); Sixth: the NPM Adjustment shall be applied to the results of clause “Fifth” pursuant to subsections IX(d)(1) and (d)(2) (or, in the case of payments due from the Subsequent Participating Manufacturers, pursuant to subsection IX(d)(4)); Seventh: in the case of payments due from the Original Participating Manufacturers to which clause “Fifth” (and therefore clause “Sixth”) does not apply, the result of clause “Fourth” shall be allocated among the Original Participating Manufacturers according to their Relative Market Shares. In the case of payments due from the Original Participating Manufacturers to which clause “Fifth” applies: (A) the Allocated Payments of all Settling States determined pursuant to clause “Fifth” (prior to reduction pursuant to clause “Sixth”) shall be added together; (B) the resulting sum shall be allocated among the Original Participating Manufacturers according to their Relative Market Shares and subsection (B)(iii) of Exhibit E hereto (if such subsection is applicable); (C) the Available NPM Adjustment (as determined pursuant to clause “Sixth”) shall be allocated among the Original Participating Manufacturers pursuant to subsection IX(d)(3); (D) the respective result of step (C) above for each Original Participating Manufacturer shall be subtracted from the respective result of step (B) above 23 for such Original Participating Manufacturer; and (E) the resulting payment amount due from each Original Participating Manufacturer shall then be allocated among the Settling States in proportion to the respective results of clause “Sixth” for each Settling State. The offsets described in clauses “Eighth” through “Twelfth” shall then be applied separately against each Original Participating Manufacturer’s resulting payment shares (on a Settling State by Settling State basis) according to each Original Participating Manufacturer’s separate entitlement to such offsets, if any, in the calendar year in question. (In the case of payments due from Subsequent Participating Manufacturers, this clause “Seventh” is inapplicable.) Eighth: the offset for miscalculated or disputed payments described in subsection XI(i) (and any carry-forwards arising from such offset) shall be applied to the results of clause “Seventh” (in the case of payments due from the Original Participating Manufacturers) or to the results of clause “Sixth” (in the case of payments due from Subsequent Participating Manufacturers); Ninth: the Federal Tobacco Legislation Offset (including any carry-forwards arising from such offset) shall be applied to the results of clause “Eighth”; Tenth: the Litigating Releasing Parties Offset (including any carry-forwards arising from such offset) shall be applied to the results of clause “Ninth”; Eleventh: the offset for claims over pursuant to subsection XII(a)(4)(B) (including any carry-forwards arising from such offset) shall be applied to the results of clause “Tenth”; Twelfth: the offset for claims over pursuant to subsection XII(a)(8) (including any carry-forwards arising from such offset) shall be applied to the results of clause “Eleventh”; and Thirteenth: in the case of payments to which clause “Fifth” applies, the Settling States’ allocated shares of the payments due from each Participating Manufacturer (as such shares have been determined in step (E) of clause “Seventh” in the case of payments from the Original Participating Manufacturers or in clause “Sixth” in the case of payments from the Subsequent Participating Manufacturers, and have been reduced by clauses “Eighth” through “Twelfth”) shall be added together to state the aggregate payment obligation of each Participating Manufacturer with respect to the payments in question. (In the case of a payment to which clause “Fifth” does not apply, the aggregate payment obligation of each Participating Manufacturer with respect to the payment in question shall be stated by the results of clause “Eighth.”) X. EFFECT OF FEDERAL TOBACCO-RELATED LEGISLATION (a) If federal tobacco-related legislation is enacted after the MSA Execution Date and on or before November 30, 2002, and if such legislation provides for payment(s) by any Original Participating Manufacturer (whether by settlement payment, tax or any other means), all or part of which are actually made available to a Settling State (“Federal Funds”), each Original Participating Manufacturer shall receive a continuing dollar-for-dollar offset for any and all amounts that are paid by such Original Participating Manufacturer pursuant to such legislation and actually made available to such Settling State (except as described in subsections (b) and (c) below). Such offset shall be applied against the applicable Original Participating Manufacturer’s share (determined as described in step E of clause “Seventh” of subsection IX(j)) of such Settling State’s Allocated Payment, up to the full amount of such Original Participating Manufacturer’s share of such Allocated Payment (as such share had been reduced by adjustment, if any, pursuant to the NPM Adjustment and has been reduced by offset, if any, pursuant to the offset for miscalculated or disputed payments). Such offset shall be made against such Original Participating Manufacturer’s share of the first Allocated Payment due after such Federal Funds are first available for receipt by such Settling State. In the event that such offset would in any given year exceed such Original Participating Manufacturer’s share of such Allocated Payment: (1) the offset to which such Original Participating Manufacturer is entitled under this section in such year shall be the full amount of such Original Participating Manufacturer’s share of such Allocated Payment, and (2) all amounts not offset by reason of subsection (1) shall carry forward and be offset in the following year(s) until all such amounts have been offset. (b) The offset described in subsection (a) shall apply only to that portion of Federal Funds, if any, that are either unrestricted as to their use, or restricted to any form of health care or to any use related to tobacco (including, but not limited to, tobacco education, cessation, control or enforcement) (other than that portion of Federal Funds, if any, that is specifically applicable to tobacco growers or communities dependent on the production of tobacco or Tobacco Products). Provided, however, that the offset described in subsection (a) shall not apply to that portion of Federal Funds, if any, whose receipt by such Settling State is conditioned upon or appropriately allocable to: (1) the relinquishment of rights or benefits under this Agreement (including the Consent Decree); or (2) actions or expenditures by such Settling State, unless: (A) such Settling State chooses to undertake such action or expenditure; (B) such actions or expenditures do not impose significant constraints on public policy choices; or (C) such actions or expenditures are both: (i) related to health care or tobacco (including, but not limited to, tobacco education, cessation, control or enforcement) and (ii) do not require such Settling State to expend state matching funds in an amount that is significant in relation to the amount of the Federal Funds made available to such Settling State. 24 (c) Subject to the provisions of subsection IX(i)(3), Subsequent Participating Manufacturers shall be entitled to the offset described in this section X to the extent that they are required to pay Federal Funds that would give rise to an offset under subsections (a) and (b) if paid by an Original Participating Manufacturer. (d) Nothing in this section X shall (1) reduce the payments to be made to the Settling States under this Agreement other than those described in subsection IX(c) (or corresponding payments under subsection IX(i)) of this Agreement; or (2) alter the Allocable Share used to determine each Settling State’s share of the payments described in subsection IX(c) (or corresponding payments under subsection IX(i)) of this Agreement. Nothing in this section X is intended to or shall reduce the total amounts payable by the Participating Manufacturers to the Settling States under this Agreement by an amount greater than the amount of Federal Funds that the Settling States could elect to receive. XI. CALCULATION AND DISBURSEMENT OF PAYMENTS (a) Independent Auditor to Make All Calculations. (1) Beginning with payments due in the year 2000, an Independent Auditor shall calculate and determine the amount of all payments owed pursuant to this Agreement, the adjustments, reductions and offsets thereto (and all resulting carry-forwards, if any), the allocation of such payments, adjustments, reductions, offsets and carry-forwards among the Participating Manufacturers and among the Settling States, and shall perform all other calculations in connection with the foregoing (including, but not limited to, determining Market Share, Relative Market Share, Base Aggregate Participating Manufacturer Market Share and Actual Aggregate Participating Manufacturer Market Share). The Independent Auditor shall promptly collect all information necessary to make such calculations and determinations. Each Participating Manufacturer and each Settling State shall provide the Independent Auditor, as promptly as practicable, with information in its possession or readily available to it necessary for the Independent Auditor to perform such calculations. The Independent Auditor shall agree to maintain the confidentiality of all such information, except that the Independent Auditor may provide such information to Participating Manufacturers and the Settling States as set forth in this Agreement. The Participating Manufacturers and the Settling States agree to maintain the confidentiality of such information. (2) Payments due from the Original Participating Manufacturers prior to January 1, 2000 (other than the first payment due pursuant to subsection IX(b)) shall be based on the 1998 Relative Market Shares of the Original Participating Manufacturers or, if the Original Participating Manufacturers are unable to agree on such Relative Market Shares, on their 1997 Relative Market Shares specified in Exhibit Q. (b) Identity of Independent Auditor. The Independent Auditor shall be a major, nationally recognized, certified public accounting firm jointly selected by agreement of the Original Participating Manufacturers and those Attorneys General of the Settling States who are members of the NAAG executive committee, who shall jointly retain the power to replace the Independent Auditor and appoint its successor. Fifty percent of the costs and fees of the Independent Auditor (but in no event more than $500,000 per annum), shall be paid by the Fund described in Exhibit J hereto, and the balance of such costs and fees shall be paid by the Original Participating Manufacturers, allocated among them according to their Relative Market Shares. The agreement retaining the Independent Auditor shall provide that the Independent Auditor shall perform the functions specified for it in this Agreement, and that it shall do so in the manner specified in this Agreement. (c) Resolution of Disputes. 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. (d) General Provisions as to Calculation of Payments. (1) Not less than 90 days prior to the scheduled due date of any payment due pursuant to this Agreement (“Payment Due Date”), the Independent Auditor shall deliver to each other Notice Party a detailed itemization of all information required by the Independent Auditor to complete its calculation of (A) the amount due from each Participating Manufacturer with respect to such payment, and (B) the portion of such amount allocable to each entity for whose benefit such payment is to be made. To the extent practicable, the Independent Auditor shall specify in such itemization which Notice Party is requested to produce which information. Each Participating Manufacturer and each Settling State shall use its best efforts to promptly supply all of the required information that is within its possession or is readily available to it to the Independent Auditor, and in any event not less than 50 days prior to such Payment Due Date. Such best efforts obligation shall be continuing in the case of information that comes within the possession of, or becomes readily available to, any Settling State or Participating Manufacturer after the date 50 days prior to such Payment Due Date. (2) Not less than 40 days prior to the Payment Due Date, the Independent Auditor shall deliver to each other Notice Party (A) detailed preliminary calculations (“Preliminary Calculations”) of the amount due from each Participating Manufacturer and of the amount allocable to each entity for whose benefit such payment is to be made, showing all applicable offsets, adjustments, reductions and carry-forwards and setting forth all the information on which the Independent Auditor relied in preparing such Preliminary Calculations, and (B) a statement of any information still required by the Independent Auditor to complete its calculations. 25 (3) Not less than 30 days prior to the Payment Due Date, any Participating Manufacturer or any Settling State that disputes any aspect of the Preliminary Calculations (including, but not limited to, disputing the methodology that the Independent Auditor employed, or the information on which the Independent Auditor relied, in preparing such calculations) shall notify each other Notice Party of such dispute, including the reasons and basis therefor. (4) Not less than 15 days prior to the Payment Due Date, the Independent Auditor shall deliver to each other Notice Party a detailed recalculation (a “Final Calculation”) of the amount due from each Participating Manufacturer, the amount allocable to each entity for whose benefit such payment is to be made, and the Account to which such payment is to be credited, explaining any changes from the Preliminary Calculation. The Final Calculation may include estimates of amounts in the circumstances described in subsection (d)(5). (5) The following provisions shall govern in the event that the information required by the Independent Auditor to complete its calculations is not in its possession by the date as of which the Independent Auditor is required to provide either a Preliminary Calculation or a Final Calculation. (A) If the information in question is not readily available to any Settling State, any Original Participating Manufacturer or any Subsequent Participating Manufacturer, the Independent Auditor shall employ an assumption as to the missing information producing the minimum amount that is likely to be due with respect to the payment in question, and shall set forth its assumption as to the missing information in its Preliminary Calculation or Final Calculation, whichever is at issue. Any Original Participating Manufacturer, Subsequent Participating Manufacturer or Settling State may dispute any such assumption employed by the Independent Auditor in its Preliminary Calculation in the manner prescribed in subsection (d)(3) or any such assumption employed by the Independent Auditor in its Final Calculation in the manner prescribed in subsection (d)(6). If the missing information becomes available to the Independent Auditor prior to the Payment Due Date, the Independent Auditor shall promptly revise its Preliminary Calculation or Final Calculation (whichever is applicable) and shall promptly provide the revised calculation to each Notice Party, showing the newly available information. If the missing information does not become available to the Independent Auditor prior to the Payment Due Date, the minimum amount calculated by the Independent Auditor pursuant to this subsection (A) shall be paid on the Payment Due Date, subject to disputes pursuant to subsections (d)(6) and (d)(8) and without prejudice to a later final determination of the correct amount. If the missing information becomes available to the Independent Auditor after the Payment Due Date, the Independent Auditor shall calculate the correct amount of the payment in question and shall apply any overpayment or underpayment as an offset or additional payment in the manner described in subsection (i). (B) If the information in question is readily available to a Settling State, Original Participating Manufacturer or Subsequent Participating Manufacturer, but such Settling State, Original Participating Manufacturer or Subsequent Participating Manufacturer does not supply such information to the Independent Auditor, the Independent Auditor shall base the calculation in question on its best estimate of such information, and shall show such estimate in its Preliminary Calculation or Final Calculation, whichever is applicable. Any Original Participating Manufacturer, Subsequent Participating Manufacturer or Settling State (except the entity that withheld the information) may dispute such estimate employed by the Independent Auditor in its Preliminary Calculation in the manner prescribed in subsection (d)(3) or such estimate employed by the Independent Auditor in its Final Calculation in the manner prescribed in subsection (d)(6). If the withheld information is not made available to the Independent Auditor more than 30 days prior to the Payment Due Date, the estimate employed by the Independent Auditor (as revised by the Independent Auditor in light of any dispute filed pursuant to the preceding sentence) shall govern the amounts to be paid on the Payment Due Date, subject to disputes pursuant to subsection (d)(6) and without prejudice to a later final determination of the correct amount. In the event that the withheld information subsequently becomes available, the Independent Auditor shall calculate the correct amount and shall apply any overpayment or underpayment as an offset or additional payment in the manner described in subsection (i). (6) Not less than five days prior to the Payment Due Date, each Participating Manufacturer and each Settling State shall deliver to each Notice Party a statement indicating whether it disputes the Independent Auditor’s Final Calculation and, if so, the disputed and undisputed amounts and the basis for the dispute. Except to the extent a Participating Manufacturer or a Settling State delivers a statement indicating the existence of a dispute by such date, the amounts set forth in the Independent Auditor’s Final Calculation shall be paid on the Payment Due Date. Provided, however, that (A) in the event that the Independent Auditor revises its Final Calculation within five days of the Payment Due Date as provided in subsection (5)(A) due to receipt of previously missing information, a Participating Manufacturer or Settling State may dispute such revision pursuant to the procedure set forth in this subsection (6) at any time prior to the Payment Due Date; and (B) prior to the date four years after the Payment Due Date, neither failure to dispute a calculation made by the Independent Auditor nor actual agreement with any calculation or payment to the Escrow Agent or to another payee shall waive any Participating Manufacturer’s or Settling State’s rights to dispute any payment (or the Independent Auditor’s calculations with respect to any payment) after the Payment Due Date. No Participating Manufacturer and no Settling State shall have a right to raise any dispute with respect to any payment or calculation after the date four years after such payment’s Payment Due Date. (7) Each Participating Manufacturer shall be obligated to pay by the Payment Due Date the undisputed portion of the total amount calculated as due from it by the Independent Auditor’s Final Calculation. Failure to pay such portion shall render the Participating Manufacturer liable for interest thereon as provided in subsection IX(h) of this Agreement, in addition to any other remedy available under this Agreement. 26 (8) As to any disputed portion of the total amount calculated to be due pursuant to the Final Calculation, any Participating Manufacturer that by the Payment Due Date pays such disputed portion into the Disputed Payments Account (as defined in the Escrow Agreement) shall not be liable for interest thereon even if the amount disputed was in fact properly due and owing. Any Participating Manufacturer that by the Payment Due Date does not pay such disputed portion into the Disputed Payments Account shall be liable for interest as provided in subsection IX(h) if the amount disputed was in fact properly due and owing. (9) On the same date that it makes any payment pursuant to this Agreement, each Participating Manufacturer shall deliver a notice to each other Notice Party showing the amount of such payment and the Account to which such payment is to be credited. (10) On the first Business Day after the Payment Due Date, the Escrow Agent shall deliver to each other Notice Party a statement showing the amounts received by it from each Participating Manufacturer and the Accounts credited with such amounts. (e) General Treatment of Payments. The Escrow Agent may disburse amounts from an Account only if permitted, and only at such time as permitted, by this Agreement and the Escrow Agreement. No amounts may be disbursed to a Settling State other than funds credited to such Settling State’s State-Specific Account (as defined in the Escrow Agreement). The Independent Auditor, in delivering payment instructions to the Escrow Agent, shall specify: the amount to be paid; the Account or Accounts from which such payment is to be disbursed; the payee of such payment (which may be an Account); and the Business Day on which such payment is to be made by the Escrow Agent. Except as expressly provided in subsection (f) below, in no event may any amount be disbursed from any Account prior to Final Approval. (f) Disbursements and Charges Not Contingent on Final Approval. Funds may be disbursed from Accounts without regard to the occurrence of Final Approval in the following circumstances and in the following manner: (1) Payments of Federal and State Taxes. Federal, state, local or other taxes imposed with respect to the amounts credited to the Accounts shall be paid from such amounts. The Independent Auditor shall prepare and file any tax returns required to be filed with respect to the escrow. All taxes required to be paid shall be allocated to and charged against the Accounts on a reasonable basis to be determined by the Independent Auditor. Upon receipt of written instructions from the Independent Auditor, the Escrow Agent shall pay such taxes and charge such payments against the Account or Accounts specified in those instructions. (2) Payments to and from Disputed Payments Account. The Independent Auditor shall instruct the Escrow Agent to credit funds from an Account to the Disputed Payments Account when a dispute arises as to such funds, and shall instruct the Escrow Agent to credit funds from the Disputed Payments Account to the appropriate payee when such dispute is resolved with finality. The Independent Auditor shall provide the Notice Parties not less than 10 Business Days prior notice before instructing the Escrow Agent to disburse funds from the Disputed Payments Account. (3) Payments to a State-Specific Account. Promptly following the occurrence of State-Specific Finality in any Settling State, such Settling State and the Original Participating Manufacturers shall notify the Independent Auditor of such occurrence. The Independent Auditor shall promptly thereafter notify each Notice Party of such State-Specific Finality and of the portions of the amounts in the Subsection IX(b) Account (First), Subsection IX(b) Account (Subsequent), Subsection IX(c)(1) Account and Subsection IX(c)(2) Account, respectively (as such Accounts are defined in the Escrow Agreement), that are at such time held in such Accounts for the benefit of such Settling State, and which are to be transferred to the appropriate State-Specific Account for such Settling State. If neither the Settling State in question nor any Participating Manufacturer disputes such amounts or the occurrence of such State-Specific Finality by notice delivered to each other Notice Party not later than 10 Business Days after delivery by the Independent Auditor of the notice described in the preceding sentence, the Independent Auditor shall promptly instruct the Escrow Agent to make such transfer. If the Settling State in question or any Participating Manufacturer disputes such amounts or the occurrence of such State-Specific Finality by notice delivered to each other Notice Party not later than 10 Business Days after delivery by the Independent Auditor of the notice described in the second sentence of this subsection (f)(3), the Independent Auditor shall promptly instruct the Escrow Agent to credit the amount disputed to the Disputed Payments Account and the undisputed portion to the appropriate State-Specific Account. No amounts may be transferred or credited to a State-Specific Account for the benefit of any State as to which State-Specific Finality has not occurred or as to which this Agreement has terminated. (4) Payments to Parties other than Particular Settling States. (A) Promptly following the occurrence of State-Specific Finality in one Settling State, such Settling State and the Original Participating Manufacturers shall notify the Independent Auditor of such occurrence. The Independent Auditor shall promptly thereafter notify each Notice Party of the occurrence of State-Specific Finality in at least one Settling State and of the amounts held in the Subsection VI(b) Account, Subsection VI(c) Account (First), and Subsection VIII(c) Account (as such Accounts are defined in the Escrow Agreement), if any. If neither any of the Settling States nor any of the Participating Manufacturers disputes such amounts or disputes the occurrence of State-Specific Finality in one Settling State, by notice delivered to each Notice Party not later than ten Business Days after delivery by the Independent Auditor of the notice described in the preceding sentence, the Independent Auditor shall promptly instruct the Escrow Agent to disburse the funds held in such Accounts to the Foundation or to the Fund specified in subsection VIII(c), as appropriate. If any Settling State or Participating Manufacturer disputes such amounts or the occurrence of such State- Specific Finality by notice delivered to each other Notice Party not later than 10 Business Days after delivery by the 27 Independent Auditor of the notice described in the second sentence of this subsection (4)(A), the Independent Auditor shall promptly instruct the Escrow Agent to credit the amounts disputed to the Disputed Payments Account and to disburse the undisputed portion to the Foundation or to the Fund specified in subsection VIII(c), as appropriate. (B) The Independent Auditor shall instruct the Escrow Agent to disburse funds on deposit in the Subsection VIII(b) Account and Subsection IX(e) Account (as such Accounts are defined in the Escrow Agreement) to NAAG or to the Foundation, as appropriate, within 10 Business Days after the date on which such amounts were credited to such Accounts. (C) Promptly following the occurrence of State-Specific Finality in Settling States having aggregate Allocable Shares equal to at least 80% of the total aggregate Allocable Shares assigned to all States that were Settling States as of the MSA Execution Date, the Settling States and the Original Participating Manufacturers shall notify the Independent Auditor of such occurrence. The Independent Auditor shall promptly thereafter notify each Notice Party of the occurrence of such State-Specific Finality and of the amounts held in the Subsection VI(c) Account (Subsequent) (as such Account is defined in the Escrow Agreement), if any. If neither any of the Settling States nor any of the Participating Manufacturers disputes such amounts or disputes the occurrence of such State-Specific Finality, by notice delivered to each Notice Party not later than 10 Business Days after delivery by the Independent Auditor of the notice described in the preceding sentence, the Independent Auditor shall promptly instruct the Escrow Agent to disburse the funds held in such Account to the Foundation. If any Settling State or Participating Manufacturer disputes such amounts or the occurrence of such State-Specific Finality by notice delivered to each other Notice Party not later than 10 Business Days after delivery by the Independent Auditor of the notice described in the second sentence of this subsection (4)(C), the Independent Auditor shall promptly instruct the Escrow Agent to credit the amounts disputed to the Disputed Payments Account and to disburse the undisputed portion to the Foundation. (5) Treatment of Payments Following Termination. (A) As to amounts held for Settling States. Promptly upon the termination of this Agreement with respect to any Settling State (whether or not as part of the termination of this Agreement as to all Settling States) such State or any Participating Manufacturer shall notify the Independent Auditor of such occurrence. The Independent Auditor shall promptly thereafter notify each Notice Party of such termination and of the amounts held in the Subsection IX(b) Account (First), the Subsection IX(b) Account (Subsequent), the Subsection IX(c)(1) Account, the Subsection IX(c)(2) Account, and the State-Specific Account for the benefit of such Settling State. If neither the State in question nor any Participating Manufacturer disputes such amounts or the occurrence of such termination by notice delivered to each other Notice Party not later than 10 Business Days after delivery by the Independent Auditor of the notice described in the preceding sentence, the Independent Auditor shall promptly instruct the Escrow Agent to transfer such amounts to the Participating Manufacturers (on the basis of their respective contributions of such funds). If the State in question or any Participating Manufacturer disputes the amounts held in the Accounts or the occurrence of such termination by notice delivered to each other Notice Party not later than 10 Business Days after delivery by the Independent Auditor of the notice described in the second sentence of this subsection (5)(A), the Independent Auditor shall promptly instruct the Escrow Agent to transfer the amount disputed to the Disputed Payments Account and the undisputed portion to the Participating Manufacturers (on the basis of their respective contributions of such funds). (B) As to amounts held for others. If this Agreement is terminated with respect to all of the Settling States, the Original Participating Manufacturers shall promptly notify the Independent Auditor of such occurrence. The Independent Auditor shall promptly thereafter notify each Notice Party of such termination and of the amounts held in the Subsection VI(b) Account, the Subsection VI(c) Account (First), the Subsection VIII(b) Account, the Subsection VIII(c) Account and the Subsection IX(e) Account. If neither any such State nor any Participating Manufacturer disputes such amounts or the occurrence of such termination by notice delivered to each other Notice Party not later than 10 Business Days after delivery by the Independent Auditor of the notice described in the preceding sentence, the Independent Auditor shall promptly instruct the Escrow Agent to transfer such amounts to the Participating Manufacturers (on the basis of their respective contributions of such funds). If any such State or any Participating Manufacturer disputes the amounts held in the Accounts or the occurrence of such termination by notice delivered to each other Notice Party not later than 10 Business Days after delivery by the Independent Auditor of the notice described in the second sentence of this subsection (5)(B), the Independent Auditor shall promptly instruct the Escrow Agent to credit the amount disputed to the Disputed Payments Account and transfer the undisputed portion to the Participating Manufacturers (on the basis of their respective contribution of such funds). (C) As to amounts held in the Subsection VI(c) Account (Subsequent). If this Agreement is terminated with respect to Settling States having aggregate Allocable Shares equal to more than 20% of the total aggregate Allocable Shares assigned to those States that were Settling States as of the MSA Execution Date, the Original Participating Manufacturers shall promptly notify the Independent Auditor of such occurrence. The Independent Auditor shall promptly thereafter notify each Notice Party of such termination and of the amounts held in the Subsection VI(c) Account (Subsequent) (as defined in the Escrow Agreement). If neither any such State with respect to which this Agreement has terminated nor any Participating Manufacturer disputes such amounts or the occurrence of such termination by notice delivered to each other Notice Party not later than 10 Business Days after delivery by the Independent Auditor of the notice described in the preceding sentence, the Independent Auditor shall promptly instruct the Escrow Agent to transfer such amounts to the Participating Manufacturers (on the basis of their respective contributions of such funds). If any such State or 28 any Participating Manufacturer disputes the amounts held in the Account or the occurrence of such termination by notice delivered to each other Notice Party not later than 10 Business Days after delivery by the Independent Auditor of the notice described in the second sentence of this subsection (5)(C), the Independent Auditor shall promptly instruct the Escrow Agent to credit the amount disputed to the Disputed Payments Account and transfer the undisputed portion to the Participating Manufacturers (on the basis of their respective contribution of such funds). (6) Determination of amounts paid or held for the benefit of each individual Settling State. For purposes of subsections (f)(3), (f)(5)(A) and (i)(2), the portion of a payment that is made or held for the benefit of each individual Settling State shall be determined: (A) in the case of a payment credited to the Subsection IX(b) Account (First) or the Subsection IX(b) Account (Subsequent), by allocating the results of clause “Eighth” of subsection IX(j) among those Settling States who were Settling States at the time that the amount of such payment was calculated, pro rata in proportion to their respective Allocable Shares; and (B) in the case of a payment credited to the Subsection IX(c)(1) Account or the Subsection IX(c)(2) Account, by the results of clause “Twelfth” of subsection IX(j) for each individual Settling State. Provided, however, that, solely for purposes of subsection (f)(3), the Settling States may by unanimous agreement agree on a different method of allocation of amounts held in the Accounts identified in this subsection (f)(6). (g) Payments to be Made Only After Final Approval. Promptly following the occurrence of Final Approval, the Settling States and the Original Participating Manufacturers shall notify the Independent Auditor of such occurrence. The Independent Auditor shall promptly thereafter notify each Notice Party of the occurrence of Final Approval and of the amounts held in the State-Specific Accounts. If neither any of the Settling States nor any of the Participating Manufacturers disputes such amounts, disputes the occurrence of Final Approval or claims that this Agreement has terminated as to any Settling State for whose benefit the funds are held in a State-Specific Account, by notice delivered to each Notice Party not later than 10 Business Days after delivery by the Independent Auditor of such notice of Final Approval, the Independent Auditor shall promptly instruct the Escrow Agent to disburse the funds held in the State-Specific Accounts to (or as directed by) the respective Settling States. If any Notice Party disputes such amounts or the occurrence of Final Approval, or claims that this Agreement has terminated as to any Settling State for whose benefit the funds are held in a State-Specific Account, by notice delivered to each other Notice Party not later than 10 Business Days after delivery by the Independent Auditor of such notice of Final Approval, the Independent Auditor shall promptly instruct the Escrow Agent to credit the amounts disputed to the Disputed Payments Account and to disburse the undisputed portion to (or as directed by) the respective Settling States. (h) Applicability to Section XVII Payments. This section XI shall not be applicable to payments made pursuant to section XVII; provided, however, that the Independent Auditor shall be responsible for calculating Relative Market Shares in connection with such payments, and the Independent Auditor shall promptly provide the results of such calculation to any Original Participating Manufacturer or Settling State that requests it do so. (i) Miscalculated or Disputed Payments. (1) Underpayments. (A) If information becomes available to the Independent Auditor not later than four years after a Payment Due Date, and such information shows that any Participating Manufacturer was instructed to make an insufficient payment on such date (“original payment”), the Independent Auditor shall promptly determine the additional payment owed by such Participating Manufacturer and the allocation of such additional payment among the applicable payees. The Independent Auditor shall then reduce such additional payment (up to the full amount of such additional payment) by any adjustments or offsets that were available to the Participating Manufacturer in question against the original payment at the time it was made (and have not since been used) but which such Participating Manufacturer was unable to use against such original payment because such adjustments or offsets were in excess of such original payment (provided that any adjustments or offsets used against such additional payment shall reduce on a dollar-for-dollar basis any remaining carry-forward held by such Participating Manufacturer with respect to such adjustment or offset). The Independent Auditor shall then add interest at the Prime Rate (calculated from the Payment Due Date in question) to the additional payment (as reduced pursuant to the preceding sentence), except that where the additional payment owed by a Participating Manufacturer is the result of an underpayment by such Participating Manufacturer caused by such Participating Manufacturer’s withholding of information as described in subsection (d)(5)(B), the applicable interest rate shall be that described in subsection IX(h). The Independent Auditor shall promptly give notice of the additional payment owed by the Participating Manufacturer in question (as reduced and/or increased as described above) to all Notice Parties, showing the new information and all calculations. Upon receipt of such notice, any Participating Manufacturer or Settling State may dispute the Independent Auditor’s calculations in the manner described in subsection (d)(3), and the Independent Auditor shall promptly notify each Notice Party of any subsequent revisions to its calculations. Not more than 15 days after receipt of such notice (or, if the Independent Auditor revises its calculations, not more than 15 days after receipt of the revisions), any Participating Manufacturer and any Settling State may dispute the Independent Auditor’s calculations in the manner prescribed in subsection (d)(6). Failure to dispute the Independent Auditor’s calculations in this manner shall constitute agreement with the Independent Auditor’s calculations, subject to the limitations set forth in subsection (d)(6). Payment of the undisputed portion of an additional payment shall be made to the Escrow Agent not more than 20 days after receipt of the notice described in this subsection (A) (or, if the Independent Auditor revises its calculations, not more than 20 days after receipt of the revisions). Failure to pay such portion shall render the Participating Manufacturer liable for interest thereon as provided in subsection IX(h). Payment of the disputed portion shall be governed by subsection (d)(8). 29 (B) To the extent a dispute as to a prior payment is resolved with finality against a Participating Manufacturer: (i) in the case where the disputed amount has been paid into the Disputed Payments Account pursuant to subsection (d)(8), the Independent Auditor shall instruct the Escrow Agent to transfer such amount to the applicable payee Account(s); (ii) in the case where the disputed amount has not been paid into the Disputed Payments Account and the dispute was identified prior to the Payment Due Date in question by delivery of a statement pursuant to subsection (d)(6) identifying such dispute, the Independent Auditor shall calculate interest on the disputed amount from the Payment Due Date in question (the applicable interest rate to be that provided in subsection IX(h)) and the allocation of such amount and interest among the applicable payees, and shall provide notice of the amount owed (and the identity of the payor and payees) to all Notice Parties; and (iii) in all other cases, the procedure described in subsection (ii) shall apply, except that the applicable interest rate shall be the Prime Rate. (2) Overpayments. (A) If a dispute as to a prior payment is resolved with finality in favor of a Participating Manufacturer where the disputed amount has been paid into the Disputed Payments Account pursuant to subsection (d)(8), the Independent Auditor shall instruct the Escrow Agent to transfer such amount to such Participating Manufacturer. (B) If information becomes available to the Independent Auditor not later than four years after a Payment Due Date showing that a Participating Manufacturer made an overpayment on such date, or if a dispute as to a prior payment is resolved with finality in favor of a Participating Manufacturer where the disputed amount has been paid but not into the Disputed Payments Account, such Participating Manufacturer shall be entitled to a continuing dollar-for-dollar offset as follows: (i) offsets under this subsection (B) shall be applied only against eligible payments to be made by such Participating Manufacturer after the entitlement to the offset arises. The eligible payments shall be: in the case of offsets arising from payments under subsection IX(b) or IX(c)(1), subsequent payments under any of such subsections; in the case of offsets arising from payments under subsection IX(c)(2), subsequent payments under such subsection or, if no subsequent payments are to be made under such subsection, subsequent payments under subsection IX(c)(1); in the case of offsets arising from payments under subsection IX(e), subsequent payments under such subsection or subsection IX(c); in the case of offsets arising from payments under subsection VI(c), subsequent payments under such subsection or, if no subsequent payments are to be made under such subsection, subsequent payments under any of subsection IX(c)(1), IX(c)(2) or IX(e); in the case of offsets arising from payments under subsection VIII(b), subsequent payments under such subsection or, if no subsequent payments are to be made under such subsection, subsequent payments under either subsection IX(c)(1) or IX(c)(2); in the case of offsets arising from payments under subsection VIII(c), subsequent payments under either subsection IX(c)(1) or IX(c)(2); and, in the case of offsets arising from payments under subsection IX(i), subsequent payments under such subsection (consistent with the provisions of this subsection (B)(i)). (ii) in the case of offsets to be applied against payments under subsection IX(c), the offset to be applied shall be apportioned among the Settling States pro rata in proportion to their respective shares of such payments, as such respective shares are determined pursuant to step E of clause “Seventh” (in the case of payments due from the Original Participating Manufacturers) or clause “Sixth” (in the case of payments due from the Subsequent Participating Manufacturers) of subsection IX(j) (except where the offset arises from an overpayment applicable solely to a particular Settling State). (iii) the total amount of the offset to which a Participating Manufacturer shall be entitled shall be the full amount of the overpayment it made, together with interest calculated from the time of the overpayment to the Payment Due Date of the first eligible payment against which the offset may be applied. The applicable interest rate shall be the Prime Rate (except that, where the overpayment is the result of a Settling State’s withholding of information as described in subsection (d)(5)(B), the applicable interest rate shall be that described in subsection IX(h)). (iv) an offset under this subsection (B) shall be applied up to the full amount of the Participating Manufacturer’s share (in the case of payments due from Original Participating Manufacturers, determined as described in the first sentence of clause “Seventh” of subsection IX(j) (or, in the case of payments pursuant to subsection IX(c), step D of such clause)) of the eligible payment in question, as such payment has been adjusted and reduced pursuant to clauses “First” through “Sixth” of subsection IX(j), to the extent each such clause is applicable to the payment in question. In the event that the offset to which a Participating Manufacturer is entitled under this subsection (B) would exceed such Participating Manufacturer’s share of the eligible payment against which it is being applied (or, in the case where such offset arises from an overpayment applicable solely to a particular Settling State, the portion of such payment that is made for the benefit of such Settling State), the offset shall be the full amount of such Participating Manufacturer’s share of such payment and all amounts not offset shall carry forward and be offset against subsequent eligible payments until all such amounts have been offset. (j) Payments After Applicable Condition. To the extent that a payment is made after the occurrence of all applicable conditions for the disbursement of such payment to the payee(s) in question, the Independent Auditor shall instruct the Escrow Agent to disburse such payment promptly following its deposit. 30 XII. SETTLING STATES’ RELEASE, DISCHARGE AND COVENANT (a) Release. (1) Upon the occurrence of State-Specific Finality in a Settling State, such Settling State shall absolutely and unconditionally release and forever discharge all Released Parties from all Released Claims that the Releasing Parties directly, indirectly, derivatively or in any other capacity ever had, now have, or hereafter can, shall or may have. (2) Notwithstanding the foregoing, this release and discharge shall not apply to any defendant in a lawsuit settled pursuant to this Agreement (other than a Participating Manufacturer) unless and until such defendant releases the Releasing Parties (and delivers to the Attorney General of the applicable Settling State a copy of such release) from any and all Claims of such defendant relating to the prosecution of such lawsuit. (3) Each Settling State (for itself and for the Releasing Parties) further covenants and agrees that it (and the Releasing Parties) shall not after the occurrence of State-Specific Finality sue or seek to establish civil liability against any Released Party based, in whole or in part, upon any of the Released Claims, and further agrees that such covenant and agreement shall be a complete defense to any such civil action or proceeding. (4) (A) Each Settling State (for itself and for the Releasing Parties) further agrees that, if a Released Claim by a Releasing Party against any person or entity that is not a Released Party (a “non-Released Party”) results in or in any way gives rise to a claim-over (on any theory whatever other than a claim based on an express written indemnity agreement) by such non-Released Party against any Released Party (and such Released Party gives notice to the applicable Settling State within 30 days of the service of such claim-over (or within 30 days after the MSA Execution Date, whichever is later) and prior to entry into any settlement of such claim-over), the Releasing Party: (i) shall reduce or credit against any judgment or settlement such Releasing Party may obtain against such non-Released Party the full amount of any judgment or settlement such non-Released Party may obtain against the Released Party on such claim-over; and (ii) shall, as part of any settlement with such non-Released Party, obtain from such non-Released Party for the benefit of such Released Party a satisfaction in full of such non-Released Party’s judgment or settlement against the Released Party. (B) Each Settling State further agrees that in the event that the provisions of subsection (4)(A) do not fully eliminate any and all liability of any Original Participating Manufacturer (or of any person or entity that is a Released Party by virtue of its relation to any Original Participating Manufacturer) with respect to claims-over (on any theory whatever other than a claim based on an express written indemnity agreement) by any non-Released Party to recover in whole or in part any liability (whether direct or indirect, or whether by way of settlement (to the extent that such Released Party has given notice to the applicable Settling State within 30 days of the service of such claim-over (or within 30 days after the MSA Execution Date, whichever is later) and prior to entry into any settlement of such claim-over), judgment or otherwise) of such non-Released Party to any Releasing Party arising out of any Released Claim, such Original Participating Manufacturer shall receive a continuing dollar-for-dollar offset for any amounts paid by such Original Participating Manufacturer (or by any person or entity that is a Released Party by virtue of its relation to such Original Participating Manufacturer) on any such liability against such Original Participating Manufacturer’s share (determined as described in step E of clause “Seventh” of subsection IX(j)) of the applicable Settling State’s Allocated Payment, up to the full amount of such Original Participating Manufacturer’s share of such Allocated Payment each year, until all such amounts paid on such liability have been offset. In the event that the offset under this subsection (4) with respect to a particular Settling State would in any given year exceed such Original Participating Manufacturer’s share of such Settling State’s Allocated Payment (as such share had been reduced by adjustment, if any, pursuant to the NPM Adjustment, and has been reduced by offsets, if any, pursuant to the offset for miscalculated or disputed payments, the Federal Tobacco Legislation Offset and the Litigating Releasing Parties Offset): (i) the offset to which such Original Participating Manufacturer is entitled under this subsection in such year shall be the full amount of such Original Participating Manufacturer’s share of such Allocated Payment; and (ii) all amounts not offset by reason of subsection (i) shall carry forward and be offset in the following year(s) until all such amounts have been offset. (C) Each Settling State further agrees that, subject to the provisions of section IX(i)(3), each Subsequent Participating Manufacturer shall be entitled to the offset described in subsection (B) above to the extent that it (or any person or entity that is a Released Party by virtue of its relationship with such Subsequent Participating Manufacturer) has paid on liability that would give rise to an offset under such subsection if paid by an Original Participating Manufacturer. (5) This release and covenant shall not operate to interfere with a Settling State’s ability to enforce as against any Participating Manufacturer the provisions of this Agreement, or with the Court’s ability to enter the Consent Decree or to maintain continuing jurisdiction to enforce such Consent Decree pursuant to the terms thereof. Provided, however, that neither subsection III(a) or III(r) of this Agreement nor subsection V(A) or V(I) of the Consent Decree shall create a right to challenge the continuation, after the MSA Execution Date, of any advertising content, claim or slogan (other than use of a Cartoon) that was not unlawful prior to the MSA Execution Date. (6) The Settling States do not purport to waive or release any claims on behalf of Indian tribes. (7) The Settling States do not waive or release any criminal liability based on federal, state or local law. 31 (8) Notwithstanding the foregoing (and the definition of Released Parties), this release and covenant shall not apply to retailers, suppliers or distributors to the extent of any liability arising from the sale or distribution of Tobacco Products of, or the supply of component parts of Tobacco Products to, any non-Released Party. (A) Each Settling State (for itself and for the Releasing Parties) agrees that, if a claim by a Releasing Party against a retailer, supplier or distributor that would be a Released Claim but for the operation of the preceding sentence results in or in any way gives rise to a claim-over (on any theory whatever) by such retailer, supplier or distributor against any Released Party (and such Released Party gives notice to the applicable Settling State within 30 days of the service of such claim-over (or within 30 days after the MSA Execution Date, whichever is later) and prior to entry into any settlement of such claim-over), the Releasing Party: (i) shall reduce or credit against any judgment or settlement such Releasing Party may obtain against such retailer, supplier or distributor the full amount of any judgment or settlement such retailer, supplier or distributor may obtain against the Released Party on such claim-over; and (ii) shall, as part of any settlement with such retailer, supplier or distributor, obtain from such retailer, supplier or distributor for the benefit of such Released Party a satisfaction in full of such retailer’s, supplier’s or distributor’s judgment or settlement against the Released Party. (B) Each Settling State further agrees that in the event that the provisions of subsection (8)(A) above do not fully eliminate any and all liability of any Original Participating Manufacturer (or any person or entity that is a Released Party by virtue of its relationship to an Original Participating Manufacturer) with respect to claims-over (on any theory whatever) by any such retailer, supplier or distributor to recover in whole or in part any liability (whether direct or indirect, or whether by way of settlement (to the extent that such Released Party has given notice to the applicable Settling State within 30 days of the service of such claim-over (or within 30 days after the MSA Execution Date, whichever is later) and prior to entry into any settlement of such claim-over), judgment or otherwise) of such retailer, supplier or distributor to any Releasing Party arising out of any claim that would be a Released Claim but for the operation of the first sentence of this subsection (8), such Original Participating Manufacturer shall receive a continuing dollar-for-dollar offset for any amounts paid by such Original Participating Manufacturer (or by any person or entity that is a Released Party by virtue of its relation to such Original Participating Manufacturer) on any such liability against such Original Participating Manufacturer’s share (determined as described in step E of clause “Seventh” of subsection IX(j)) of the applicable Settling State’s Allocated Payment, up to the full amount of such Original Participating Manufacturer’s share of such Allocated Payment each year, until all such amounts paid on such liability have been offset. In the event that the offset under this subsection (8) with respect to a particular Settling State would in any given year exceed such Original Participating Manufacturer’s share of such Settling State’s Allocated Payment (as such share had been reduced by adjustment, if any, pursuant to the NPM Adjustment, and has been reduced by offsets, if any, pursuant to the offset for miscalculated or disputed payments, the Federal Tobacco Legislation Offset, the Litigating Releasing Parties Offset and the offset for claims-over under subsection XII(a)(4)(B)): (i) the offset to which such Original Participating Manufacturer is entitled under this subsection in such year shall be the full amount of such Original Participating Manufacturer’s share of such Allocated Payment; and (ii) all amounts not offset by reason of clause (i) shall carry forward and be offset in the following year(s) until all such amounts have been offset. (C) Each Settling State further agrees that, subject to the provisions of subsection IX(i)(3), each Subsequent Participating Manufacturer shall be entitled to the offset described in subsection (B) above to the extent that it (or any person or entity that is a Released Party by virtue of its relationship with such Subsequent Participating Manufacturer) has paid on liability that would give rise to an offset under such subsection if paid by an Original Participating Manufacturer. (9) Notwithstanding any provision of law, statutory or otherwise, which provides that a general release does not extend to claims which the creditor does not know or suspect to exist in its favor at the time of executing the release, which if known by it must have materially affected its settlement with the debtor, the releases set forth in this section XII release all Released Claims against the Released Parties, whether known or unknown, foreseen or unforeseen, suspected or unsuspected, that the Releasing Parties may have against the Released Parties, and the Releasing Parties understand and acknowledge the significance and consequences of waiver of any such provision and hereby assume full responsibility for any injuries, damages or losses that the Releasing Parties may incur. (b) Released Claims Against Released Parties. If a Releasing Party (or any person or entity enumerated in subsection II(pp), without regard to the power of the Attorney General to release claims of such person or entity) nonetheless attempts to maintain a Released Claim against a Released Party, such Released Party shall give written notice of such potential claim to the Attorney General of the applicable Settling State within 30 days of receiving notice of such potential claim (or within 30 days after the MSA Execution Date, whichever is later) (unless such potential claim is being maintained by such Settling State). The Released Party may offer the release and covenant as a complete defense. If it is determined at any point in such action that the release of such claim is unenforceable or invalid for any reason (including, but not limited to, lack of authority to release such claim), the following provisions shall apply: (1) The Released Party shall take all ordinary and reasonable measures to defend the action fully. The Released Party may settle or enter into a stipulated judgment with respect to the action at any time in its sole discretion, but in such event the offset described in subsection (b)(2) or (b)(3) below shall apply only if the Released Party obtains the relevant Attorney General’s consent to such settlement or stipulated judgment, which consent shall not be unreasonably withheld. The Released Party shall not be entitled to the offset described in subsection (b)(2) or (b)(3) below if such Released Party failed to take ordinary and reasonable measures to defend the action fully. 32 (2) The following provisions shall apply where the Released Party is an Original Participating Manufacturer (or any person or entity that is a Released Party by virtue of its relationship with an Original Participating Manufacturer): (A) In the event of a settlement or stipulated judgment, the settlement or stipulated amount shall give rise to a continuing offset as such amount is actually paid against the full amount of such Original Participating Manufacturer’s share (determined as described in step E of clause “Seventh” of subsection IX(j)) of the applicable Settling State’s Allocated Payment until such time as the settlement or stipulated amount is fully credited on a dollar-for-dollar basis. (B) Judgments (other than a default judgment) against a Released Party in such an action shall, upon payment of such judgment, give rise to an immediate and continuing offset against the full amount of such Original Participating Manufacturer’s share (determined as described in subsection (A)) of the applicable Settling State’s Allocated Payment, until such time as the judgment is fully credited on a dollar-for-dollar basis. (C) Each Settling State reserves the right to intervene in such an action (unless such action was brought by the Settling State) to the extent authorized by applicable law in order to protect the Settling State’s interest under this Agreement. Each Participating Manufacturer agrees not to oppose any such intervention. (D) In the event that the offset under this subsection (b)(2) with respect to a particular Settling State would in any given year exceed such Original Participating Manufacturer’s share of such Settling State’s Allocated Payment (as such share had been reduced by adjustment, if any, pursuant to the NPM Adjustment, and has been reduced by offsets, if any, pursuant to the Federal Tobacco Legislation Offset and the offset for miscalculated or disputed payments): (i) the offset to which such Original Participating Manufacturer is entitled under this subsection (2) in such year shall be the full amount of such Original Participating Manufacturer’s share of such Allocated Payment; and (ii) all amounts not offset by reason of clause (i) shall carry forward and be offset in the following year(s) until all such amounts have been offset. (3) The following provisions shall apply where the Released Party is a Subsequent Participating Manufacturer (or any person or entity that is a Released Party by virtue of its relationship with a Subsequent Participating Manufacturer): Subject to the provisions of subsection IX(i)(3), each Subsequent Participating Manufacturer shall be entitled to the offset as described in subsections (2)(A)-(C) above against payments it otherwise would owe under section IX(i) to the extent that it (or any person or entity that is a Released Party by virtue of its relationship with such Subsequent Participating Manufacturer) has paid on a settlement, stipulated judgment or judgment that would give rise to an offset under such subsections if paid by an Original Participating Manufacturer. XIII. CONSENT DECREES AND DISMISSAL OF CLAIMS (a) Within 10 days after the MSA Execution Date (or, as to any Settling State identified in the Additional States provision of Exhibit D, concurrently with the filing of its lawsuit), each Settling State and each Participating Manufacturer that is a party in any of the lawsuits identified in Exhibit D shall jointly move for a stay of all proceedings in such Settling State’s lawsuit with respect to the Participating Manufacturers and all other Released Parties (except any proceeding seeking public disclosure of documents pursuant to subsection IV(b)). Such stay of a Settling State’s lawsuit shall be dissolved upon the earlier of the occurrence of State-Specific Finality or termination of this Agreement with respect to such Settling State pursuant to subsection XVIII(u)(1). (b) Not later than December 11, 1998 (or, as to any Settling State identified in the Additional States provision of Exhibit D, concurrently with the filing of its lawsuit): (1) each Settling State that is a party to a lawsuit identified in Exhibit D and each Participating Manufacturer will: (A) tender this Agreement to the Court in such Settling State for its approval; and (B) tender to the Court in such Settling State for entry a consent decree conforming to the model consent decree attached hereto as Exhibit L (revisions or changes to such model consent decree shall be limited to the extent required by state procedural requirements to reflect accurately the factual setting of the case in question, but shall not include any substantive revision to the duties or obligations of any Settling State or Participating Manufacturer, except by agreement of all Original Participating Manufacturers); and (2) each Settling State shall seek entry of an order of dismissal of claims dismissing with prejudice all claims against the Participating Manufacturers and any other Released Party in such Settling State’s action identified in Exhibit D. Provided, however, that the Settling State is not required to seek entry of such an order in such Settling State’s action against such a Released Party (other than a Participating Manufacturer) unless and until such Released Party has released the Releasing Parties (and delivered to the Attorney General of such Settling State a copy of such release) (which release shall be effective upon the occurrence of State-Specific Finality in such Settling State, and shall recite that in the event this Agreement is terminated with respect to such Settling State pursuant to subsection XVIII(u)(1) the Released Party agrees that the order of dismissal shall be null and void and of no effect) from any and all Claims of such Released Party relating to the prosecution of such action as provided in subsection XII(a)(2). 33 XIV. PARTICIPATING MANUFACTURERS’ DISMISSAL OF RELATED LAWSUITS (a) Upon State-Specific Finality in a Settling State, each Participating Manufacturer will dismiss without prejudice (and without costs and fees) the lawsuit(s) listed in Exhibit M pending in such Settling State in which the Participating Manufacturer is a plaintiff. Within 10 days after the MSA Execution Date, each Participating Manufacturer and each Settling State that is a party in any of the lawsuits listed in Exhibit M shall jointly move for a stay of all proceedings in such lawsuit. Such stay of a lawsuit against a Settling State shall be dissolved upon the earlier of the occurrence of State- Specific Finality in such Settling State or termination of this Agreement with respect to such Settling State pursuant to subsection XVIII(u)(1). (b) Upon State-Specific Finality in a Settling State, each Participating Manufacturer will release and discharge any and all monetary Claims against such Settling State and any of such Settling State’s officers, employees, agents, administrators, representatives, officials acting in their official capacity, agencies, departments, commissions, divisions and counsel relating to or in connection with the lawsuit(s) commenced by the Attorney General of such Settling State identified in Exhibit D. (c) Upon State-Specific Finality in a Settling State, each Participating Manufacturer will release and discharge any and all monetary Claims against all subdivisions (political or otherwise, including, but not limited to, municipalities, counties, parishes, villages, unincorporated districts and hospital districts) of such Settling State, and any of their officers, employees, agents, administrators, representatives, officials acting in their official capacity, agencies, departments, commissions, divisions and counsel arising out of Claims that have been waived and released with continuing full force and effect pursuant to section XII of this Agreement. XV. VOLUNTARY ACT OF THE PARTIES The Settling States and the Participating Manufacturers acknowledge and agree that this Agreement is voluntarily entered into by each Settling State and each Participating Manufacturer as the result of arm’s-length negotiations, and each Settling State and each Participating Manufacturer was represented by counsel in deciding to enter into this Agreement. Each Participating Manufacturer further acknowledges that it understands that certain provisions of this Agreement may require it to act or refrain from acting in a manner that could otherwise give rise to state or federal constitutional challenges and that, by voluntarily consenting to this Agreement, it (and the Tobacco-Related Organizations (or any trade associations formed or controlled by any Participating Manufacturer)) waives for purposes of performance of this Agreement any and all claims that the provisions of this Agreement violate the state or federal constitutions. Provided, however, that nothing in the foregoing shall constitute a waiver as to the entry of any court order (or any interpretation thereof) that would operate to limit the exercise of any constitutional right except to the extent of the restrictions, limitations or obligations expressly agreed to in this Agreement or the Consent Decree. XVI. CONSTRUCTION (a) No Settling State or Participating Manufacturer shall be considered the drafter of this Agreement or any Consent Decree, or any provision of either, for the purpose of any statute, case law or rule of interpretation or construction that would or might cause any provision to be construed against the drafter. (b) Nothing in this Agreement shall be construed as approval by the Settling States of any Participating Manufacturer’s business organizations, operations, acts or practices, and no Participating Manufacturer may make any representation to the contrary. XVII. RECOVERY OF COSTS AND ATTORNEYS’ FEES (a) The Original Participating Manufacturers agree that, with respect to any Settling State in which the Court has approved this Agreement and the Consent Decree, they shall severally reimburse the following “Governmental Entities”: (1) the office of the Attorney General of such Settling State; (2) the office of the governmental prosecuting authority for any political subdivision of such Settling State with a lawsuit pending against any Participating Manufacturer as of July 1, 1998 (as identified in Exhibit N) that has released such Settling State and such Participating Manufacturer(s) from any and all Released Claims (a “Litigating Political Subdivision”); and (3) other appropriate agencies of such Settling State and such Litigating Political Subdivision, for reasonable costs and expenses incurred in connection with the litigation or resolution of claims asserted by or against the Participating Manufacturers in the actions set forth in Exhibits D, M and N; provided that such costs and expenses are of the same nature as costs and expenses for which the Original Participating Manufacturers would reimburse their own counsel or agents (but not including costs and expenses relating to lobbying activities). (b) The Original Participating Manufacturers further agree severally to pay the Governmental Entities in any Settling State in which State-Specific Finality has occurred an amount sufficient to compensate such Governmental Entities for time reasonably expended by attorneys and paralegals employed in such offices in connection with the litigation or resolution of claims asserted against or by the Participating Manufacturers in the actions identified in Exhibits D, M and N (but not including time relating to lobbying activities), such amount to be calculated based upon hourly rates equal to the market rate in such Settling State for private attorneys and paralegals of equivalent experience and seniority. (c) Such Governmental Entities seeking payment pursuant to subsection (a) and/or (b) shall provide the Original Participating Manufacturers with an appropriately documented statement of all costs, expenses and attorney and paralegal time for which payment is sought, and, solely with respect to payments sought pursuant to subsection (b), shall do so no earlier than the date on which State-Specific Finality occurs in such Settling State. All amounts to be paid pursuant to 34 subsections (a) and (b) shall be subject to reasonable verification if requested by any Original Participating Manufacturer; provided, however, that nothing contained in this subsection (c) shall constitute, cause, or require the performance of any act that would constitute any waiver (in whole or in part) of any attorney-client privilege, work product protection or common interest/joint prosecution privilege. All such amounts to be paid pursuant to subsections (a) and (b) shall be subject to an aggregate cap of $150 million for all Settling States, shall be paid promptly following submission of the appropriate documentation (and the completion of any verification process), shall be paid separately and apart from any other amounts due pursuant to this Agreement, and shall be paid severally by each Original Participating Manufacturer according to its Relative Market Share. All amounts to be paid pursuant to subsection (b) shall be paid to such Governmental Entities in the order in which State-Specific Finality has occurred in such Settling States (subject to the $150 million aggregate cap). (d) The Original Participating Manufacturers agree that, upon the occurrence of State-Specific Finality in a Settling State, they will severally pay reasonable attorneys’ fees to the private outside counsel, if any, retained by such Settling State (and each Litigating Political Subdivision, if any, within such Settling State) in connection with the respective actions identified in Exhibits D, M and N and who are designated in Exhibit S for each Settling State by the relevant Attorney General (and for each Litigating Political Subdivision, as later certified in writing to the Original Participating Manufacturers by the relevant governmental prosecuting authority of each Litigating Political Subdivision) as having been retained by and having represented such Settling State (or such Litigating Political Subdivision), in accordance with the terms described in the Model Fee Payment Agreement attached as Exhibit O. XVIII. MISCELLANEOUS (a) Effect of Current or Future Law. If any current or future law includes obligations or prohibitions applying to Tobacco Product Manufacturers related to any of the provisions of this Agreement, each Participating Manufacturer shall comply with this Agreement unless compliance with this Agreement would violate such law. (b) Limited Most-Favored Nation Provision. (1) If any Participating Manufacturer enters into any future settlement agreement of other litigation comparable to any of the actions identified in Exhibit D brought by a non-foreign governmental plaintiff other than the federal government (“Future Settlement Agreement”): (A) before October 1, 2000, on overall terms more favorable to such governmental plaintiff than the overall terms of this Agreement (after due consideration of relevant differences in population or other appropriate factors), then, unless a majority of the Settling States determines that the overall terms of the Future Settlement Agreement are not more favorable than the overall terms of this Agreement, the overall terms of this Agreement will be revised so that the Settling States will obtain treatment with respect to such Participating Manufacturer at least as relatively favorable as the overall terms provided to any such governmental plaintiff; provided, however, that as to economic terms this Agreement shall not be revised based on any such Future Settlement Agreement if such Future Settlement Agreement is entered into after: (i) the impaneling of the jury (or, in the event of a non-jury trial, the commencement of trial) in such litigation or any severed or bifurcated portion thereof; or (ii) any court order or judicial determination relating to such litigation that (x) grants judgment (in whole or in part) against such Participating Manufacturer; or (y) grants injunctive or other relief that affects the assets or on-going business activities of such Participating Manufacturer in a manner other than as expressly provided for in this Agreement; or (B) on or after October 1, 2000, on non-economic terms more favorable to such governmental plaintiff than the non-economic terms of this Agreement, and such Future Settlement Agreement includes terms that provide for the implementation of non-economic tobacco-related public health measures different from those contained in this Agreement, then this Agreement shall be revised with respect to such Participating Manufacturer to include terms comparable to such non-economic terms, unless a majority of the Settling States elects against such revision. (2) If any Settling State resolves by settlement Claims against any Non-Participating Manufacturer after the MSA Execution Date comparable to any Released Claim, and such resolution includes overall terms that are more favorable to such Non-Participating Manufacturer than the terms of this Agreement (including, without limitation, any terms that relate to the marketing or distribution of Tobacco Products and any term that provides for a lower settlement cost on a per pack sold basis), then the overall terms of this Agreement will be revised so that the Original Participating Manufacturers will obtain, with respect to that Settling State, overall terms at least as relatively favorable (taking into account, among other things, all payments previously made by the Original Participating Manufacturers and the timing of any payments) as those obtained by such Non-Participating Manufacturer pursuant to such resolution of Claims. The foregoing shall include but not be limited: (a) to the treatment by any Settling State of a Future Affiliate, as that term is defined in agreements between any of the Settling States and Brooke Group Ltd., Liggett & Myers Inc. and/or Liggett Group, Inc. (“Liggett”), whether or not such Future Affiliate is merged with, or its operations combined with, Liggett or any Affiliate thereof; and (b) to any application of the terms of any such agreement (including any terms subsequently negotiated pursuant to any such agreement) to a brand of Cigarettes (or tobacco-related assets) as a result of the purchase by or sale to Liggett of such brand or assets or as a result of any combination of ownership among Liggett and any entity that manufactures Tobacco Products. Provided, however, that revision of this Agreement pursuant to this subsection (2) shall not be required by virtue of the subsequent entry into this Agreement by a Tobacco Product Manufacturer that has not become a Participating Manufacturer as of the MSA Execution Date. Notwithstanding the provisions of subsection XVIII(j), the provisions of this subsection XVIII(b)(2) may be waived by (and only by) unanimous agreement of the Original Participating Manufacturers. 35 (3) The parties agree that if any term of this Agreement is revised pursuant to subsection (b)(l) or (b)(2) above and the substance of such term before it was revised was also a term of the Consent Decree, each affected Settling State and each affected Participating Manufacturer shall jointly move the Court to amend the Consent Decree to conform the terms of the Consent Decree to the revised terms of the Agreement. (4) If at any time any Settling State agrees to relieve, in any respect, any Participating Manufacturer’s obligation to make the payments as provided in this Agreement, then, with respect to that Settling State, the terms of this Agreement shall be revised so that the other Participating Manufacturers receive terms as relatively favorable. (c) Transfer of Tobacco Brands. No Original Participating Manufacturer may sell or otherwise transfer or permit the sale or transfer of any of its Cigarette brands, Brand Names, Cigarette product formulas or Cigarette businesses (other than a sale or transfer of Cigarette brands or Brand Names to be sold, product formulas to be used, or Cigarette businesses to be conducted, by the acquiror or transferee exclusively outside of the States) to any person or entity unless such person or entity is an Original Participating Manufacturer or prior to the sale or acquisition agrees to assume the obligations of an Original Participating Manufacturer with respect to such Cigarette brands, Brand Names, Cigarette product formulas or businesses. No Participating Manufacturer may sell or otherwise transfer any of its Cigarette brands, Brand Names, Cigarette product formulas or Cigarette businesses (other than a sale or transfer of Cigarette brands or Brand Names to be sold, Cigarette product formulas to be used, or businesses to be conducted, by the acquiror or transferee exclusively outside of the States) to any person or entity unless such person or entity is or becomes prior to the sale or acquisition a Participating Manufacturer. In the event of any such sale or transfer of a Cigarette brand, Brand Name, Cigarette product formula or Cigarette business by a Participating Manufacturer to a person or entity that within 180 days prior to such sale or transfer was a Non-Participating Manufacturer, the Participating Manufacturer shall certify to the Settling States that it has determined that such person or entity has the capability to perform the obligations under this Agreement. Such certification shall not survive beyond one year following the date of any such transfer. Each Original Participating Manufacturer certifies and represents that, except as provided in Exhibit R, it (or a wholly owned Affiliate) exclusively owns and controls in the States the Brand Names of those Cigarettes that it currently manufactures for sale (or sells) in the States and that it has the capacity to enter into an effective agreement concerning the sale or transfer of such Brand Names pursuant to this subsection XVIII(c). Nothing in this Agreement is intended to create any right for a State to obtain any Cigarette product formula that it would not otherwise have under applicable law. (d) Payments in Settlement. All payments to be made by the Participating Manufacturers pursuant to this Agreement are in settlement of all of the Settling States’ antitrust, consumer protection, common law negligence, statutory, common law and equitable claims for monetary, restitutionary, equitable and injunctive relief alleged by the Settling States with respect to the year of payment or earlier years, except that no part of any payment under this Agreement is made in settlement of an actual or potential liability for a fine, penalty (civil or criminal) or enhanced damages or is the cost of a tangible or intangible asset or other future benefit. (e) No Determination or Admission. This Agreement is not intended to be and shall not in any event be construed or deemed to be, or represented or caused to be represented as, an admission or concession or evidence of (1) any liability or any wrongdoing whatsoever on the part of any Released Party or that any Released Party has engaged in any of the activities barred by this Agreement; or (2) personal jurisdiction over any person or entity other than the Participating Manufacturers. Each Participating Manufacturer specifically disclaims and denies any liability or wrongdoing whatsoever with respect to the claims and allegations asserted against it by the Attorneys General of the Settling States and the Litigating Political Subdivisions. Each Participating Manufacturer has entered into this Agreement solely to avoid the further expense, inconvenience, burden and risk of litigation. (f) Non-Admissibility. The settlement negotiations resulting in this Agreement have been undertaken by the Settling States and the Participating Manufacturers in good faith and for settlement purposes only, and no evidence of negotiations or discussions underlying this Agreement shall be offered or received in evidence in any action or proceeding for any purpose. Neither this Agreement nor any public discussions, public statements or public comments with respect to this Agreement by any Settling State or Participating Manufacturer or its agents shall be offered or received in evidence in any action or proceeding for any purpose other than in an action or proceeding arising under or relating to this Agreement. (g) Representations of Parties. Each Settling State and each Participating Manufacturer hereby represents that this Agreement has been duly authorized and, upon execution, will constitute a valid and binding contractual obligation, enforceable in accordance with its terms, of each of them. The signatories hereto on behalf of their respective Settling States expressly represent and warrant that they have the authority to settle and release all Released Claims of their respective Settling States and any of their respective Settling States’ past, present and future agents, officials acting in their official capacities, legal representatives, agencies, departments, commissions and divisions, and that such signatories are aware of no authority to the contrary. It is recognized that the Original Participating Manufacturers are relying on the foregoing representation and warranty in making the payments required by and in otherwise performing under this Agreement. The Original Participating Manufacturers shall have the right to terminate this Agreement pursuant to subsection XVIII(u) as to any Settling State as to which the foregoing representation and warranty is breached or not effectively given. (h) Obligations Several, Not Joint. All obligations of the Participating Manufacturers pursuant to this Agreement (including, but not limited to, all payment obligations) are intended to be, and shall remain, several and not joint. 36 (i) Headings. The headings of the sections and subsections of this Agreement are not binding and are for reference only and do not limit, expand or otherwise affect the contents or meaning of this Agreement. (j) Amendment and Waiver. 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. (k) Notices. All notices or other communications to any party to this Agreement shall be in writing (including, but not limited to, facsimile, telex, telecopy or similar writing) and shall be given at the addresses specified in Exhibit P (as it may be amended to reflect any additional Participating Manufacturer that becomes a party to this Agreement after the MSA Execution Date). Any Settling State or Participating Manufacturer may change or add the name and address of the persons designated to receive notice on its behalf by notice given (effective upon the giving of such notice) as provided in this subsection. (l) Cooperation. Each Settling State and each Participating Manufacturer agrees to use its best efforts and to cooperate with each other to cause this Agreement and the Consent Decrees to become effective, to obtain all necessary approvals, consents and authorizations, if any, and to execute all documents and to take such other action as may be appropriate in connection herewith. Consistent with the foregoing, each Settling State and each Participating Manufacturer agrees that it will not directly or indirectly assist or encourage any challenge to this Agreement or any Consent Decree by any other person, and will support the integrity and enforcement of the terms of this Agreement and the Consent Decrees. Each Settling State shall use its best efforts to cause State-Specific Finality to occur as to such Settling State. (m) Designees to Discuss Disputes. Within 14 days after the MSA Execution Date, each Settling State’s Attorney General and each Participating Manufacturer shall provide written notice of its designation of a senior representative to discuss with the other signatories to this Agreement any disputes and/or other issues that may arise with respect to this Agreement. Each Settling State’s Attorney General shall provide such notice of the name, address and telephone number of the person it has so designated to each Participating Manufacturer and to NAAG. Each Participating Manufacturer shall provide such notice of the name, address and telephone number of the person it has so designated to each Settling State’s Attorney General, to NAAG and to each other Participating Manufacturer. (n) Governing Law. This Agreement (other than the Escrow Agreement) shall be governed by the laws of the relevant Settling State, without regard to the conflict of law rules of such Settling State. The Escrow Agreement shall be governed by the laws of the State in which the Escrow Court is located, without regard to the conflict of law rules of such State. (o) Severability. (1) Sections VI, VII, IX, X, XI, XII, XIII, XIV, XVI, XVIII(b), (c), (d), (e), (f), (g), (h), (o), (p), (r), (s), (u), (w), (z), (bb), (dd), and Exhibits A, B, and E hereof (“Nonseverable Provisions”) are not severable, except to the extent that severance of section VI is permitted by Settling States pursuant to subsection VI(i) hereof. The remaining terms of this Agreement are severable, as set forth herein. (2) If a court materially modifies, renders unenforceable, or finds to be unlawful any of the Nonseverable Provisions, the NAAG executive committee shall select a team of Attorneys General (the “Negotiating Team”) to attempt to negotiate an equivalent or comparable substitute term or other appropriate credit or adjustment (a “Substitute Term”) with the Original Participating Manufacturers. In the event that the court referred to in the preceding sentence is located in a Settling State, the Negotiating Team shall include the Attorney General of such Settling State. The Original Participating Manufacturers shall have no obligation to agree to any Substitute Term. If any Original Participating Manufacturer does not agree to a Substitute Term, this Agreement shall be terminated in all Settling States affected by the court’s ruling. The Negotiating Team shall submit any proposed Substitute Term negotiated by the Negotiating Team and agreed to by all of the Original Participating Manufacturers to the Attorneys General of all of the affected Settling States for their approval. If any affected Settling State does not approve the proposed Substitute Term, this Agreement in such Settling State shall be terminated. (3) If a court materially modifies, renders unenforceable, or finds to be unlawful any term of this Agreement other than a Nonseverable Provision: (A) The remaining terms of this Agreement shall remain in full force and effect. (B) Each Settling State whose rights or obligations under this Agreement are affected by the court’s decision in question (the “Affected Settling State”) and the Participating Manufacturers agree to negotiate in good faith a Substitute Term. Any agreement on a Substitute Term reached between the Participating Manufacturers and the Affected Settling State shall not modify or amend the terms of this Agreement with regard to any other Settling State. 37 (C) If the Affected Settling State and the Participating Manufacturers are unable to agree on a Substitute Term, then they will submit the issue to non-binding mediation. If mediation fails to produce agreement to a Substitute Term, then that term shall be severed and the remainder of this Agreement shall remain in full force and effect. (4) If a court materially modifies, renders unenforceable, or finds to be unlawful any portion of any provision of this Agreement, the remaining portions of such provision shall be unenforceable with respect to the affected Settling State unless a Substitute Term is arrived at pursuant to subsection (o)(2) or (o)(3) hereof, whichever is applicable. (p) Intended Beneficiaries. No portion of this Agreement shall provide any rights to, or be enforceable by, any person or entity that is not a Settling State or a Released Party. No Settling State may assign or otherwise convey any right to enforce any provision of this Agreement. (q) Counterparts. This Agreement may be executed in counterparts. Facsimile or photocopied signatures shall be considered as valid signatures as of the date affixed, although the original signature pages shall thereafter be appended. (r) Applicability. The obligations and duties of each Participating Manufacturer set forth herein are applicable only to actions taken (or omitted to be taken) within the States. This subsection (r) shall not be construed as extending the territorial scope of any obligation or duty set forth herein whose scope is otherwise limited by the terms hereof. (s) Preservation of Privilege. Nothing contained in this Agreement or any Consent Decree, and no act required to be performed pursuant to this Agreement or any Consent Decree, is intended to constitute, cause or effect any waiver (in whole or in part) of any attorney-client privilege, work product protection or common interest/joint defense privilege, and each Settling State and each Participating Manufacturer agrees that it shall not make or cause to be made in any forum any assertion to the contrary. (t) Non-Release. Except as otherwise specifically provided in this Agreement, nothing in this Agreement shall limit, prejudice or otherwise interfere with the rights of any Settling State or any Participating Manufacturer to pursue any and all rights and remedies it may have against any Non-Participating Manufacturer or other non-Released Party. (u) Termination. (1) Unless otherwise agreed to by each of the Original Participating Manufacturers and the Settling State in question, in the event that (A) State-Specific Finality in a Settling State does not occur in such Settling State on or before December 31, 2001; or (B) this Agreement or the Consent Decree has been disapproved by the Court (or, in the event of an appeal from or review of a decision of the Court to approve this Agreement and the Consent Decree, by the court hearing such appeal or conducting such review), and the time to Appeal from such disapproval has expired, or, in the event of an Appeal from such disapproval, the Appeal has been dismissed or the disapproval has been affirmed by the court of last resort to which such Appeal has been taken and such dismissal or disapproval has become no longer subject to further Appeal (including, without limitation, review by the United States Supreme Court); or (C) this Agreement is terminated in a Settling State for whatever reason (including, but not limited to, pursuant to subsection XVIII(o) of this Agreement), then this Agreement and all of its terms (except for the non-admissibility provisions hereof, which shall continue in full force and effect) shall be canceled and terminated with respect to such Settling State, and it and all orders issued by the courts in such Settling State pursuant hereto shall become null and void and of no effect. (2) If this Agreement is terminated with respect to a Settling State for whatever reason, then (A) the applicable statute of limitation or any similar time requirement shall be tolled from the date such Settling State signed this Agreement until the later of the time permitted by applicable law or for one year from the date of such termination, with the effect that the parties shall be in the same position with respect to the statute of limitation as they were at the time such Settling State filed its action, and (B) the parties shall jointly move the Court for an order reinstating the actions and claims dismissed pursuant to sections XIII and XIV hereof, with the effect that the parties shall be in the same position with respect to those actions and claims as they were at the time the action or claim was stayed or dismissed. (v) Freedom of Information Requests. Upon the occurrence of State-Specific Finality in a Settling State, each Participating Manufacturer will withdraw in writing any and all requests for information, administrative applications, and proceedings brought or caused to be brought by such Participating Manufacturer pursuant to such Settling State’s freedom of information law relating to the subject matter of the lawsuits identified in Exhibit D. (w) Bankruptcy. The following provisions shall apply if a Participating Manufacturer both enters Bankruptcy and at any time thereafter is not timely performing its financial obligations as required under this Agreement: (1) In the event that both a number of Settling States equal to at least 75% of the total number of Settling States and Settling States having aggregate Allocable Shares equal to at least 75% of the total aggregate Allocable Shares assigned to all Settling States deem (by written notice to the Participating Manufacturers other than the bankrupt Participating Manufacturer) that the financial obligations of this Agreement have been terminated and rendered null and void as to such bankrupt Participating Manufacturer (except as provided in subsection (A) below) due to a material breach by such Participating Manufacturer, whereupon, with respect to all Settling States: (A) all agreements, all concessions, all reductions of Releasing Parties’ Claims, and all releases and covenants not to sue, contained in this Agreement shall be null and void as to such Participating Manufacturer. Provided, however, that (i) all reductions of Releasing Parties’ Claims, and all releases and covenants not to sue, contained in this Agreement shall remain in full force and effect as to all persons or entities (other than the bankrupt Participating Manufacturer itself or any person or entity that, as a result of the Bankruptcy, obtains domestic tobacco assets of such 38 Participating Manufacturer (unless such person or entity is itself a Participating Manufacturer)) who (but for the first sentence of this subsection (A)) would otherwise be Released Parties by virtue of their relationship with the bankrupt Participating Manufacturer; and (ii) in the event a Settling State asserts any Released Claim against a bankrupt Participating Manufacturer after the termination of this Agreement with respect to such Participating Manufacturer as described in this subsection (1) and receives a judgment, settlement or distribution arising from such Released Claim, then the amount of any payments such Settling State has previously received from such Participating Manufacturer under this Agreement shall be applied against the amount of any such judgment, settlement or distribution (provided that in no event shall such Settling State be required to refund any payments previously received from such Participating Manufacturer pursuant to this Agreement); (B) the Settling States shall have the right to assert any and all claims against such Participating Manufacturer in the Bankruptcy or otherwise without regard to any limits otherwise provided in this Agreement (subject to any and all defenses against such claims); (C) the Settling States may exercise all rights provided under the federal Bankruptcy Code (or other applicable bankruptcy law) with respect to their Claims against such Participating Manufacturer, including the right to initiate and complete police and regulatory actions against such Participating Manufacturer pursuant to the exceptions to the automatic stay set forth in section 362(b) of the Bankruptcy Code (provided, however, that such Participating Manufacturer may contest whether the Settling State’s action constitutes a police and regulatory action); and (D) to the extent that any Settling State is pursuing a police and regulatory action against such Participating Manufacturer as described in subsection (1)(C), such Participating Manufacturer shall not request or support a request that the Bankruptcy court utilize the authority provided under section 105 of the Bankruptcy Code to impose a discretionary stay on the Settling State’s action. The Participating Manufacturers further agree that they will not request, seek or support relief from the terms of this Agreement in any proceeding before any court of law (including the federal bankruptcy courts) or an administrative agency or through legislative action, including (without limitation) by way of joinder in or consent to or acquiescence in any such pleading or instrument filed by another. (2) Whether or not the Settling States exercise the option set forth in subsection (1) (and whether or not such option, if exercised, is valid and enforceable): (A) In the event that the bankrupt Participating Manufacturer is an Original Participating Manufacturer, such Participating Manufacturer shall continue to be treated as an Original Participating Manufacturer for all purposes under this Agreement except (i) such Participating Manufacturer shall be treated as a Non-Participating Manufacturer (and not as an Original Participating Manufacturer or Participating Manufacturer) for all purposes with respect to subsections IX(d)(1), IX(d)(2) and IX(d)(3) (including, but not limited to, that the Market Share of such Participating Manufacturer shall not be included in Base Aggregate Participating Manufacturer Market Share or Actual Aggregate Participating Manufacturer Market Share, and that such Participating Manufacturer’s volume shall not be included for any purpose under subsection IX(d)(1)(D)); (ii) such Participating Manufacturer’s Market Share shall not be included as that of a Participating Manufacturer for the purpose of determining whether the trigger percentage specified in subsection IX(e) has been achieved (provided that such Participating Manufacturer shall be treated as an Original Participating Manufacturer for all other purposes with respect to such subsection); (iii) for purposes of subsection (B)(iii) of Exhibit E, such Participating Manufacturer shall continue to be treated as an Original Participating Manufacturer, but its operating income shall be recalculated by the Independent Auditor to reflect what such income would have been had such Participating Manufacturer made the payments that would have been due under this Agreement but for the Bankruptcy; (iv) for purposes of subsection XVIII(c), such Participating Manufacturer shall not be treated as an Original Participating Manufacturer or as a Participating Manufacturer to the extent that after entry into Bankruptcy it becomes the acquiror or transferee of Cigarette brands, Brand Names, Cigarette product formulas or Cigarette businesses of any Participating Manufacturer (provided that such Participating Manufacturer shall continue to be treated as an Original Participating Manufacturer and Participating Manufacturer for all other purposes under such subsection); and (v) as to any action that by the express terms of this Agreement requires the unanimous agreement of all Original Participating Manufacturers. (B) In the event that the bankrupt Participating Manufacturer is a Subsequent Participating Manufacturer, such Participating Manufacturer shall continue to be treated as a Subsequent Participating Manufacturer for all purposes under this Agreement except (i) such Participating Manufacturer shall be treated as a Non-Participating Manufacturer (and not as a Subsequent Participating Manufacturer or Participating Manufacturer) for all purposes with respect to subsections IX(d)(1), (d)(2) and (d)(4) (including, but not limited to, that the Market Share of such Participating Manufacturer shall not be included in Base Aggregate Participating Manufacturer Market Share or Actual Aggregate Participating Manufacturer Market Share, and that such Participating Manufacturer’s volume shall not be included for any purpose under subsection IX(d)(1)(D)); (ii) such Participating Manufacturer’s Market Share shall not be included as that of a Participating Manufacturer for the purpose of determining whether the trigger percentage specified in subsection IX(e) has been achieved (provided that such Participating Manufacturer shall be treated as a Subsequent Participating Manufacturer for all other purposes with respect to such subsection); and (iii) for purposes of subsection XVIII(c), such Participating Manufacturer shall not be treated as a Subsequent Participating Manufacturer or as a Participating Manufacturer to the extent that after entry into Bankruptcy it becomes the acquiror or transferee of Cigarette brands, Brand Names, Cigarette product formulas or Cigarette businesses of any Participating Manufacturer (provided that such Participating Manufacturer shall 39 continue to be treated as a Subsequent Participating Manufacturer and Participating Manufacturer for all other purposes under such subsection). (C) Revision of this Agreement pursuant to subsection XVIII(b)(2) shall not be required by virtue of any resolution on an involuntary basis in the Bankruptcy of Claims against the bankrupt Participating Manufacturer. (x) Notice of Material Transfers. Each Participating Manufacturer shall provide notice to each Settling State at least 20 days before consummating a sale, transfer of title or other disposition, in one transaction or series of related transactions, of assets having a fair market value equal to five percent or more (determined in accordance with United States generally accepted accounting principles) of the consolidated assets of such Participating Manufacturer. (y) Entire Agreement. This Agreement (together with any agreements expressly contemplated hereby and any other contemporaneous written agreements) embodies the entire agreement and understanding between and among the Settling States and the Participating Manufacturers relating to the subject matter hereof and supersedes (l) all prior agreements and understandings relating to such subject matter, whether written or oral, and (2) all purportedly contemporaneous oral agreements and understandings relating to such subject matter. (z) Business Days. Any obligation hereunder that, under the terms of this Agreement, is to be performed on a day that is not a Business Day shall be performed on the first Business Day thereafter. (aa) Subsequent Signatories. With respect to a Tobacco Product Manufacturer that signs this Agreement after the MSA Execution Date, the timing of obligations under this Agreement (other than payment obligations, which shall be governed by subsection II(jj)) shall be negotiated to provide for the institution of such obligations on a schedule not more favorable to such subsequent signatory than that applicable to the Original Participating Manufacturers. (bb) Decimal Places. Any figure or percentage referred to in this Agreement shall be carried to seven decimal places. (cc) Regulatory Authority. Nothing in section III of this Agreement is intended to affect the legislative or regulatory authority of any local or State government. (dd) Successors. In the event that a Participating Manufacturer ceases selling a brand of Tobacco Products in the States that such Participating Manufacturer owned in the States prior to July 1, 1998, and an Affiliate of such Participating Manufacturer thereafter and after the MSA Execution Date intentionally sells such brand in the States, such Affiliate shall be considered to be the successor of such Participating Manufacturer with respect to such brand. Performance by any such successor of the obligations under this Agreement with respect to the sales of such brand shall be subject to court-ordered specific performance. (ee) Export Packaging. Each Participating Manufacturer shall place a visible indication on each pack of Cigarettes it manufactures for sale outside of the fifty United States and the District of Columbia that distinguishes such pack from packs of Cigarettes it manufactures for sale in the fifty United States and the District of Columbia. (ff) Actions Within Geographic Boundaries of Settling States. To the extent that any provision of this Agreement expressly prohibits, restricts, or requires any action to be taken “within” any Settling State or the Settling States, the relevant prohibition, restriction, or requirement applies within the geographic boundaries of the applicable Settling State or Settling States, including, but not limited to, Indian country or Indian trust land within such geographic boundaries. (gg) Notice to Affiliates. Each Participating Manufacturer shall give notice of this Agreement to each of its Affiliates. IN WITNESS WHEREOF, each Settling State and each Participating Manufacturer, through their fully authorized representatives, have agreed to this Agreement. [Signatures Intentionally Omitted] A-1 EXHIBIT A STATE ALLOCATION PERCENTAGES State Percentage Alabama 1.6161308% Alaska 0.3414187% Arizona 1.4738845% Arkansas 0.8280661% California 12.7639554% Colorado 1.3708614% Connecticut 1.8565373% Delaware 0.3954695% D.C. 0.6071183% Florida 0.0000000% Georgia 2.4544575% Hawaii 0.6018650% Idaho 0.3632632% Illinois 4.6542472% Indiana 2.0398033% Iowa 0.8696670% Kansas 0.8336712% Kentucky 1.7611586% Louisiana 2.2553531% Maine 0.7693505% Maryland 2.2604570% Massachusetts 4.0389790% Michigan 4.3519476% Minnesota 0.0000000% Mississippi 0.0000000% Missouri 2.2746011% Montana 0.4247591% Nebraska 0.5949833% Nevada 0.6099351% New Hampshire 0.6659340% New Jersey 3.8669963% New Mexico 0.5963897% New York 12.7620310% North Carolina 2.3322850% North Dakota 0.3660138% Ohio 5.0375098% Oklahoma 1.0361370% Oregon 1.1476582% Pennsylvania 5.7468588% Rhode Island 0.7189054% South Carolina 1.1763519% South Dakota 0.3489458% Tennessee 2.4408945% Texas 0.0000000% Utah 0.4448869% Vermont 0.4111851% Virginia 2.0447451% Washington 2.0532582% West Virginia 0.8864604% Wisconsin 2.0720390% Wyoming 0.2483449% American Samoa 0.0152170% N. Mariana Isld. 0.0084376% Guam 0.0219371% U.S. Virgin Isld. 0.0173593% Puerto Rico 1.1212774% Total 100.0000000% B-1 EXHIBIT B FORM OF ESCROW AGREEMENT This Escrow Agreement is entered into as of _______________, 1998 by the undersigned State officials (on behalf of their respective Settling States), the undersigned Participating Manufacturers and ____________________ as escrow agent (the “Escrow Agent”). WITNESSETH: WHEREAS, the Settling States and the Participating Manufacturers have entered into a settlement agreement entitled the “Master Settlement Agreement” (the “Agreement”); and WHEREAS, the Agreement requires the Settling States and the Participating Manufacturers to enter into this Escrow Agreement. NOW, THEREFORE, the parties hereto agree as follows: SECTION 1. Appointment of Escrow Agent. The Settling States and the Participating Manufacturers hereby appoint ______________________ to serve as Escrow Agent under this Agreement on the terms and conditions set forth herein, and the Escrow Agent, by its execution hereof, hereby accepts such appointment and agrees to perform the duties and obligations of the Escrow Agent set forth herein. The Settling States and the Participating Manufacturers agree that the Escrow Agent appointed under the terms of this Escrow Agreement shall be the Escrow Agent as defined in, and for all purposes of, the Agreement. SECTION 2. Definitions. (a) Capitalized terms used in this Escrow Agreement and not otherwise defined herein shall have the meaning given to such terms in the Agreement. (b) “Escrow Court” means the court of the State of New York to which the Agreement is presented for approval, or such other court as agreed to by the Original Participating Manufacturers and a majority of those Attorneys General who are both the Attorney General of a Settling State and a member of the NAAG executive committee at the time in question. SECTION 3. Escrow and Accounts. (a) All funds received by the Escrow Agent pursuant to the terms of the Agreement shall be held and disbursed in accordance with the terms of this Escrow Agreement. Such funds and any earnings thereon shall constitute the “Escrow” and shall be held by the Escrow Agent separate and apart from all other funds and accounts of the Escrow Agent, the Settling States and the Participating Manufacturers. (b) The Escrow Agent shall allocate the Escrow among the following separate accounts (each an “Account” and collectively the “Accounts”): SUBSECTION VI(B) ACCOUNT SUBSECTION VI(C) ACCOUNT (FIRST) SUBSECTION VI(C) ACCOUNT (SUBSEQUENT) SUBSECTION VIII(B) ACCOUNT SUBSECTION VIII(C) ACCOUNT SUBSECTION IX(B) ACCOUNT (FIRST) SUBSECTION IX(B) ACCOUNT (SUBSEQUENT) SUBSECTION IX(C)(1) ACCOUNT SUBSECTION IX(C)(2) ACCOUNT SUBSECTION IX(E) ACCOUNT DISPUTED PAYMENTS ACCOUNT STATE-SPECIFIC ACCOUNTS WITH RESPECT TO EACH SETTLING STATE IN WHICH STATE-SPECIFIC FINALITY OCCURS. (c) All amounts credited to an Account shall be retained in such Account until disbursed therefrom in accordance with the provisions of this Escrow Agreement pursuant to (i) written instructions from the Independent Auditor; or (ii) written instructions from all of the following: all of the Original Participating Manufacturers; all of the Subsequent Participating Manufacturers that contributed to such amounts in such Account; and all of the Settling States (collectively, the “Escrow Parties”). In the event of a conflict, instructions pursuant to clause (ii) shall govern over instructions pursuant to clause (i). (d) On the first Business Day after the date any payment is due under the Agreement, the Escrow Agent shall deliver to each other Notice Party a written statement showing the amount of such payment (or indicating that no payment was made, if such is the case), the source of such payment, the Account or Accounts to which such payment has been B-2 credited, and the payment instructions received by the Escrow Agent from the Independent Auditor with respect to such payment. (e) The Escrow Agent shall comply with all payment instructions received from the Independent Auditor unless before 11:00 a.m. (New York City time) on the scheduled date of payment it receives written instructions to the contrary from all of the Escrow Parties, in which event it shall comply with such instructions. (f) On the first Business Day after disbursing any funds from an Account, the Escrow Agent shall deliver to each other Notice Party a written statement showing the amount disbursed, the date of such disbursement and the payee of the disbursed funds. SECTION 4. Failure of Escrow Agent to Receive Instructions. In the event that the Escrow Agent fails to receive any written instructions contemplated by this Escrow Agreement, the Escrow Agent shall be fully protected in refraining from taking any action required under any section of this Escrow Agreement other than Section 5 until such written instructions are received by the Escrow Agent. SECTION 5. Investment of Funds by Escrow Agent. The Escrow Agent shall invest and reinvest all amounts from time to time credited to the Accounts in either (i) direct obligations of, or obligations the principal and interest on which are unconditionally guaranteed by, the United States of America; (ii) repurchase agreements fully collateralized by securities described in clause (i) above; (iii) money market accounts maturing within 30 days of the acquisition thereof and issued by a bank or trust company organized under the laws of the United States of America or of any of the 50 States thereof (a “United States Bank”) and having combined capital, surplus and undistributed profits in excess of $500,000,000; or (iv) demand deposits with any United States Bank having combined capital, surplus and undistributed profits in excess of $500,000,000. To the extent practicable, monies credited to any Account shall be invested in such a manner so as to be available for use at the times when monies are expected to be disbursed by the Escrow Agent and charged to such Account. Obligations purchased as an investment of monies credited to any Account shall be deemed at all times to be a part of such Account and the income or interest earned, profits realized or losses suffered with respect to such investments (including, without limitation, any penalty for any liquidation of an investment required to fund a disbursement to be charged to such Account), shall be credited or charged, as the case may be, to, such Account and shall be for the benefit of, or be borne by, the person or entity entitled to payment from such Account. In choosing among the investment options described in clauses (i) through (iv) above, the Escrow Agent shall comply with any instructions received from time to time from all of the Escrow Parties. In the absence of such instructions, the Escrow Agent shall invest such sums in accordance with clause (i) above. With respect to any amounts credited to a State-Specific Account, the Escrow Agent shall invest and reinvest all amounts credited to such Account in accordance with the law of the applicable Settling State to the extent such law is inconsistent with this Section 5. SECTION 6. Substitute Form W-9; Qualified Settlement Fund. Each signatory to this Escrow Agreement shall provide the Escrow Agent with a correct taxpayer identification number on a substitute Form W-9 or if it does not have such a number, a statement evidencing its status as an entity exempt from back-up withholding, within 30 days of the date hereof (and, if it supplies a Form W-9, indicate thereon that it is not subject to backup withholding). The escrow established pursuant to this Escrow Agreement is intended to be treated as a Qualified Settlement Fund for federal tax purposes pursuant to Treas. Reg. § 1.468B-l. The Escrow Agent shall comply with all applicable tax filing, payment and reporting requirements, including, without limitation, those imposed under Treas. Reg. § 1.468B, and if requested to do so shall join in the making of the relation-back election under such regulation. SECTION 7. Duties and Liabilities of Escrow Agent. The Escrow Agent shall have no duty or obligation hereunder other than to take such specific actions as are required of it from time to time under the provisions of this Escrow Agreement, and it shall incur no liability hereunder or in connection herewith for anything whatsoever other than any liability resulting from its own gross negligence or willful misconduct. The Escrow Agent shall not be bound in any way by any agreement or contract between the Participating Manufacturers and the Settling States (whether or not the Escrow Agent has knowledge thereof) other than this Escrow Agreement, and the only duties and responsibilities of the Escrow Agent shall be the duties and obligations specifically set forth in this Escrow Agreement. SECTION 8. Indemnification of Escrow Agent. The Participating Manufacturers shall indemnify, hold harmless and defend the Escrow Agent from and against any and all losses, claims, liabilities and reasonable expenses, including the reasonable fees of its counsel, which it may suffer or incur in connection with the performance of its duties and obligations under this Escrow Agreement, except for those losses, claims, liabilities and expenses resulting solely and directly from its own gross negligence or willful misconduct. SECTION 9. Resignation of Escrow Agent. The Escrow Agent may resign at any time by giving written notice thereof to the other parties hereto, but such resignation shall not become effective until a successor Escrow Agent, selected by the Original Participating Manufacturers and the Settling States, shall have been appointed and shall have accepted such appointment in writing. If an instrument of acceptance by a successor Escrow Agent shall not have been delivered to the resigning Escrow Agent within 90 days after the giving of such notice of resignation, the resigning Escrow Agent may, at the expense of the Participating Manufacturers (to B-3 be shared according to their pro rata Market Shares), petition the Escrow Court for the appointment of a successor Escrow Agent. SECTION 10. Escrow Agent Fees and Expenses. The Participating Manufacturers shall pay to the Escrow Agent its fees as set forth in Appendix A hereto as amended from time to time by agreement of the Original Participating Manufacturers and the Escrow Agent. The Participating Manufacturers shall pay to the Escrow Agent its reasonable fees and expenses, including all reasonable expenses, charges, counsel fees, and other disbursements incurred by it or by its attorneys, agents and employees in the performance of its duties and obligations under this Escrow Agreement. Such fees and expenses shall be shared by the Participating Manufacturers according to their pro rata Market Shares. SECTION 11. Notices. All notices, written instructions or other communications to any party or other person hereunder shall be given in the same manner as, shall be given to the same person as, and shall be effective at the same time as provided in subsection XVIII(k) of the Agreement. SECTION 12. Setoff; Reimbursement. The Escrow Agent acknowledges that it shall not be entitled to set off against any funds in, or payable from, any Account to satisfy any liability of any Participating Manufacturer. Each Participating Manufacturer that pays more than its pro rata Market Share of any payment that is made by the Participating Manufacturers to the Escrow Agent pursuant to Section 8, 9 or 10 hereof shall be entitled to reimbursement of such excess from the other Participating Manufacturers according to their pro rata Market Shares of such excess. SECTION 13. Intended Beneficiaries; Successors. No persons or entities other than the Settling States, the Participating Manufacturers and the Escrow Agent are intended beneficiaries of this Escrow Agreement, and only the Settling States, the Participating Manufacturers and the Escrow Agent shall be entitled to enforce the terms of this Escrow Agreement. Pursuant to the Agreement, the Settling States have designated NAAG and the Foundation as recipients of certain payments; for all purposes of this Escrow Agreement, the Settling States shall be the beneficiaries of such payments entitled to enforce payment thereof. The provisions of this Escrow Agreement shall be binding upon and inure to the benefit of the parties hereto and, in the case of the Escrow Agent and Participating Manufacturers, their respective successors. Each reference herein to the Escrow Agent or to a Participating Manufacturer shall be construed as a reference to its successor, where applicable. SECTION 14. Governing Law. This Escrow Agreement shall be construed in accordance with and governed by the laws of the State in which the Escrow Court is located, without regard to the conflicts of law rules of such state. SECTION 15. Jurisdiction and Venue. The parties hereto irrevocably and unconditionally submit to the continuing exclusive jurisdiction of the Escrow Court for purposes of any suit, action or proceeding seeking to interpret or enforce any provision of, or based on any right arising out of, this Escrow Agreement, and the parties hereto agree not to commence any such suit, action or proceeding except in the Escrow Court. The parties hereto hereby irrevocably and unconditionally waive any objection to the laying of venue of any such suit, action or proceeding in the Escrow Court and hereby further irrevocably waive and agree not to plead or claim in the Escrow Court that any such suit, action or proceeding has been brought in an inconvenient forum. SECTION 16. Amendments. This Escrow Agreement may be amended only by written instrument executed by all of the parties hereto that would be affected by the amendment. The waiver of any rights conferred hereunder shall be effective only if made in a written instrument executed by the waiving party. 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, of this Escrow Agreement, nor shall such waiver be deemed to be or construed as a waiver by any other party. SECTION 17. Counterparts. This Agreement may be signed in any number of counterparts, each of which shall be an original, with the same effect as if the signatures thereto and hereto were upon the same instrument. Delivery by facsimile of a signed counterpart shall be deemed delivery for purposes of acknowledging acceptance hereof; however, an original executed Escrow Agreement must promptly thereafter be delivered to each party. SECTION 18. Captions. The captions herein are included for convenience of reference only and shall be ignored in the construction and interpretation hereof. SECTION 19. Conditions to Effectiveness. This Escrow Agreement shall become effective when each party hereto shall have signed a counterpart hereof. The parties hereto agree to use their best efforts to seek an order of the Escrow Court approving, and retaining continuing jurisdiction over, the Escrow Agreement as soon as possible, and agree that such order shall relate back to, and be deemed effective as of, the date this Escrow Agreement became effective. B-4 SECTION 20. Address for Payments. Whenever funds are under the terms of this Escrow Agreement required to be disbursed to a Settling State, a Participating Manufacturer, NAAG or the Foundation, the Escrow Agent shall disburse such funds by wire transfer to the account specified by such payee by written notice delivered to all Notice Parties in accordance with Section 11 hereof at least five Business Days prior to the date of payment. Whenever funds are under the terms of this Escrow Agreement required to be disbursed to any other person or entity, the Escrow Agent shall disburse such funds to such account as shall have been specified in writing by the Independent Auditor for such payment at least five Business Days prior to the date of payment. SECTION 21. Reporting. The Escrow Agent shall provide such information and reporting with respect to the escrow as the Independent Auditor may from time to time request. IN WITNESS WHEREOF, the parties have executed this Escrow Agreement as of the day and year first hereinabove written. [Signature Blocks] B-5 Appendix A Schedule Of Fees And Expenses C-1 EXHIBIT C FORMULA FOR CALCULATING INFLATION ADJUSTMENTS (1) Any amount that, in any given year, is to be adjusted for inflation pursuant to this Exhibit (the “Base Amount”) shall be adjusted upward by adding to such Base Amount the Inflation Adjustment. (2) The Inflation Adjustment shall be calculated by multiplying the Base Amount by the Inflation Adjustment Percentage applicable in that year. (3) The Inflation Adjustment Percentage applicable to payments due in the year 2000 shall be equal to the greater of 3% or the CPI%. For example, if the Consumer Price Index for December 1999 (as released in January 2000) is 2% higher than the Consumer Price Index for December 1998 (as released in January 1999), then the CPI% with respect to a payment due in 2000 would be 2%. The Inflation Adjustment Percentage applicable in the year 2000 would thus be 3%. (4) The Inflation Adjustment Percentage applicable to payments due in any year after 2000 shall be calculated by applying each year the greater of 3% or the CPI% on the Inflation Adjustment Percentage applicable to payments due in the prior year. Continuing the example in subsection (3) above, if the CPI% with respect to a payment due in 2001 is 6%, then the Inflation Adjustment Percentage applicable in 2001 would be 9.1800000% (an additional 6% applied on the 3% Inflation Adjustment Percentage applicable in 2000), and if the CPI% with respect to a payment due in 2002 is 4%, then the Inflation Adjustment Percentage applicable in 2002 would be 13.5472000% (an additional 4% applied on the 9.1800000% Inflation Adjustment Percentage applicable in 2001). (5) “Consumer Price Index” means the Consumer Price Index for All Urban Consumers as published by the Bureau of Labor Statistics of the U.S. Department of Labor (or other similar measures agreed to by the Settling States and the Participating Manufacturers). (6) The “CPI%” means the actual total percent change in the Consumer Price Index during the calendar year immediately preceding the year in which the payment in question is due. (7) Additional Examples. (A) Calculating the Inflation Adjustment Percentages: Payment Year Hypothetical CPI% Percentage to be applied on the Inflation Adjustment Percentage for the prior year (i.e., the greater of 3% or the CPI%) Inflation Adjustment Percentage 2000 2.4% 3.0% 3.0000000% 2001 2.1% 3.0% 6.0900000% 2002 3.5% 3.5% 9.8031500% 2003 3.5% 3.5% 13.6462603% 2004 4.0% 4.0% 18.1921107% 2005 2.2% 3.0% 21.7378740% 2006 1.6% 3.0% 25.3900102% (B) Applying the Inflation Adjustment: Using the hypothetical Inflation Adjustment Percentages set forth in section (7)(A): -- the subsection IX(c)(1) base payment amount for 2002 of $6,500,000,000 as adjusted for inflation would equal $7,137,204,750; -- the subsection IX(c)(1) base payment amount for 2004 of $8,000,000,000 as adjusted for inflation would equal $9,455,368,856; -- the subsection IX(c)(1) base payment amount for 2006 of $8,000,000,000 as adjusted for inflation would equal $10,031,200,816. D-1 EXHIBIT D LIST OF LAWSUITS 1. Alabama Blaylock et al. v. American Tobacco Co. et al., Circuit Court, Montgomery County, No. CV-96-1508-PR 2. Alaska State of Alaska v. Philip Morris, Inc., et al., Superior Court, First Judicial District of Juneau, No. IJU-97915 CI (Alaska) 3. Arizona State of Arizona v. American Tobacco Co., Inc., et al., Superior Court, Maricopa County, No. CV-96-14769 (Ariz.) 4. Arkansas State of Arkansas v. The American Tobacco Co., Inc., et al., Chancery Court, 6th Division, Pulaski County, No. IJ 97-2982 (Ark.) 5. California People of the State of California et al. v. Philip Morris, Inc., et al., Superior Court, Sacramento County, No. 97-AS- 30301 6. Colorado State of Colorado et al., v. R.J. Reynolds Tobacco Co., et al., District Court, City and County of Denver, No. 97CV3432 (Colo.) 7. Connecticut State of Connecticut v. Philip Morris, et al., Superior Court, Judicial District of Waterbury No. X02 CV96- 0148414S (Conn.) 8. Georgia State of Georgia et al. v. Philip Morris, Inc., et al., Superior Court, Fulton County, No. CA E-61692 (Ga.) 9. Hawaii State of Hawaii v. Brown & Williamson Tobacco Corp., et al., Circuit Court, First Circuit, No. 97-0441-01 (Haw.) 10. Idaho State of Idaho v. Philip Morris, Inc., et al., Fourth Judicial District, Ada County, No. CVOC 9703239D (Idaho) 11. Illinois People of the State of Illinois v. Philip Morris et al., Circuit Court of Cook County, No. 96-L13146 (Ill.) 12. Indiana State of Indiana v. Philip Morris, Inc., et al., Marion County Superior Court, No. 49D 07-9702-CT-000236 (Ind.) 13. Iowa State of Iowa v. R.J. Reynolds Tobacco Company et al., Iowa District Court, Fifth Judicial District, Polk County, No. CL71048 (Iowa) 14. Kansas State of Kansas v. R.J. Reynolds Tobacco Company, et al., District Court of Shawnee County, Division 2, No. 96- CV-919 (Kan.) 15. Louisiana Ieyoub v. The American Tobacco Company, et al., 14th Judicial District Court, Calcasieu Parish, No. 96-1209 (La.) 16. Maine State of Maine v. Philip Morris, Inc., et al., Superior Court, Kennebec County, No. CV 97-134 (Me.) 17. Maryland Maryland v. Philip Morris Incorporated, et al., Baltimore City Circuit Court, No. 96-122017-CL211487 (Md.) 18. Massachusetts Commonwealth of Massachusetts v. Philip Morris Inc., et al., Middlesex Superior Court, No. 95-7378 (Mass.) 19. Michigan Kelley v. Philip Morris Incorporated, et al., Ingham County Circuit Court, 30th Judicial Circuit, No. 96-84281-CZ (Mich.) 20. Missouri State of Missouri v. American Tobacco Co., Inc. et al., Circuit Court, City of St. Louis, No. 972-1465 (Mo.) 21. Montana State of Montana v. Philip Morris, Inc., et al., First Judicial Court, Lewis and Clark County, No. CDV 9700306-14 (Mont.) 22. Nebraska State of Nebraska v. R.J. Reynolds Tobacco Co., et al., District Court, Lancaster County, No. 573277 (Neb.) D-2 23. Nevada Nevada v. Philip Morris, Incorporated, et al., Second Judicial Court, Washoe County, No. CV97-03279 (Nev.) 24. New Hampshire New Hampshire v. R.J. Reynolds, Tobacco Co., et al., New Hampshire Superior Court, Merrimack County, No. 97- E-165 (N.H.) 25. New Jersey State of New Jersey v. R.J. Reynolds Tobacco Company, et al., Superior Court, Chancery Division, Middlesex County, No. C-254-96 (N.J.) 26. New Mexico State of New Mexico, v. The American Tobacco Co., et al., First Judicial District Court, County of Santa Fe, No. SF- 1235 c (N.M.) 27. New York State State of New York et al. v. Philip Morris, Inc., et al., Supreme Court of the State of New York, County of New York, No. 400361/97 (N.Y.) 28. Ohio State of Ohio v. Philip Morris, Inc., et al., Court of Common Pleas, Franklin County, No. 97CVH055114 (Ohio) 29. Oklahoma State of Oklahoma, et al. v. R.J. Reynolds Tobacco Company, et al., District Court, Cleveland County, No. CJ-96- 1499-L (Okla.) 30. Oregon State of Oregon v. The American Tobacco Co., et al., Circuit Court, Multnomah County, No. 9706-04457 (Or.) 31. Pennsylvania Commonwealth of Pennsylvania v. Philip Morris, Inc., et al., Court of Common Pleas, Philadelphia County, April Term 1997, No. 2443 32. Puerto Rico Rossello, et al. v. Brown & Williamson Tobacco Corporation, et al., U.S. District Court, Puerto Rico, No. 97- 1910JAF 33. Rhode Island State of Rhode Island v. American Tobacco Co., et al., Rhode Island Superior Court, Providence, No. 97-3058 (R.I.) 34. South Carolina State of South Carolina v. Brown & Williamson Tobacco Corporation, et al., Court of Common Pleas, Fifth Judicial Circuit, Richland County, No. 97-CP-40-1686 (S.C.) 35. South Dakota State of South Dakota, et al. v. Philip Morris, Inc., et al., Circuit Court, Hughes County, Sixth Judicial Circuit, No. 98-65 (S.D.) 36. Utah State of Utah v. R.J. Reynolds Tobacco Company, et al., U.S. District Court, Central Division, No. 96 CV 0829W (Utah) 37. Vermont State of Vermont v. Philip Morris, Inc., et al., Chittenden Superior Court, Chittenden County, No. 744-97 (Vt.) and 5816-98 (Vt.) 38. Washington State of Washington v. American Tobacco Co. Inc., et al., Superior Court of Washington, King County, No. 96-2- 1505608SEA (Wash.) 39. West Virginia McGraw, et al. v. The American Tobacco Company, et al., Kanawha County Circuit Court, No. 94-1707 (W. Va.) 40. Wisconsin State of Wisconsin v. Philip Morris Inc., et al., Circuit Court, Branch 11, Dane County, No. 97-CV-328 (Wis.) Additional States For each Settling State not listed above, the lawsuit or other legal action filed by the Attorney General or Governor of such Settling State against Participating Manufacturers in the Court in such Settling State prior to 30 days after the MSA Execution Date asserting Released Claims. E-1 EXHIBIT E FORMULA FOR CALCULATING VOLUME ADJUSTMENTS Any amount that by the terms of the Master Settlement Agreement is to be adjusted pursuant to this Exhibit E (the “Applicable Base Payment”) shall be adjusted in the following manner: (A) In the event the aggregate number of Cigarettes shipped in or to the fifty United States, the District of Columbia, and Puerto Rico by the Original Participating Manufacturers in the Applicable Year (as defined hereinbelow) (the “Actual Volume”) is greater than 475,656,000,000 Cigarettes (the “Base Volume”), the Applicable Base Payment shall be multiplied by the ratio of the Actual Volume to the Base Volume. (B) In the event the Actual Volume is less than the Base Volume, i. The Applicable Base Payment shall be reduced by subtracting from it the amount equal to such Applicable Base Payment multiplied both by 0.98 and by the result of (i) 1(one) minus (ii) the ratio of the Actual Volume to the Base Volume. ii. Solely for purposes of calculating volume adjustments to the payments required under subsection IX(c)(1), if a reduction of the Base Payment due under such subsection results from the application of subparagraph (B)(i) of this Exhibit E, but the Original Participating Manufacturers’ aggregate operating income from sales of Cigarettes for the Applicable Year in the fifty United States, the District of Columbia, and Puerto Rico (the “Actual Operating Income”) is greater than $7,195,340,000 (the “Base Operating Income”) (such Base Operating Income being adjusted upward in accordance with the formula for inflation adjustments set forth in Exhibit C hereto beginning December 31, 1996 to be applied for each year after 1996) then the amount by which such Base Payment is reduced by the application of subsection (B)(i) shall be reduced (but not below zero) by the amount calculated by multiplying (i) a percentage equal to the aggregate Allocable Shares of the Settling States in which State-Specific Finality has occurred by (ii) 25% of such increase in such operating income. For purposes of this Exhibit E, “operating income from sales of Cigarettes” shall mean operating income from sales of Cigarettes in the fifty United States, the District of Columbia, and Puerto Rico: (a) before goodwill amortization, trademark amortization, restructuring charges and restructuring related charges, minority interest, net interest expense, non-operating income and expense, general corporate expenses and income taxes; and (b) excluding extraordinary items, cumulative effect of changes in method of accounting and discontinued operations -- all as such income is reported to the United States Securities and Exchange Commission (“SEC”) for the Applicable Year (either independently by the Participating Manufacturer or as part of consolidated financial statements reported to the SEC by an Affiliate of such Participating Manufacturer) or, in the case of an Original Participating Manufacturer that does not report income to the SEC, as reported in financial statements prepared in accordance with U.S. generally accepted accounting principles and audited by a nationally recognized accounting firm. For years subsequent to 1998, the determination of the Original Participating Manufacturers’ aggregate operating income from sales of Cigarettes shall not exclude any charges or expenses incurred or accrued in connection with this Agreement or any prior settlement of a tobacco and health case and shall otherwise be derived using the same principles as were employed in deriving such Original Participating Manufacturers’ aggregate operating income from sales of Cigarettes in 1996. iii. Any increase in a Base Payment pursuant to subsection (B)(ii) above shall be allocated among the Original Participating Manufacturers in the following manner: (1) only to those Original Participating Manufacturers whose operating income from sales of Cigarettes in the fifty United States, the District of Columbia and Puerto Rico for the year for which the Base Payment is being adjusted is greater than their respective operating income from such sales of Cigarettes (including operating income from such sales of any of their Affiliates that do not continue to have such sales after the MSA Execution Date) in 1996 (as increased for inflation as provided in Exhibit C hereto beginning December 31, 1996 to be applied for each year after 1996); and (2) among the Original Participating Manufacturers described in paragraph (1) above in proportion to the ratio of (x) the increase in the operating income from sales of Cigarettes (as described in paragraph (1)) of the Original Participating Manufacturer in question, to (y) the aggregate increase in the operating income from sales of Cigarettes (as described in paragraph (1)) of those Original Participating Manufacturers described in paragraph (1) above. (C) “Applicable Year” means the calendar year immediately preceding the year in which the payment at issue is due, regardless of when such payment is made. (D) For purposes of this Exhibit, shipments shall be measured as provided in subsection II(mm). F-1 EXHIBIT F POTENTIAL LEGISLATION NOT TO BE OPPOSED 1. Limitations on Youth access to vending machines. 2. Inclusion of cigars within the definition of tobacco products. 3. Enhancement of enforcement efforts to identify and prosecute violations of laws prohibiting retail sales to Youth. 4. Encouraging or supporting use of technology to increase effectiveness of age-of-purchase laws, such as, without limitation, the use of programmable scanners, scanners to read drivers’ licenses, or use of other age/ID data banks. 5. Limitations on promotional programs for non-tobacco goods using tobacco products as prizes or give-aways. 6. Enforcement of access restrictions through penalties on Youth for possession or use. 7. Limitations on tobacco product advertising in or on school facilities, or wearing of tobacco logo merchandise in or on school property. 8. Limitations on non-tobacco products which are designed to look like tobacco products, such as bubble gum cigars, candy cigarettes, etc. G-1 EXHIBIT G OBLIGATIONS OF THE TOBACCO INSTITUTE UNDER THE MASTER SETTLEMENT AGREEMENT (a) Upon court approval of a plan of dissolution The Tobacco Institute (“TI”) will: (1) Employees. Promptly notify and arrange for the termination of the employment of all employees; provided, however, that TI may continue to engage any employee who is (A) essential to the wind-down function as set forth in section (g) herein; (B) reasonably needed for the sole purpose of directing and supporting TI’s defense of ongoing litigation; or (C) reasonably needed for the sole purpose of performing the Tobacco Institute Testing Laboratory’s (the “TITL”) industry-wide cigarette testing pursuant to the Federal Trade Commission (the “FTC”) method or any other testing prescribed by state or federal law as set forth in section (h) herein. (2) Employee Benefits. Fund all employee benefit and pension programs; provided, however, that unless ERISA or other federal or state law prohibits it, such funding will be accomplished through periodic contributions by the Original Participating Manufacturers, according to their Relative Market Shares, into a trust or a like mechanism, which trust or like mechanism will be established within 90 days of court approval of the plan of dissolution. An opinion letter will be appended to the dissolution plan to certify that the trust plan is not inconsistent with ERISA or employee benefit pension contracts. (3) Leases. Terminate all leaseholds at the earliest possible date pursuant to the leases; provided, however, that TI may retain or lease anew such space (or lease other space) as needed for its wind-down activities, for TITL testing as described herein, and for subsequent litigation defense activities. Immediately upon execution of this Agreement, TI will provide notice to each of its landlords of its desire to terminate its lease with such landlord, and will request that the landlord take all steps to re-lease the premises at the earliest possible date consistent with TI’s performance of its obligations hereunder. TI will vacate such leasehold premises as soon as they are re-leased or on the last day of wind-down, whichever occurs first. (b) Assets/Debts. Within 60 days after court approval of a plan of dissolution, TI will provide to the Attorney General of New York and append to the dissolution plan a description of all of its assets, its debts, tax claims against it, claims of state and federal governments against it, creditor claims against it, pending litigation in which it is a party and notices of claims against it. (c) Documents. Subject to the privacy protections provided by New York Public Officers Law §§ 91-99, TI will provide a copy of or otherwise make available to the State of New York all documents in its possession, excluding those that TI continues to claim to be subject to any attorney-client privilege, attorney work product protection, common interest/joint defense privilege or any other applicable privilege (collectively, “privilege”) after the re-examination of privilege claims pursuant to court order in State of Oklahoma v. R.J. Reynolds Tobacco Company, et al., CJ-96-2499-L (Dist. Ct., Cleveland County) (the “Oklahoma action”): (1) TI will deliver to the Attorney General of the State of New York a copy of the privilege log served by it in the Oklahoma action. Upon a written request by the Attorney General, TI will deliver an updated version of its privilege log, if any such updated version exists. (2) The disclosure of any document or documents claimed to be privileged will be governed by section IV of this Agreement. (3) At the conclusion of the document production and privilege logging process, TI will provide a sworn affidavit that all documents in its possession have been made available to the Attorney General of New York except for documents claimed to be privileged, and that any privilege logs that already exist have been made available to the Attorney General. (d) Remaining Assets. On mutual agreement between TI and the Attorney General of New York, a not-for-profit health or child welfare organization will be named as the beneficiary of any TI assets that remain after lawful transfers of assets and satisfaction of TI’s employee benefit obligations and any other debts, liabilities or claims. (e) Defense of Litigation. Pursuant to Section 1006 of the New York Not-for-Profit Corporations Law, TI will have the right to continue to defend its litigation interests with respect to any claims against it that are pending or threatened now or that are brought or threatened in the future. TI will retain sole discretion over all litigation decisions, including, without limitation, decisions with respect to asserting any privileges or defenses, having privileged communications and creating privileged documents, filing pleadings, responding to discovery requests, making motions, filing affidavits and briefs, conducting party and non-party discovery, retaining expert witnesses and consultants, preparing for and defending itself at trial, settling any claims asserted against it, intervening or otherwise participating in litigation to protect interests that it deems significant to its defense, and otherwise directing or conducting its defense. Pursuant to existing joint defense agreements, TI may continue to assist its current or former members in defense of any litigation brought or threatened against them. TI also may enter into any new joint defense agreement or agreements that it deems significant to its defense of pending or threatened claims. TI may continue to engage such employees as reasonably needed for the sole purpose of directing and supporting its defense of ongoing litigation. As soon as TI has no litigation pending against it, it will dissolve completely and will cease all functions consistent with the requirements of law. G-2 (f) No public statement. Except as necessary in the course of litigation defense as set forth in section (e) above, upon court approval of a plan of dissolution, neither TI nor any of its employees or agents acting in their official capacity on behalf of TI will issue any statements, press releases, or other public statement concerning tobacco. (g) Wind-down. After court approval of a plan of dissolution, TI will effectuate wind-down of all activities (other than its defense of litigation as described in section (e) above) expeditiously, and in no event later than 180 days after the date of court approval of the plan of dissolution. TI will provide monthly status reports to the Attorney General of New York regarding the progress of wind-down efforts and work remaining to be done with respect to such efforts. (h) TITL. Notwithstanding any other provision of this Exhibit G or the dissolution plan, TI may perform TITL industry-wide cigarette testing pursuant to the FTC method or any other testing prescribed by state or federal law until such function is transferred to another entity, which transfer will be accomplished as soon as practicable but in no event more than 180 days after court approval of the dissolution plan. (i) Jurisdiction. After the filing of a Certificate of Dissolution, pursuant to Section 1004 of the New York Not-for- Profit Corporation Law, the Supreme Court for the State of New York will have continuing jurisdiction over the dissolution of TI and the winding-down of TI’s activities, including any litigation-related activities described in subsection (e) herein. (j) No Determination or Admission. The dissolution of TI and any proceedings taken hereunder are not intended to be and shall not in any event be construed as, deemed to be, or represented or caused to be represented by any Settling State as, an admission or concession or evidence of any liability or any wrongdoing whatsoever on the part of TI, any of its current or former members or anyone acting on their behalf. TI specifically disclaims and denies any liability or wrongdoing whatsoever with respect to the claims and allegations asserted against it by the Attorneys General of the Settling States. (k) Court Approval. The Attorney General of the State of New York and the Original Participating Manufacturers will prepare a joint plan of dissolution for submission to the Supreme Court of the State of New York, all of the terms of which will be agreed on and consented to by the Attorney General and the Original Participating Manufacturers consistent with this schedule. The Original Participating Manufacturers and their employees, as officers and directors of TI, will take whatever steps are necessary to execute all documents needed to develop such a plan of dissolution and to submit it to the court for approval. If any court makes any material change to any term or provision of the plan of dissolution agreed upon and consented to by the Attorney General and the Original Participating Manufacturers, then: (1) the Original Participating Manufacturers may, at their election, nevertheless proceed with the dissolution plan as modified by the court; or (2) if the Original Participating Manufacturers elect not to proceed with the court-modified dissolution plan, the Original Participating Manufacturers will be released from any obligations or undertakings under this Agreement or this schedule with respect to TI; provided, however, that the Original Participating Manufacturers will engage in good faith negotiations with the New York Attorney General to agree upon the term or terms of the dissolution plan that the court may have modified in an effort to agree upon a dissolution plan that may be resubmitted for the court’s consideration. H-1 EXHIBIT H DOCUMENT PRODUCTION Section 1. (a) Philip Morris Companies, Inc., et al., v. American Broadcasting Companies, Inc., et al., At Law No. 760CL94X00816-00 (Cir. Ct., City of Richmond) (b) Harley-Davidson v. Lorillard Tobacco Co., No. 93-947 (S.D.N.Y.) (c) Lorillard Tobacco Co. v. Harley-Davidson, No. 93-6098 (E.D. Wis.) (d) Brown & Williamson v. Jacobson and CBS, Inc., No. 82-648 (N.D. Ill.) (e) The FTC investigations of tobacco industry advertising and promotion as embodied in the following cites: 46 FTC 706 48 FTC 82 46 FTC 735 47 FTC 1393 108 F. Supp. 573 55 FTC 354 56 FTC 96 79 FTC 255 80 FTC 455 Investigation #8023069 Investigation #8323222 Each Original Participating Manufacturer and Tobacco-Related Organization will conduct its own reasonable inquiry to determine what documents or deposition testimony, if any, it produced or provided in the above-listed matters. Section 2. (a) State of Washington v. American Tobacco Co., et al., No. 96-2-15056-8 SEA (Wash. Super. Ct., County of King) (b) In re Mike Moore, Attorney General, ex rel, State of Mississippi Tobacco Litigation, No. 94-1429 (Chancery Ct., Jackson, Miss.) (c) State of Florida v. American Tobacco Co., et al., No. CL 95-1466 AH (Fla. Cir. Ct., 15th Judicial Cir., Palm Beach Co.) (d) State of Texas v. American Tobacco Co., et al., No. 5-96CV-91 (E.D. Tex.) (e) Minnesota v. Philip Morris et al., No. C-94-8565 (Minn. Dist. Ct., County of Ramsey) (f) Broin v. R.J. Reynolds, No. 91-49738 CA (22) (11th Judicial Ct., Dade County, Florida) I-1 EXHIBIT I INDEX AND SEARCH FEATURES FOR DOCUMENT WEBSITE (a) Each Original Participating Manufacturer and Tobacco-Related Organization will create and maintain on its website, at its expense, an enhanced, searchable index, as described below, using Alta-Vista or functionally comparable software, for all of the documents currently on its website and all documents being placed on its website pursuant to section IV of this Agreement. (b) The searchable indices of documents on these websites will include: (1) all of the information contained in the 4(b) indices produced to the State Attorneys General (excluding fields specific only to the Minnesota action other than “request number”); (2) the following additional fields of information (or their substantial equivalent) to the extent such information already exists in an electronic format that can be incorporated into such an index: Document ID Master ID Other Number Document Date Primary Type Other Type Person Attending Person Noted Person Author Person Recipient Person Copied Person Mentioned Organization Author Organization Recipient Organization Copied Organization Mentioned Organization Attending Organization Noted Physical Attachment 1 Physical Attachment 2 Characteristics File Name Site Area Verbatim Title Old Brand Primary Brand Mentioned Brand Page Count (c) Each Original Participating Manufacturer and Tobacco-Related Organization will add, if not already available, a user-friendly document retrieval feature on the Website consisting of a “view all pages” function with enhanced image viewer capability that will enable users to choose to view and/or print either “all pages” for a specific document or “page-by- page”. (d) Each Original Participating Manufacturer and Tobacco-Related Organizations will provide at its own expense to NAAG a copy set in electronic form of its website document images and its accompanying subsection IV(h) index in ASCII- delimited form for all of the documents currently on its website and all of the documents described in subsection IV(d) of this Agreement. The Original Participating Manufacturers and Tobacco-Related Organizations will not object to any subsequent distribution and/or reproduction of these copy sets. J-1 EXHIBIT J TOBACCO ENFORCEMENT FUND PROTOCOL The States’ Antitrust/Consumer Protection Tobacco Enforcement Fund (“Fund”) is established by the Attorneys General of the Settling States, acting through NAAG, pursuant to section VIII(c) of the Agreement. The following shall be the primary and mandatory protocol for the administration of the Fund. Section A Fund Purpose Section 1 The monies to be paid pursuant to section VIII(c) of the Agreement shall be placed by NAAG in a new and separate interest bearing account, denominated the States’ Antitrust/ Consumer Protection Tobacco Enforcement Fund, which shall not then or thereafter be commingled with any other funds or accounts. However, nothing herein shall prevent deposits into the account so long as monies so deposited are then lawfully committed for the purpose of the Fund as set forth herein. Section 2 A committee of three Attorneys General (“Special Committee”) shall be established to determine disbursements from the account, using the process described herein. The three shall be the Attorney General of the State of Washington, the Chair of NAAG’s antitrust committee, and the Chair of NAAG’s consumer protection committee. In the event that an Attorney General shall hold either two or three of the above stated positions, that Attorney General may serve only in a single capacity, and shall be replaced in the remaining positions by first, the President of NAAG, next by the President-Elect of NAAG and if necessary the Vice-President of NAAG. Section 3 The purpose of the Fund is: (1) to enforce and implement the terms of the Agreement, in particular, by partial payment of the monetary costs of the Independent Auditor as contemplated by the Agreement; and (2) to provide monetary assistance to the various states’ attorneys general: (A) to investigate and/or litigate suspected violations of the Agreement and/or Consent Decree; (B) to investigate and/or litigate suspected violations of state and/or federal antitrust or consumer protection laws with respect to the manufacture, use, marketing and sales of tobacco products; and (C) to enforce the Qualifying Statute (“Qualifying Actions”). The Special Committee shall entertain requests only from Settling States for disbursement from the fund associated with a Qualifying Action (“Grant Application”). Section B Administration Standards Relative to Grant Applications Section 1 The Special Committee shall not entertain any Grant Application to pay salaries or ordinary expenses of regular employees of any Attorney General’s office. Section 2 The affirmative vote of two or more of the members of the Special Committee shall be required to approve any Grant Application. Section 3 The decision of the Special Committee shall be final and non-appealable. Section 4 The Attorney General of the State of Washington shall be chair of the Special Committee and shall annually report to the Attorneys General on the requests for funds from the Fund and the actions of the Special Committee upon the requests. Section 5 When a Grant Application to the Fund is made by an Attorney General who is then a member of the Special Committee, such member will be temporarily replaced on the Committee, but only for the determination of such Grant Application. The remaining members of the Special Committee shall designate an Attorney General to replace the Attorney General so disqualified, in order to consider the application. Section 6 The Fund shall be maintained in a federally insured depository institution located in Washington, D.C. Funds may be invested in federal government-backed vehicles. The Fund shall be regularly reported on NAAG financial statements and subject to annual audit. Section 7 Withdrawals from and checks drawn on the Fund will require at least two of three authorized signatures. The three persons so authorized shall be the executive director, the deputy director, and controller of NAAG. Section 8 The Special Committee shall meet in person or telephonically as necessary to determine whether a grant is sought for assistance with a Qualifying Action and whether and to what extent the Grant Application is accepted. The chair of the J-2 Special Committee shall designate the times for such meetings, so that a response is made to the Grant Application as expeditiously as practicable. Section 9 The Special Committee may issue a grant from the Fund only when an Attorney General certifies that the monies will be used in connection with a Qualifying Action, to wit: (A) to investigate and/or litigate suspected violations of the Agreement and/or Consent Decree; (B) to investigate and/or litigate suspected violations of state and/or federal antitrust or consumer protection laws with respect to the manufacture, use, marketing and sales of tobacco products; and (C) to enforce the Qualifying Statute. The Attorney General submitting such application shall further certify that the entire grant of monies from the Fund will be used to pay for such investigation and/or litigation. The Grant Application shall describe the nature and scope of the intended action and use of the funds which may be granted. Section 10 To the extent permitted by law, each Attorney General whose Grant Application is favorably acted upon shall promise to pay back to the Fund all of the amounts received from the Fund in the event the state is successful in litigation or settlement of a Qualifying Action. In the event that the monetary recovery, if any, obtained is not sufficient to pay back the entire amount of the grant, the Attorney General shall pay back as much as is permitted by the recovery. In all instances where monies are granted, the Attorney General(s) receiving monies shall provide an accounting to NAAG of all disbursements received from the Fund no later than the 30th of June next following such disbursement. Section 11 In addition to the repayments to the Fund contemplated in the preceding section, the Special Committee may deposit in the Fund any other monies lawfully committed for the precise purpose of the Fund as set forth in section A(3) above. For example, the Special Committee may at its discretion accept for deposit in the Fund a foundation grant or court-ordered award for state antitrust and/or consumer protection enforcement as long as the monies so deposited become part of and subject to the same rules, purposes and limitations of the Fund. Section 12 The Special Committee shall be the sole and final arbiter of all Grant Applications and of the amount awarded for each such application, if any. Section 13 The Special Committee shall endeavor to maintain the Fund for as long a term as is consistent with the purpose of the Fund. The Special Committee will limit the total amount of grants made to a single state to no more than $500,000.00. The Special Committee will not award a single grant in excess of $200,000.00, unless the grant involves more than one state, in which case, a single grant so made may not total more than $300,000.00. The Special Committee may, in its discretion and by unanimous vote, decide to waive these limitations if it determines that special circumstances exist. Such decision, however, shall not be effective unless ratified by a two-thirds majority vote of the NAAG executive committee. Section C Grant Application Procedures Section 1 This Protocol shall be transmitted to the Attorneys General within 90 days after the MSA Execution Date. It may not be amended unless by recommendation of the NAAG executive committee and majority vote of the Settling States. NAAG will notify the Settling States of any amendments promptly and will transmit yearly to the attorneys general a statement of the Fund balance and a summary of deposits to and withdrawals from the Fund in the previous calendar or fiscal year. Section 2 Grant Applications must be in writing and must be signed by the Attorney General submitting the application. Section 3 Grant Applications must include the following: (A) A description of the contemplated/pending action, including the scope of the alleged violation and the area (state/regional/multi-state) likely to be affected by the suspected offending conduct. (B) A statement whether the action is actively and currently pursued by any other Attorney General or other prosecuting authority. (C) A description of the purposes for which the monies sought will be used. (D) The amount requested. (E) A directive as to how disbursements from the Fund should be made, e.g., either directly to a supplier of services (consultants, experts, witnesses, and the like), to the Attorney General’s office directly, or in the case of multi-state action, to one or more Attorneys General’s offices designated as a recipient of the monies. J-3 (F) A statement that the applicant Attorney(s) General will, to the extent permitted by law, pay back to the Fund all, or as much as is possible, of the monies received, upon receipt of any monetary recovery obtained in the contemplated/pending litigation or settlement of the action. (G) A certification that no part of the grant monies will be used to pay the salaries or ordinary expenses of any regular employee of the office of the applicant(s) and that the grant will be used solely to pay for the stated purpose. (H) A certification that an accounting will be provided to NAAG of all monies received by the applicant(s) by no later than the 30th of June next following any receipt of such monies. Section 4 All Grant Applications shall be submitted to the NAAG office at the following address: National Association of Attorneys General, 750 1st Street, NE, Suite 1100, Washington D.C. 20002. Section 5 The Special Committee will endeavor to act upon all complete and properly submitted Grant Applications within 30 days of receipt of said applications. Section D Other Disbursements from the Fund Section 1 To enforce and implement the terms of the Agreement, the Special Committee shall direct disbursements from the Fund to comply with the partial payment obligations set forth in section XI of the Agreement relative to costs of the Independent Auditor. A report of such disbursements shall be included in the accounting given pursuant to section C(1) above. Section E Administrative Costs Section 1 NAAG shall receive from the Fund on July 1, 1999 and on July 1 of each year thereafter an administrative fee of $100,000 for its administrative costs in performing its duties under the Protocol and this Agreement. The NAAG executive committee may adjust the amount of the administrative fee in extraordinary circumstances. K-1 EXHIBIT K MARKET CAPITALIZATION PERCENTAGES Philip Morris Incorporated 68.0000000% Brown & Williamson Tobacco Corporation 17.9000000% Lorillard Tobacco Company 7.3000000% R.J. Reynolds Tobacco Company 6.8000000% Total 100.0000000% L-1 EXHIBIT L MODEL CONSENT DECREE IN THE [XXXXXX] COURT OF THE STATE OF [XXXXXX] IN AND FOR THE COUNTY OF [XXXXX] - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - x STATE OF [XXXXXXXXXXX], Plaintiff, v. [XXXXXX XXXXX XXXX], et al., Defendants. - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - x CAUSE NO. XXXXXX CONSENT DECREE AND FINAL JUDGMENT WHEREAS, Plaintiff, the State of [name of Settling State], commenced this action on [date], [by and through its Attorney General [name]], pursuant to [her/his/its] common law powers and the provisions of [state and/or federal law]; WHEREAS, the State of [name of Settling State] asserted various claims for monetary, equitable and injunctive relief on behalf of the State of [name of Settling State] against certain tobacco product manufacturers and other defendants; WHEREAS, Defendants have contested the claims in the State’s complaint [and amended complaints, if any] and denied the State’s allegations [and asserted affirmative defenses]; WHEREAS, the parties desire to resolve this action in a manner which appropriately addresses the State’s public health concerns, while conserving the parties’ resources, as well as those of the Court, which would otherwise be expended in litigating a matter of this magnitude; and WHEREAS, the Court has made no determination of any violation of law, this Consent Decree and Final Judgment being entered prior to the taking of any testimony and without trial or final adjudication of any issue of fact or law; NOW, THEREFORE, IT IS HEREBY ORDERED, ADJUDGED AND DECREED, AS FOLLOWS: I. JURISDICTION AND VENUE This Court has jurisdiction over the subject matter of this action and over each of the Participating Manufacturers. Venue is proper in this [county/district]. II. DEFINITIONS The definitions set forth in the Agreement (a copy of which is attached hereto) are incorporated herein by reference. III. APPLICABILITY A. This Consent Decree and Final Judgment applies only to the Participating Manufacturers in their corporate capacity acting through their respective successors and assigns, directors, officers, employees, agents, subsidiaries, divisions, or other internal organizational units of any kind or any other entities acting in concert or participation with them. The remedies, penalties and sanctions that may be imposed or assessed in connection with a violation of this Consent Decree and Final Judgment (or any order issued in connection herewith) shall only apply to the Participating Manufacturers, and shall not be imposed or assessed against any employee, officer or director of any Participating Manufacturer, or against any other person or entity as a consequence of such violation, and there shall be no jurisdiction under this Consent Decree and Final Judgment to do so. B. This Consent Decree and Final Judgment is not intended to and does not vest standing in any third party with respect to the terms hereof. No portion of this Consent Decree and Final Judgment shall provide any rights to, or be enforceable by, any person or entity other than the State of [name of Settling State] or a Released Party. The State of [name of Settling State] may not assign or otherwise convey any right to enforce any provision of this Consent Decree and Final Judgment. IV. VOLUNTARY ACT OF THE PARTIES The parties hereto expressly acknowledge and agree that this Consent Decree and Final Judgment is voluntarily entered into as the result of arm’s-length negotiation, and all parties hereto were represented by counsel in deciding to enter into this Consent Decree and Final Judgment. V. INJUNCTIVE AND OTHER EQUITABLE RELIEF Each Participating Manufacturer is permanently enjoined from: L-2 A. Taking any action, directly or indirectly, to target Youth within the State of [name of Settling State] in the advertising, promotion or marketing of Tobacco Products, or taking any action the primary purpose of which is to initiate, maintain or increase the incidence of Youth smoking within the State of [name of Settling State]. B. After 180 days after the MSA Execution Date, using or causing to be used within the State of [name of Settling State] any Cartoon in the advertising, promoting, packaging or labeling of Tobacco Products. C. After 30 days after the MSA Execution Date, making or causing to be made any payment or other consideration to any other person or entity to use, display, make reference to or use as a prop within the State of [name of Settling State] any Tobacco Product, Tobacco Product package, advertisement for a Tobacco Product, or any other item bearing a Brand Name in any Media; provided, however, that the foregoing prohibition shall not apply to (1) Media where the audience or viewers are within an Adult-Only Facility (provided such Media are not visible to persons outside such Adult-Only Facility); (2) Media not intended for distribution or display to the public; (3) instructional Media concerning non-conventional cigarettes viewed only by or provided only to smokers who are Adults; and (4) actions taken by any Participating Manufacturer in connection with a Brand Name Sponsorship permitted pursuant to subsections III(c)(2)(A) and III(c)(2)(B)(i) of the Agreement, and use of a Brand Name to identify a Brand Name Sponsorship permitted by subsection III(c)(2)(B)(ii). D. Beginning July 1, 1999, marketing, distributing, offering, selling, licensing or causing to be marketed, distributed, offered, sold, or licensed (including, without limitation, by catalogue or direct mail), within the State of [name of Settling State], any apparel or other merchandise (other than Tobacco Products, items the sole function of which is to advertise Tobacco Products, or written or electronic publications) which bears a Brand Name. Provided, however, that nothing in this section shall (1) require any Participating Manufacturer to breach or terminate any licensing agreement or other contract in existence as of June 20, 1997 (this exception shall not apply beyond the current term of any existing contract, without regard to any renewal or option term that may be exercised by such Participating Manufacturer); (2) prohibit the distribution to any Participating Manufacturer’s employee who is not Underage of any item described above that is intended for the personal use of such an employee; (3) require any Participating Manufacturer to retrieve, collect or otherwise recover any item that prior to the MSA Execution Date was marketed, distributed, offered, sold, licensed or caused to be marketed, distributed, offered, sold or licensed by such Participating Manufacturer; (4) apply to coupons or other items used by Adults solely in connection with the purchase of Tobacco Products; (5) apply to apparel or other merchandise used within an Adult-Only Facility that is not distributed (by sale or otherwise) to any member of the general public; or (6) apply to apparel or other merchandise (a) marketed, distributed, offered, sold, or licensed at the site of a Brand Name Sponsorship permitted pursuant to subsection III(c)(2)(A) or III(c)(2)(B)(i) of the Agreement by the person to which the relevant Participating Manufacturer has provided payment in exchange for the use of the relevant Brand Name in the Brand Name Sponsorship or a third-party that does not receive payment from the relevant Participating Manufacturer (or any Affiliate of such Participating Manufacturer) in connection with the marketing, distribution, offer, sale or license of such apparel or other merchandise, or (b) used at the site of a Brand Name Sponsorship permitted pursuant to subsections III(c)(2)(A) or III(c)(2)(B)(i) of the Agreement (during such event) that are not distributed (by sale or otherwise) to any member of the general public. E. After the MSA Execution Date, distributing or causing to be distributed within the State of [name of Settling State] any free samples of Tobacco Products except in an Adult-Only Facility. For purposes of this Consent Decree and Final Judgment, a “free sample” does not include a Tobacco Product that is provided to an Adult in connection with (1) the purchase, exchange or redemption for proof of purchase of any Tobacco Products (including, but not limited to, a free offer in connection with the purchase of Tobacco Products, such as a “two-for-one” offer), or (2) the conducting of consumer testing or evaluation of Tobacco Products with persons who certify that they are Adults. F. Using or causing to be used as a brand name of any Tobacco Product pursuant to any agreement requiring the payment of money or other valuable consideration, any nationally recognized or nationally established brand name or trade name of any non-tobacco item or service or any nationally recognized or nationally established sports team, entertainment group or individual celebrity. Provided, however, that the preceding sentence shall not apply to any Tobacco Product brand name in existence as of July 1, 1998. For the purposes of this provision, the term “other valuable consideration” shall not include an agreement between two entities who enter into such agreement for the sole purpose of avoiding infringement claims. G. After 60 days after the MSA Execution Date and through and including December 31, 2001, manufacturing or causing to be manufactured for sale within the State of [name of Settling State] any pack or other container of Cigarettes containing fewer than 20 Cigarettes (or, in the case of roll-your-own tobacco, any package of roll-your-own tobacco containing less than 0.60 ounces of tobacco); and, after 150 days after the MSA Execution Date and through and including December 31, 2001, selling or distributing within the State of [name of Settling State] any pack or other container of Cigarettes containing fewer than 20 Cigarettes (or, in the case of roll-your-own tobacco, any package of roll-your-own tobacco containing less than 0.60 ounces of tobacco). H. Entering into any contract, combination or conspiracy with any other Tobacco Product Manufacturer that has the purpose or effect of: (1) limiting competition in the production or distribution of information about health hazards or other consequences of the use of their products; (2) limiting or suppressing research into smoking and health; or (3) limiting or suppressing research into the marketing or development of new products. Provided, however, that nothing in the preceding L-3 sentence shall be deemed to (1) require any Participating Manufacturer to produce, distribute or otherwise disclose any information that is subject to any privilege or protection; (2) preclude any Participating Manufacturer from entering into any joint defense or joint legal interest agreement or arrangement (whether or not in writing), or from asserting any privilege pursuant thereto; or (3) impose any affirmative obligation on any Participating Manufacturer to conduct any research. I. Making any material misrepresentation of fact regarding the health consequences of using any Tobacco Product, including any tobacco additives, filters, paper or other ingredients. Provided, however, that nothing in the preceding sentence shall limit the exercise of any First Amendment right or the assertion of any defense or position in any judicial, legislative or regulatory forum. VI. MISCELLANEOUS PROVISIONS A. Jurisdiction of this case is retained by the Court for the purposes of implementing and enforcing the Agreement and this Consent Decree and Final Judgment and enabling the continuing proceedings contemplated herein. Whenever possible, the State of [name of Settling State] and the Participating Manufacturers shall seek to resolve any issue that may exist as to compliance with this Consent Decree and Final Judgment by discussion among the appropriate designees named pursuant to subsection XVIII(m) of the Agreement. The State of [name of Settling State] and/or any Participating Manufacturer may apply to the Court at any time for further orders and directions as may be necessary or appropriate for the implementation and enforcement of this Consent Decree and Final Judgment. Provided, however, that with regard to subsections V(A) and V(I) of this Consent Decree and Final Judgment, the Attorney General shall issue a cease and desist demand to the Participating Manufacturer that the Attorney General believes is in violation of either of such sections at least ten Business Days before the Attorney General applies to the Court for an order to enforce such subsections, unless the Attorney General reasonably determines that either a compelling time-sensitive public health and safety concern requires more immediate action or the Court has previously issued an Enforcement Order to the Participating Manufacturer in question for the same or a substantially similar action or activity. For any claimed violation of this Consent Decree and Final Judgment, in determining whether to seek an order for monetary, civil contempt or criminal sanctions for any claimed violation, the Attorney General shall give good-faith consideration to whether: (1) the Participating Manufacturer that is claimed to have committed the violation has taken appropriate and reasonable steps to cause the claimed violation to be cured, unless that party has been guilty of a pattern of violations of like nature; and (2) a legitimate, good-faith dispute exists as to the meaning of the terms in question of this Consent Decree and Final Judgment. The Court in any case in its discretion may determine not to enter an order for monetary, civil contempt or criminal sanctions. B. This Consent Decree and Final Judgment is not intended to be, and shall not in any event be construed as, or deemed to be, an admission or concession or evidence of (1) any liability or any wrongdoing whatsoever on the part of any Released Party or that any Released Party has engaged in any of the activities barred by this Consent Decree and Final Judgment; or (2) personal jurisdiction over any person or entity other than the Participating Manufacturers. Each Participating Manufacturer specifically disclaims and denies any liability or wrongdoing whatsoever with respect to the claims and allegations asserted against it in this action, and has stipulated to the entry of this Consent Decree and Final Judgment solely to avoid the further expense, inconvenience, burden and risk of litigation. C. Except as expressly provided otherwise in the Agreement, this Consent Decree and Final Judgment shall not be modified (by this Court, by any other court or by any other means) unless the party seeking modification demonstrates, by clear and convincing evidence, that it will suffer irreparable harm from new and unforeseen conditions. Provided, however, that the provisions of sections III, V, VI and VII of this Consent Decree and Final Judgment shall in no event be subject to modification without the consent of the State of [name of Settling State] and all affected Participating Manufacturers. In the event that any of the sections of this Consent Decree and Final Judgment enumerated in the preceding sentence are modified by this Court, by any other court or by any other means without the consent of the State of [name of Settling State] and all affected Participating Manufacturers, then this Consent Decree and Final Judgment shall be void and of no further effect. Changes in the economic conditions of the parties shall not be grounds for modification. It is intended that the Participating Manufacturers will comply with this Consent Decree and Final Judgment as originally entered, even if the Participating Manufacturers’ obligations hereunder are greater than those imposed under current or future law (unless compliance with this Consent Decree and Final Judgment would violate such law). A change in law that results, directly or indirectly, in more favorable or beneficial treatment of any one or more of the Participating Manufacturers shall not support modification of this Consent Decree and Final Judgment. D. In any proceeding which results in a finding that a Participating Manufacturer violated this Consent Decree and Final Judgment, the Participating Manufacturer or Participating Manufacturers found to be in violation shall pay the State’s costs and attorneys’ fees incurred by the State of [name of Settling State] in such proceeding. E. The remedies in this Consent Decree and Final Judgment are cumulative and in addition to any other remedies the State of [name of Settling State] may have at law or equity, including but not limited to its rights under the Agreement. Nothing herein shall be construed to prevent the State from bringing an action with respect to conduct not released pursuant to the Agreement, even though that conduct may also violate this Consent Decree and Final Judgment. Nothing in this Consent Decree and Final Judgment is intended to create any right for [name of Settling State] to obtain any Cigarette product formula that it would not otherwise have under applicable law. L-4 F. No party shall be considered the drafter of this Consent Decree and Final Judgment for the purpose of any statute, case law or rule of interpretation or construction that would or might cause any provision to be construed against the drafter. Nothing in this Consent Decree and Final Judgment shall be construed as approval by the State of [name of Settling State] of the Participating Manufacturers’ business organizations, operations, acts or practices, and the Participating Manufacturers shall make no representation to the contrary. G. The settlement negotiations resulting in this Consent Decree and Final Judgment have been undertaken in good faith and for settlement purposes only, and no evidence of negotiations or discussions underlying this Consent Decree and Final Judgment shall be offered or received in evidence in any action or proceeding for any purpose. Neither this Consent Decree and Final Judgment nor any public discussions, public statements or public comments with respect to this Consent Decree and Final Judgment by the State of [name of Settling State] or any Participating Manufacturer or its agents shall be offered or received in evidence in any action or proceeding for any purpose other than in an action or proceeding arising under or relating to this Consent Decree and Final Judgment. H. All obligations of the Participating Manufacturers pursuant to this Consent Decree and Final Judgment (including, but not limited to, all payment obligations) are, and shall remain, several and not joint. I. The provisions of this Consent Decree and Final Judgment are applicable only to actions taken (or omitted to be taken) within the States. Provided, however, that the preceding sentence shall not be construed as extending the territorial scope of any provision of this Consent Decree and Final Judgment whose scope is otherwise limited by the terms thereof. J. Nothing in subsection V(A) or V(I) of this Consent Decree shall create a right to challenge the continuation, after the MSA Execution Date, of any advertising content, claim or slogan (other than use of a Cartoon) that was not unlawful prior to the MSA Execution Date. K. If the Agreement terminates in this State for any reason, then this Consent Decree and Final Judgment shall be void and of no further effect. VII. FINAL DISPOSITION A. The Agreement, the settlement set forth therein, and the establishment of the escrow provided for therein are hereby approved in all respects, and all claims are hereby dismissed with prejudice as provided therein. B. The Court finds that the person[s] signing the Agreement have full and complete authority to enter into the binding and fully effective settlement of this action as set forth in the Agreement. The Court further finds that entering into this settlement is in the best interests of the State of [name of Settling State]. LET JUDGMENT BE ENTERED ACCORDINGLY DATED this _____ day of ______________, 1998. M-1 EXHIBIT M LIST OF PARTICIPATING MANUFACTURERS’ LAWSUITS AGAINST THE SETTLING STATES 1. Philip Morris, Inc., et al. v. Margery Bronster, Attorney General of the State of Hawaii, In Her Official Capacity, Civ. No. 96-00722HG, United States District Court for the District of Hawaii 2. Philip Morris, Inc., et al. v. Bruce Botelho, Attorney General of the State of Alaska, In His Official Capacity, Civ. No. A97-0003CV, United States District Court for the District of Alaska 3. Philip Morris, Inc., et al. v. Scott Harshbarger, Attorney General of the Commonwealth of Massachusetts, In His Official Capacity, Civ. No. 95-12574-GAO, United States District Court for the District of Massachusetts 4. Philip Morris, Inc., et al. v. Richard Blumenthal, Attorney General of the State of Connecticut, In His Official Capacity, Civ. No. 396CV01221 (PCD), United States District Court for the District of Connecticut 5. Philip Morris, et al. v. William H. Sorrell, et al., No. 1:98-ev-132, United States District Court for the District of Vermont N-1 EXHIBIT N LITIGATING POLITICAL SUBDIVISIONS 1. City of New York, et al. v. The Tobacco Institute, Inc. et al., Supreme Court of the State of New York, County of New York, Index No. 406225/96 2. County of Erie v. The Tobacco Institute, Inc. et al., Supreme Court of the State of New York, County of Erie, Index No. I 1997/359 3. County of Los Angeles v. R.J. Reynolds Tobacco Co. et al., San Diego Superior Court, No. 707651 4. The People v. Philip Morris, Inc. et al., San Francisco Superior Court, No. 980864 5. County of Cook v. Philip Morris, Inc. et al., Circuit Court of Cook County, Ill., No. 97-L-4550 O-1 EXHIBIT O MODEL STATE FEE PAYMENT AGREEMENT This STATE Fee Payment Agreement (the “STATE Fee Payment Agreement”) is entered into as of _________, _____ between and among the Original Participating Manufacturers and STATE Outside Counsel (as defined herein), to provide for payment of attorneys’ fees pursuant to Section XVII of the Master Settlement Agreement (the “Agreement”). WITNESSETH: WHEREAS, the State of STATE and the Original Participating Manufacturers have entered into the Agreement to settle and resolve with finality all Released Claims against the Released Parties, including the Original Participating Manufacturers, as set forth in the Agreement; and WHEREAS, Section XVII of the Agreement provides that the Original Participating Manufacturers shall pay reasonable attorneys’ fees to those private outside counsel identified in Exhibit S to the Agreement, pursuant to the terms hereof; NOW, THEREFORE, BE IT KNOWN THAT, in consideration of the mutual agreement of the State of STATE and the Original Participating Manufacturers to the terms of the Agreement and of the mutual agreement of STATE Outside Counsel and the Original Participating Manufacturers to the terms of this STATE Fee Payment Agreement, and such other consideration described herein, the Original Participating Manufacturers and STATE Outside Counsel agree as follows: SECTION 1. Definitions. All definitions contained in the Agreement are incorporated by reference herein, except as to terms specifically defined herein. (a) “Action” means the lawsuit identified in Exhibit D, M or N to the Agreement that has been brought by or against the State of STATE [or Litigating Political Subdivision]. (b) “Allocated Amount” means the amount of any Applicable Quarterly Payment allocated to any Private Counsel (including STATE Outside Counsel) pursuant to section 17 hereof. (c) “Allocable Liquidated Share” means, in the event that the sum of all Payable Liquidated Fees of Private Counsel as of any date specified in section 8 hereof exceeds the Applicable Liquidation Amount for any payment described therein, a percentage share of the Applicable Liquidation Amount equal to the proportion of (i) the amount of the Payable Liquidated Fee of STATE Outside Counsel to (ii) the sum of Payable Liquidated Fees of all Private Counsel. (d) “Applicable Liquidation Amount” means, for purposes of the payments described in section 8 hereof — (i) for the payment described in subsection (a) thereof, $125 million; (ii) for the payment described in subsection (b) thereof, the difference between (A) $250 million and (B) the sum of all amounts paid in satisfaction of all Payable Liquidated Fees of Outside Counsel pursuant to subsection (a) thereof; (iii) for the payment described in subsection (c) thereof, the difference between (A) $250 million and (B) the sum of all amounts paid in satisfaction of all Payable Liquidated Fees of Outside Counsel pursuant to subsections (a) and (b) thereof; (iv) for the payment described in subsection (d) thereof, the difference between (A) $250 million and (B) the sum of all amounts paid in satisfaction of all Payable Liquidated Fees of Outside Counsel pursuant to subsections (a), (b) and (c) thereof; (v) for the payment described in subsection (e) thereof, the difference between (A) $250 million and (B) the sum of all amounts paid in satisfaction of all Payable Liquidated Fees of Outside Counsel pursuant to subsections (a), (b), (c) and (d) thereof; (vi) for each of the first, second and third quarterly payments for any calendar year described in subsection (f) thereof, $62.5 million; and (vii) for each of the fourth calendar quarterly payments for any calendar year described in subsection (f) thereof, the difference between (A) $250 million and (B) the sum of all amounts paid in satisfaction of all Payable Liquidated Fees of Outside Counsel with respect to the preceding calendar quarters of the calendar year. (e) “Application” means a written application for a Fee Award submitted to the Panel, as well as all supporting materials (which may include video recordings of interviews). (f) “Approved Cost Statement” means both (i) a Cost Statement that has been accepted by the Original Participating Manufacturers; and (ii) in the event that a Cost Statement submitted by STATE Outside Counsel is disputed, the determination by arbitration pursuant to subsection (b) of section 19 hereof as to the amount of the reasonable costs and expenses of STATE Outside Counsel. (g) “Cost Statement” means a signed and attested statement of reasonable costs and expenses of Outside Counsel for any action identified on Exhibit D, M or N to the Agreement that has been brought by or against a Settling State or Litigating Political Subdivision. O-2 (h) “Designated Representative” means the person designated in writing, by each person or entity identified in Exhibit S to the Agreement [by the Attorney General of the State of STATE or as later certified in writing by the governmental prosecuting authority of the Litigating Political Subdivision], to act as their agent in receiving payments from the Original Participating Manufacturers for the benefit of STATE Outside Counsel pursuant to sections 8, 16 and 19 hereof, as applicable. (i) “Director” means the Director of the Private Adjudication Center of the Duke University School of Law or such other person or entity as may be chosen by agreement of the Original Participating Manufacturers and the Committee described in the second sentence of paragraph (b)(ii) of section 11 hereof. (j) “Eligible Counsel” means Private Counsel eligible to be allocated a part of a Quarterly Fee Amount pursuant to section 17 hereof. (k) “Federal Legislation” means federal legislation that imposes an enforceable obligation on Participating Defendants to pay attorneys’ fees with respect to Private Counsel. (l) “Fee Award” means any award of attorneys’ fees by the Panel in connection with a Tobacco Case. (m) “Liquidated Fee” means an attorneys’ fee for Outside Counsel for any action identified on Exhibit D, M or N to the Agreement that has been brought by or against a Settling State or Litigating Political Subdivision, in an amount agreed upon by the Original Participating Manufacturers and such Outside Counsel. (n) “Outside Counsel” means all those Private Counsel identified in Exhibit S to the Agreement. (o) “Panel” means the three-member arbitration panel described in section 11 hereof. (p) “Party” means (i) STATE Outside Counsel and (ii) an Original Participating Manufacturer. (q) “Payable Cost Statement” means the unpaid amount of a Cost Statement as to which all conditions precedent to payment have been satisfied. (r) “Payable Liquidated Fee” means the unpaid amount of a Liquidated Fee as to which all conditions precedent to payment have been satisfied. (s) “Previously Settled States” means the States of Mississippi, Florida and Texas. (t) “Private Counsel” means all private counsel for all plaintiffs in a Tobacco Case (including STATE Outside Counsel). (u) “Quarterly Fee Amount” means, for purposes of the quarterly payments described in sections 16, 17 and 18 hereof — (i) for each of the first, second and third calendar quarters of any calendar year beginning with the first calendar quarter of 1999 and ending with the third calendar quarter of 2008, $125 million; (ii) for each fourth calendar quarter of any calendar year beginning with the fourth calendar quarter of 1999 and ending with the fourth calendar quarter of 2003, the sum of (A) $125 million and (B) the difference, if any, between (1) $375 million and (2) the sum of all amounts paid in satisfaction of all Fee Awards of Private Counsel during such calendar year, if any; (iii) for each fourth calendar quarter of any calendar year beginning with the fourth calendar quarter of 2004 and ending with the fourth calendar quarter of 2008, the sum of (A) $125 million; (B) the difference between (1) $375 million; and (2) the sum of all amounts paid in satisfaction of all Fee Awards of Private Counsel during such calendar year, if any; and (C) the difference, if any, between (1) $250 million and (2) the product of (a) .2 (two tenths) and (b) the sum of all amounts paid in satisfaction of all Liquidated Fees of Outside Counsel pursuant to section 8 hereof, if any; (iv) for each of the first, second and third calendar quarters of any calendar year beginning with the first calendar quarter of 2009, $125 million; and (v) for each fourth calendar quarter of any calendar year beginning with the fourth calendar quarter of 2009, the sum of (A) $125 million and (B) the difference, if any, between (1) $375 million and (2) the sum of all amounts paid in satisfaction of all Fee Awards of Private Counsel during such calendar year, if any. (v) “Related Persons” means each Original Participating Manufacturer’s past, present and future Affiliates, divisions, officers, directors, employees, representatives, insurers, lenders, underwriters, Tobacco-Related Organizations, trade associations, suppliers, agents, auditors, advertising agencies, public relations entities, attorneys, retailers and distributors (and the predecessors, heirs, executors, administrators, successors and assigns of each of the foregoing). (w) “State of STATE” means the [applicable Settling State or the Litigating Political Subdivision], any of its past, present and future agents, officials acting in their official capacities, legal representatives, agencies, departments, commissions and subdivisions. (x) “STATE Outside Counsel” means all persons or entities identified in Exhibit S to the Agreement by the Attorney General of State of STATE [or as later certified by the office of the governmental prosecuting authority for the Litigating Political Subdivision] as having been retained by and having represented the STATE in connection with the Action, acting collectively by unanimous decision of all such persons or entities. O-3 (y) “Tobacco Case” means any tobacco and health case (other than a non-class action personal injury case brought directly by or on behalf of a single natural person or the survivor of such person or for wrongful death, or any non- class action consolidation of two or more such cases). (z) “Unpaid Fee” means the unpaid portion of a Fee Award. SECTION 2. Agreement to Pay Fees. The Original Participating Manufacturers will pay reasonable attorneys’ fees to STATE Outside Counsel for their representation of the State of STATE in connection with the Action, as provided herein and subject to the Code of Professional Responsibility of the American Bar Association. Nothing herein shall be construed to require the Original Participating Manufacturers to pay any attorneys’ fees other than (i) a Liquidated Fee or a Fee Award and (ii) a Cost Statement, as provided herein, nor shall anything herein require the Original Participating Manufacturers to pay any Liquidated Fee, Fee Award or Cost Statement in connection with any litigation other than the Action. SECTION 3. Exclusive Obligation of the Original Participating Manufacturers. The provisions set forth herein constitute the entire obligation of the Original Participating Manufacturers with respect to payment of attorneys’ fees of STATE Outside Counsel (including costs and expenses) in connection with the Action and the exclusive means by which STATE Outside Counsel or any other person or entity may seek payment of fees by the Original Participating Manufacturers or Related Persons in connection with the Action. The Original Participating Manufacturers shall have no obligation pursuant to Section XVII of the Agreement to pay attorneys’ fees in connection with the Action to any counsel other than STATE Outside Counsel, and they shall have no other obligation to pay attorneys’ fees to or otherwise to compensate STATE Outside Counsel, any other counsel or representative of the State of STATE or the State of STATE itself with respect to attorneys’ fees in connection with the Action. SECTION 4. Release. (a) Each person or entity identified in Exhibit S to the Agreement by the Attorney General of the State of STATE [or as certified by the office of the governmental prosecuting authority for the Litigating Political Subdivision] hereby irrevocably releases the Original Participating Manufacturers and all Related Persons from any and all claims that such person or entity ever had, now has or hereafter can, shall or may have in any way related to the Action (including but not limited to any negotiations related to the settlement of the Action). Such release shall not be construed as a release of any person or entity as to any of the obligations undertaken herein in connection with a breach thereof. (b) In the event that STATE Outside Counsel and the Original Participating Manufacturers agree upon a Liquidated Fee pursuant to section 7 hereof, it shall be a precondition to any payment by the Original Participating Manufacturers to the Designated Representative pursuant to section 8 hereof that each person or entity identified in Exhibit S to the Agreement by the Attorney General of the State of STATE [or as certified by the office of the governmental prosecuting authority for the Litigating Political Subdivision] shall have irrevocably released all entities represented by STATE Outside Counsel in the Action, as well as all persons acting by or on behalf of such entities (including the Attorney General [or the office of the governmental prosecuting authority] and each other person or entity identified on Exhibit S to the Agreement by the Attorney General [or the office of the governmental prosecuting authority]) from any and all claims that such person or entity ever had, now has or hereafter can, shall or may have in any way related to the Action (including but not limited to any negotiations related to the settlement of the Action). Such release shall not be construed as a release of any person or entity as to any of the obligations undertaken herein in connection with a breach thereof. SECTION 5. No Effect on STATE Outside Counsel’s Fee Contract. The rights and obligations, if any, of the respective parties to any contract between the State of STATE and STATE Outside Counsel shall be unaffected by this STATE Fee Payment Agreement except (a) insofar as STATE Outside Counsel grant the release described in subsection (b) of section 4 hereof; and (b) to the extent that STATE Outside Counsel receive any payments in satisfaction of a Fee Award pursuant to section 16 hereof, any amounts so received shall be credited, on a dollar-for-dollar basis, against any amount payable to STATE Outside Counsel by the State of STATE [or the Litigating Political Subdivision] under any such contract. SECTION 6. Liquidated Fees. (a) In the event that the Original Participating Manufacturers and STATE Outside Counsel agree upon the amount of a Liquidated Fee, the Original Participating Manufacturers shall pay such Liquidated Fee, pursuant to the terms hereof. (b) The Original Participating Manufacturers’ payment of any Liquidated Fee pursuant to this STATE Fee Payment Agreement shall be subject to (i) satisfaction of the conditions precedent stated in section 4 and paragraph (c)(ii) of section 7 hereof; and (ii) the payment schedule and the annual and quarterly aggregate national caps specified in sections 8 and 9 hereof, which shall apply to all payments made with respect to Liquidated Fees of all Outside Counsel. SECTION 7. Negotiation of Liquidated Fees. (a) If STATE Outside Counsel seek to be paid a Liquidated Fee, the Designated Representative shall so notify the Original Participating Manufacturers. The Original Participating Manufacturers may at any time make an offer of a Liquidated Fee to the Designated Representative in an amount set by the unanimous agreement, and at the sole discretion, of the Original Participating Manufacturers and, in any event, shall collectively make such an offer to the Designated Representative no more than 60 Business Days after receipt of notice by the Designated Representative that STATE Outside O-4 Counsel seek to be paid a Liquidated Fee. The Original Participating Manufacturers shall not be obligated to make an offer of a Liquidated Fee in any particular amount. Within ten Business Days after receiving such an offer, STATE Outside Counsel shall either accept the offer, reject the offer or make a counteroffer. (b) The national aggregate of all Liquidated Fees to be agreed to by the Original Participating Manufacturers in connection with the settlement of those actions indicated on Exhibits D, M and N to the Agreement shall not exceed one billion two hundred fifty million dollars ($1,250,000,000). (c) If the Original Participating Manufacturers and STATE Outside Counsel agree in writing upon a Liquidated Fee: (i) STATE Outside Counsel shall not be eligible for a Fee Award; (ii) such Liquidated Fee shall not become a Payable Liquidated Fee until such time as (A) State-Specific Finality has occurred in the State of STATE; (B) each person or entity identified in Exhibit S to the Agreement by the Attorney General of the State of STATE [or as certified by the office of the governmental prosecuting authority of the Litigating Political Subdivision] has granted the release described in subsection (b) of section 4 hereof; and (C) notice of the events described in subparagraphs (A) and (B) of this paragraph has been provided to the Original Participating Manufacturers. (iii) payment of such Liquidated Fee pursuant to sections 8 and 9 hereof (together with payment of costs and expenses pursuant to section 19 hereof), shall be STATE Outside Counsel’s total and sole compensation by the Original Participating Manufacturers in connection with the Action. (d) If the Original Participating Manufacturers and STATE Outside Counsel do not agree in writing upon a Liquidated Fee, STATE Outside Counsel may submit an Application to the Panel for a Fee Award to be paid as provided in sections 16, 17 and 18 hereof. SECTION 8. Payment of Liquidated Fee. In the event that the Original Participating Manufacturers and STATE Outside Counsel agree in writing upon a Liquidated Fee, and until such time as the Designated Representative has received payments in full satisfaction of such Liquidated Fee — (a) On February 1, 1999, if the Liquidated Fee of STATE Outside Counsel became a Payable Liquidated Fee before January 15, 1999, each Original Participating Manufacturer shall severally pay to the Designated Representative its Relative Market Share of the lesser of (i) the Payable Liquidated Fee of STATE Outside Counsel, (ii) $5 million or (iii) in the event that the sum of all Payable Liquidated Fees of all Outside Counsel as of January 15, 1999 exceeds the Applicable Liquidation Amount, the Allocable Liquidated Share of STATE Outside Counsel. (b) On August 1, 1999, if the Liquidated Fee of STATE Outside Counsel became a Payable Liquidated Fee on or after January 15, 1999 and before July 15, 1999, each Original Participating Manufacturer shall severally pay to the Designated Representative its Relative Market Share of the lesser of (i) the Payable Liquidated Fee of STATE Outside Counsel, (ii) $5 million or (iii) in the event that the sum of all Payable Liquidated Fees of all Outside Counsel that became Payable Liquidated Fees on or after January 15, 1999 and before July 15, 1999 exceeds the Applicable Liquidation Amount, the Allocable Liquidated Share of STATE Outside Counsel. (c) On December 15, 1999, if the Liquidated Fee of STATE Outside Counsel became a Payable Liquidated Fee on or after July 15, 1999 and before December 1, 1999, each Original Participating Manufacturer shall severally pay to the Designated Representative its Relative Market Share of the lesser of (i) the Payable Liquidated Fee of STATE Outside Counsel, (ii) $5 million or (iii) in the event that the sum of all Payable Liquidated Fees of all Outside Counsel that became Payable Liquidated Fees on or after July 15, 1999 and before December 1, 1999 exceeds the Applicable Liquidation Amount, the Allocable Liquidated Share of STATE Outside Counsel. (d) On December 15, 1999, if the Liquidated Fee of STATE Outside Counsel became a Payable Liquidated Fee before December 1, 1999, each Original Participating Manufacturer shall severally pay to the Designated Representative its Relative Market Share of the lesser of (i) the Payable Liquidated Fee of STATE Outside Counsel, or (ii) $5 million or (iii) in the event that the sum of all Payable Liquidated Fees of all Outside Counsel that become Payable Liquidated Fees before December 1, 1999 exceeds the Applicable Liquidation Amount, the Allocable Liquidated Share of STATE Outside Counsel. (e) On December 15, 1999, if the Liquidated Fee of STATE Outside Counsel became a Payable Liquidated Fee before December 1, 1999, each Original Participating Manufacturer shall severally pay to the Designated Representative its Relative Market Share of the lesser of (i) the Payable Liquidated Fee of STATE Outside Counsel or (ii) in the event that the sum of all Payable Liquidated Fees of all Outside Counsel that became Payable Liquidated Fees before December 1, 1999 exceeds the Applicable Liquidation Amount, the Allocable Liquidated Share of STATE Outside Counsel. (f) On the last day of each calendar quarter, beginning with the first calendar quarter of 2000 and ending with the fourth calendar quarter of 2003, if the Liquidated Fee of STATE Outside Counsel became a Payable Liquidated Fee at least 15 Business Days prior to the last day of each such calendar quarter, each Original Participating Manufacturer shall severally pay to the Designated Representative its Relative Market Share of the lesser of (i) the Payable Liquidated Fee of STATE Outside Counsel or (ii) in the event that the sum of all Payable Liquidated Fees of all Outside Counsel as of the date 15 Business Days prior to the date of the payment in question exceeds the Applicable Liquidation Amount, the Allocable Liquidated Share of STATE Outside Counsel. O-5 SECTION 9. Limitations on Payments of Liquidated Fees. Notwithstanding any other provision hereof, all payments by the Original Participating Manufacturers with respect to Liquidated Fees shall be subject to the following: (a) Under no circumstances shall the Original Participating Manufacturers be required to make any payment that would result in aggregate national payments of Liquidated Fees: (i) during 1999, totaling more than $250 million; (ii) with respect to any calendar quarter beginning with the first calendar quarter of 2000 and ending with the fourth calendar quarter of 2003, totaling more than $62.5 million, except to the extent that a payment with respect to any prior calendar quarter of any calendar year did not total $62.5 million; or (iii) with respect to any calendar quarter after the fourth calendar quarter of 2003, totaling more than zero. (b) The Original Participating Manufacturers’ obligations with respect to the Liquidated Fee of STATE Outside Counsel, if any, shall be exclusively as provided in this STATE Fee Payment Agreement, and notwithstanding any other provision of law, such Liquidated Fee shall not be entered as or reduced to a judgment against the Original Participating Manufacturers or considered as a basis for requiring a bond or imposing a lien or any other encumbrance. SECTION 10. Fee Awards. (a) In the event that the Original Participating Manufacturers and STATE Outside Counsel do not agree in writing upon a Liquidated Fee as described in section 7 hereof, the Original Participating Manufacturers shall pay, pursuant to the terms hereof, the Fee Award awarded by the Panel to STATE Outside Counsel. (b) The Original Participating Manufacturers’ payment of any Fee Award pursuant to this STATE Fee Payment Agreement shall be subject to the payment schedule and the annual and quarterly aggregate national caps specified in sections 17 and 18 hereof, which shall apply to: (i) all payments of Fee Awards in connection with an agreement to pay fees as part of the settlement of any Tobacco Case on terms that provide for payment by the Original Participating Manufacturers or other defendants acting in agreement with the Original Participating Manufacturers (collectively, “Participating Defendants”) of fees with respect to any Private Counsel, subject to an annual cap on payment of all such fees; and (ii) all payments of attorneys’ fees (other than fees for attorneys of Participating Defendants) pursuant to Fee Awards for activities in connection with any Tobacco Case resolved by operation of Federal Legislation. SECTION 11. Composition of the Panel. (a) The first and the second members of the Panel shall both be permanent members of the Panel and, as such, will participate in the determination of all Fee Awards. The third Panel member shall not be a permanent Panel member, but instead shall be a state-specific member selected to determine Fee Awards on behalf of Private Counsel retained in connection with litigation within a single state. Accordingly, the third, state-specific member of the Panel for purposes of determining Fee Awards with respect to litigation in the State of STATE shall not participate in any determination as to any Fee Award with respect to litigation in any other state (unless selected to participate in such determinations by such persons as may be authorized to make such selections under other agreements). (b) The members of the Panel shall be selected as follows: (i) The first member shall be the natural person selected by Participating Defendants. (ii) The second member shall be the person jointly selected by the agreement of Participating Defendants and a majority of the committee described in the fee payment agreements entered in connection with the settlements of the Tobacco Cases brought by the Previously Settled States. In the event that the person so selected is unable or unwilling to continue to serve, a replacement for such member shall be selected by agreement of the Original Participating Manufacturers and a majority of the members of a committee composed of the following members: Joseph F. Rice, Richard F. Scruggs, Steven W. Berman, Walter Umphrey, one additional representative, to be selected in the sole discretion of NAAG, and two representatives of Private Counsel in Tobacco Cases, to be selected at the sole discretion of the Original Participating Manufacturers. (iii) The third, state-specific member for purposes of determining Fee Awards with respect to litigation in the State of STATE shall be a natural person selected by STATE Outside Counsel, who shall notify the Director and the Original Participating Manufacturers of the name of the person selected. SECTION 12. Application of STATE Outside Counsel. (a) STATE Outside Counsel shall make a collective Application for a single Fee Award, which shall be submitted to the Director. Within five Business Days after receipt of the Application by STATE Outside Counsel, the Director shall serve the Application upon the Original Participating Manufacturers and the STATE. The Original Participating Manufacturers shall submit all materials in response to the Application to the Director by the later of (i) 60 Business Days after service of the Application upon the Original Participating Manufacturers by the Director, (ii) five Business Days after the date of State-Specific Finality in the State of STATE or (iii) five Business Days after the date on which notice of the name of the third, state-specific panel member described in paragraph (b)(iii) of section 11 hereof has been provided to the Director and the Original Participating Manufacturers. O-6 (b) The Original Participating Manufacturers may submit to the Director any materials that they wish and, notwithstanding any restrictions or representations made in any other agreements, the Original Participating Manufacturers shall be in no way constrained from contesting the amount of the Fee Award requested by STATE Outside Counsel. The Director, the Panel, the State of STATE, the Original Participating Manufacturers and STATE Outside Counsel shall preserve the confidentiality of any attorney work-product materials or other similar confidential information that may be submitted. (c) The Director shall forward the Application of STATE Outside Counsel, as well as all written materials relating to such Application that have been submitted by the Original Participating Manufacturers pursuant to subsection (b) of this section, to the Panel within five Business Days after the later of (i) the expiration of the period for the Original Participating Manufacturers to submit such materials or (ii) the earlier of (A) the date on which the Panel issues a Fee Award with respect to any Application of other Private Counsel previously forwarded to the Panel by the Director or (B) 30 Business Days after the forwarding to the Panel of the Application of other Private Counsel most recently forwarded to the Panel by the Director. The Director shall notify the Parties upon forwarding the Application (and all written materials relating thereto) to the Panel. (d) In the event that either Party seeks a hearing before the Panel, such Party may submit a request to the Director in writing within five Business Days after the forwarding of the Application of STATE Outside Counsel to the Panel by the Director, and the Director shall promptly forward the request to the Panel. If the Panel grants the request, it shall promptly set a date for hearing, such date to fall within 30 Business Days after the date of the Panel’s receipt of the Application. SECTION 13. Panel Proceedings. The proceedings of the Panel shall be conducted subject to the terms of this Agreement and of the Protocol of Panel Procedures attached as an Appendix hereto. SECTION 14. Award of Fees to STATE Outside Counsel. The members of the Panel will consider all relevant information submitted to them in reaching a decision as to a Fee Award that fairly provides for full reasonable compensation of STATE Outside Counsel. In considering the amount of the Fee Award, the Panel shall not consider any Liquidated Fee agreed to by any other Outside Counsel, any offer of or negotiations relating to any proposed liquidated fee for STATE Outside Counsel or any Fee Award that already has been or yet may be awarded in connection with any other Tobacco Case. The Panel shall not be limited to an hourly-rate or lodestar analysis in determining the amount of the Fee Award of STATE Outside Counsel, but shall take into account the totality of the circumstances. The Panel’s decisions as to the Fee Award of STATE Outside Counsel shall be in writing and shall report the amount of the fee awarded (with or without explanation or opinion, at the Panel’s discretion). The Panel shall determine the amount of the Fee Award to be paid to STATE Outside Counsel within the later of 30 calendar days after receiving the Application (and all related materials) from the Director or 15 Business Days after the last date of any hearing held pursuant to subsection (d) of section 12 hereof. The Panel’s decision as to the Fee Award of STATE Outside Counsel shall be final, binding and non-appealable. SECTION 15. Costs of Arbitration. All costs and expenses of the arbitration proceedings held by the Panel, including costs, expenses and compensation of the Director and of the Panel members (but not including any costs, expenses or compensation of counsel making applications to the Panel), shall be borne by the Original Participating Manufacturers in proportion to their Relative Market Shares. SECTION 16. Payment of Fee Award of STATE Outside Counsel. On or before the tenth Business Day after the last day of each calendar quarter beginning with the first calendar quarter of 1999, each Original Participating Manufacturer shall severally pay to the Designated Representative its Relative Market Share of the Allocated Amount for STATE Outside Counsel for the calendar quarter with respect to which such quarterly payment is being made (the “Applicable Quarter”). SECTION 17. Allocated Amounts of Fee Awards. The Allocated Amount for each Private Counsel with respect to any payment to be made for any particular Applicable Quarter shall be determined as follows: (a) The Quarterly Fee Amount shall be allocated equally among each of the three months of the Applicable Quarter. The amount for each such month shall be allocated among those Private Counsel retained in connection with Tobacco Cases settled before or during such month (each such Private Counsel being an “Eligible Counsel” with respect to such monthly amount), each of which shall be allocated a portion of each such monthly amount up to (or, in the event that the sum of all Eligible Counsel’s respective Unpaid Fees exceeds such monthly amount, in proportion to) the amount of such Eligible Counsel’s Unpaid Fees. The monthly amount for each month of the calendar quarter shall be allocated among those Eligible Counsel having Unpaid Fees, without regard to whether there may be Eligible Counsel that have not yet been granted or denied a Fee Award as of the last day of the Applicable Quarter. The allocation of subsequent Quarterly Fee Amounts for the calendar year, if any, shall be adjusted, as necessary, to account for any Eligible Counsel that are granted Fee Awards in a subsequent quarter of such calendar year, as provided in paragraph (b)(ii) of this section. (b) In the event that the amount for a given month is less than the sum of the Unpaid Fees of all Eligible Counsel: O-7 (i) in the case of the first quarterly allocation for any calendar year, such monthly amount shall be allocated among all Eligible Counsel for such month in proportion to the amounts of their respective Unpaid Fees. (ii) in the case of a quarterly allocation after the first quarterly allocation, the Quarterly Fee Amount shall be allocated among only those Private Counsel, if any, that were Eligible Counsel with respect to any monthly amount for any prior quarter of the calendar year but were not allocated a proportionate share of such monthly amount (either because such Private Counsel’s applications for Fee Awards were still under consideration as of the last day of the calendar quarter containing the month in question or for any other reason), until each such Eligible Counsel has been allocated a proportionate share of all such prior monthly payments for the calendar year (each such share of each such Eligible Counsel being a “Payable Proportionate Share”). In the event that the sum of all Payable Proportionate Shares exceeds the Quarterly Fee Amount, the Quarterly Fee Amount shall be allocated among such Eligible Counsel on a monthly basis in proportion to the amounts of their respective Unpaid Fees (without regard to whether there may be other Eligible Counsel with respect to such prior monthly amounts that have not yet been granted or denied a Fee Award as of the last day of the Applicable Quarter). In the event that the sum of all Payable Proportionate Shares is less than the Quarterly Fee Amount, the amount by which the Quarterly Fee Amount exceeds the sum of all such Payable Proportionate Shares shall be allocated among each month of the calendar quarter, each such monthly amount to be allocated among those Eligible Counsel having Unpaid Fees in proportion to the amounts of their respective Unpaid Fees (without regard to whether there may be Eligible Counsel that have not yet been granted or denied a Fee Award as of the last day of the Applicable Quarter). (c) Adjustments pursuant to subsection (b)(ii) of this section 17 shall be made separately for each calendar year. No amounts paid in any calendar year shall be subject to refund, nor shall any payment in any given calendar year affect the allocation of payments to be made in any subsequent calendar year. SECTION 18. Credits to and Limitations on Payment of Fee Awards. Notwithstanding any other provision hereof, all payments by the Original Participating Manufacturers with respect to Fee Awards shall be subject to the following: (a) Under no circumstances shall the Original Participating Manufacturers be required to make payments that would result in aggregate national payments and credits by Participating Defendants with respect to all Fee Awards of Private Counsel: (i) during any year beginning with 1999, totaling more than the sum of the Quarterly Fee Amounts for each calendar quarter of the calendar year, excluding certain payments with respect to any Private Counsel for 1998 that are paid in 1999; and (ii) during any calendar quarter beginning with the first calendar quarter of 1999, totaling more than the Quarterly Fee Amount for such quarter, excluding certain payments with respect to any Private Counsel for 1998 that are paid in 1999. (b) The Original Participating Manufacturers’ obligations with respect to the Fee Award of STATE Outside Counsel, if any, shall be exclusively as provided in this STATE Fee Payment Agreement, and notwithstanding any other provision of law, such Fee Award shall not be entered as or reduced to a judgment against the Original Participating Manufacturers or considered as a basis for requiring a bond or imposing a lien or any other encumbrance. SECTION 19. Reimbursement of Outside Counsel’s Costs. (a) The Original Participating Manufacturers shall reimburse STATE Outside Counsel for reasonable costs and expenses incurred in connection with the Action, provided that such costs and expenses are of the same nature as costs and expenses for which the Original Participating Manufacturers ordinarily reimburse their own counsel or agents. Payment of any Approved Cost Statement pursuant to this STATE Fee Payment Agreement shall be subject to (i) the condition precedent of approval of the Agreement by the Court for the State of STATE and (ii) the payment schedule and the aggregate national caps specified in subsection (c) of this section, which shall apply to all payments made with respect to Cost Statements of all Outside Counsel. (b) In the event that STATE Outside Counsel seek to be reimbursed for reasonable costs and expenses incurred in connection with the Action, the Designated Representative shall submit a Cost Statement to the Original Participating Manufacturers. Within 30 Business Days after receipt of any such Cost Statement, the Original Participating Manufacturers shall either accept the Cost Statement or dispute the Cost Statement, in which event the Cost Statement shall be subject to a full audit by examiners to be appointed by the Original Participating Manufacturers (in their sole discretion). Any such audit will be completed within 120 Business Days after the date the Cost Statement is received by the Original Participating Manufacturers. Upon completion of such audit, if the Original Participating Manufacturers and STATE Outside Counsel cannot agree as to the appropriate amount of STATE Outside Counsel’s reasonable costs and expenses, the Cost Statement and the examiner’s audit report shall be submitted to the Director for arbitration before the Panel or, in the event that STATE Outside Counsel and the Original Participating Manufacturers have agreed upon a Liquidated Fee pursuant to section 7 hereof, before a separate three-member panel of independent arbitrators, to be selected in a manner to be agreed to by STATE Outside Counsel and the Original Participating Manufacturers, which shall determine the amount of STATE Outside Counsel’s reasonable costs and expenses for the Action. In determining such reasonable costs and expenses, the members of the arbitration panel shall be governed by the Protocol of Panel Procedures attached as an Appendix hereto. The amount of O-8 STATE Outside Counsel’s reasonable costs and expenses determined pursuant to arbitration as provided in the preceding sentence shall be final, binding and non-appealable. (c) Any Approved Cost Statement of STATE Outside Counsel shall not become a Payable Cost Statement until approval of the Agreement by the Court for the State of STATE. Within five Business Days after receipt of notification thereof by the Designated Representative, each Original Participating Manufacturer shall severally pay to the Designated Representative its Relative Market Share of the Payable Cost Statement of STATE Outside Counsel, subject to the following: (i) All Payable Cost Statements of Outside Counsel shall be paid in the order in which such Payable Cost Statements became Payable Cost Statements. (ii) Under no circumstances shall the Original Participating Manufacturers be required to make payments that would result in aggregate national payments by Participating Defendants of all Payable Cost Statements of Private Counsel in connection with all of the actions identified in Exhibits D, M and N to the Agreement, totaling more than $75 million for any given year. (iii) Any Payable Cost Statement of Outside Counsel not paid during the year in which it became a Payable Cost Statement as a result of paragraph (ii) of this subsection shall become payable in subsequent years, subject to paragraphs (i) and (ii), until paid in full. (d) The Original Participating Manufacturers’ obligations with respect to reasonable costs and expenses incurred by STATE Outside Counsel in connection with the Action shall be exclusively as provided in this STATE Fee Payment Agreement, and notwithstanding any other provision of law, any Approved Cost Statement determined pursuant to subsection (b) of this section (including any Approved Cost Statement determined pursuant to arbitration before the Panel or the separate three-member panel of independent arbitrators described therein) shall not be entered as or reduced to a judgment against the Original Participating Manufacturers or considered as a basis for requiring a bond or imposing a lien or any other incumbrance. SECTION 20. Distribution of Payments among STATE Outside Counsel. (a) All payments made to the Designated Representative pursuant to this STATE Fee Payment Agreement shall be for the benefit of each person or entity identified in Exhibit S to the Agreement by the Attorney General of the State of STATE [or as certified by the governmental prosecuting authority of the Litigating Political Subdivision], each of which shall receive from the Designated Representative a percentage of each such payment in accordance with the fee sharing agreement, if any, among STATE Outside Counsel (or any written amendment thereto). (b) The Original Participating Manufacturers shall have no obligation, responsibility or liability with respect to the allocation among those persons or entities identified in Exhibit S to the Agreement by the Attorney General of the State of STATE [or as certified by the governmental prosecuting authority of the Litigating Political Subdivision], or with respect to any claim of misallocation, of any amounts paid to the Designated Representative pursuant to this STATE Fee Payment Agreement. SECTION 21. Calculations of Amounts. All calculations that may be required hereunder shall be performed by the Original Participating Manufacturers, with notice of the results thereof to be given promptly to the Designated Representative. Any disputes as to the correctness of calculations made by the Original Participating Manufacturers shall be resolved pursuant to the procedures described in Section XI(c) of the Agreement for resolving disputes as to calculations by the Independent Auditor. SECTION 22. Payment Responsibility. (a) Each Original Participating Manufacturer shall be severally liable for its share of all payments pursuant to this STATE Fee Payment Agreement. Under no circumstances shall any payment due hereunder or any portion thereof become the joint obligation of the Original Participating Manufacturers or the obligation of any person other than the Original Participating Manufacturer from which such payment is originally due, nor shall any Original Participating Manufacturer be required to pay a portion of any such payment greater than its Relative Market Share. (b) Due to the particular corporate structures of R. J. Reynolds Tobacco Company (“Reynolds”) and Brown & Williamson Tobacco Corporation (“Brown & Williamson”) with respect to their non-domestic tobacco operations, Reynolds and Brown & Williamson shall each be severally liable for its respective share of each payment due pursuant to this STATE Fee Payment Agreement up to (and its liability hereunder shall not exceed) the full extent of its assets used in, and earnings and revenues derived from, its manufacture and sale in the United States of Tobacco Products intended for domestic consumption, and no recourse shall be had against any of its other assets or earnings to satisfy such obligations. SECTION 23. Termination. In the event that the Agreement is terminated with respect to the State of STATE pursuant to Section XVIII(u) of the Agreement (or for any other reason) the Designated Representative and each person or entity identified in Exhibit S to the Agreement by the Attorney General of the State of STATE [or as certified by the governmental prosecuting authority of the Litigating Political Subdivision] shall immediately refund to the Original Participating Manufacturers all amounts received under this STATE Fee Payment Agreement. O-9 SECTION 24. Intended Beneficiaries. No provision hereof creates any rights on the part of, or is enforceable by, any person or entity that is not a Party or a person covered by either of the releases described in section 4 hereof, except that sections 5 and 20 hereof create rights on the part of, and shall be enforceable by, the State of STATE. Nor shall any provision hereof bind any non-signatory or determine, limit or prejudice the rights of any such person or entity. SECTION 25. Representations of Parties. The Parties hereto hereby represent that this STATE Fee Payment Agreement has been duly authorized and, upon execution, will constitute a valid and binding contractual obligation, enforceable in accordance with its terms, of each of the Parties hereto. SECTION 26. No Admission. This STATE Fee Payment Agreement is not intended to be and shall not in any event be construed as, or deemed to be, an admission or concession or evidence of any liability or wrongdoing whatsoever on the part of any signatory hereto or any person covered by either of the releases provided under section 4 hereof. The Original Participating Manufacturers specifically disclaim and deny any liability or wrongdoing whatsoever with respect to the claims released under section 4 hereof and enter into this STATE Fee Payment Agreement for the sole purposes of memorializing the Original Participating Manufacturers’ rights and obligations with respect to payment of attorneys’ fees pursuant to the Agreement and avoiding the further expense, inconvenience, burden and uncertainty of potential litigation. SECTION 27. Non-admissibility. This STATE Fee Payment Agreement having been undertaken by the Parties hereto in good faith and for settlement purposes only, neither this STATE Fee Payment Agreement nor any evidence of negotiations relating hereto shall be offered or received in evidence in any action or proceeding other than an action or proceeding arising under this STATE Fee Payment Agreement. SECTION 28. Amendment and Waiver. This STATE Fee Payment Agreement may be amended only by a written instrument executed by the Parties. The waiver of any rights conferred hereunder shall be effective only if made by written instrument executed by the waiving Party. The waiver by any Party of any breach hereof shall not be deemed to be or construed as a waiver of any other breach, whether prior, subsequent or contemporaneous, of this STATE Fee Payment Agreement. SECTION 29. Notices. All notices or other communications to any party hereto shall be in writing (including but not limited to telex, facsimile or similar writing) and shall be given to the notice parties listed on Schedule A hereto at the addresses therein indicated. Any Party hereto may change the name and address of the person designated to receive notice on behalf of such Party by notice given as provided in this section including an updated list conformed to Schedule A hereto. SECTION 30. Governing Law. This STATE Fee Payment Agreement shall be governed by the laws of the State of STATE without regard to the conflict of law rules of such State. SECTION 31. Construction. None of the Parties hereto shall be considered to be the drafter hereof or of any provision hereof for the purpose of any statute, case law or rule of interpretation or construction that would or might cause any provision to be construed against the drafter hereof. SECTION 32. Captions. The captions of the sections hereof are included for convenience of reference only and shall be ignored in the construction and interpretation hereof. SECTION 33. Execution of STATE Fee Payment Agreement. This STATE Fee Payment Agreement may be executed in counterparts. Facsimile or photocopied signatures shall be considered valid signatures as of the date hereof, although the original signature pages shall thereafter be appended to this STATE Fee Payment Agreement. SECTION 34. Entire Agreement of Parties. This STATE Fee Payment Agreement contains an entire, complete and integrated statement of each and every term and provision agreed to by and among the Parties with respect to payment of attorneys’ fees by the Original Participating Manufacturers in connection with the Action and is not subject to any condition or covenant, express or implied, not provided for herein. IN WITNESS WHEREOF, the Parties hereto, through their fully authorized representatives, have agreed to this STATE Fee Payment Agreement as of this __th day of ________, 1998. [SIGNATURE BLOCK] O-10 APPENDIX to MODEL FEE PAYMENT AGREEMENT PROTOCOL OF PANEL PROCEEDINGS This Protocol of procedures has been agreed to between the respective parties to the STATE Fee Payment Agreement, and shall govern the arbitration proceedings provided for therein. SECTION 1. Definitions. All definitions contained in the STATE Fee Payment Agreement are incorporated by reference herein. SECTION 2. Chairman. The person selected to serve as the permanent, neutral member of the Panel as described in paragraph (b)(ii) of section 11 of the STATE Fee Payment Agreement shall serve as the Chairman of the Panel. SECTION 3. Arbitration Pursuant to Agreement. The members of the Panel shall determine those matters committed to the decision of the Panel under the STATE Fee Payment Agreement, which shall govern as to all matters discussed therein. SECTION 4. ABA Code of Ethics. Each of the members of the Panel shall be governed by the Code of Ethics for Arbitrators in Commercial Disputes prepared by the American Arbitration Association and the American Bar Association (the “Code of Ethics”) in conducting the arbitration proceedings pursuant to the STATE Fee Payment Agreement, subject to the terms of the STATE Fee Payment Agreement and this Protocol. Each of the party-appointed members of the Panel shall be governed by Canon VII of the Code of Ethics. No person may engage in any ex parte communications with the permanent, neutral member of the Panel selected pursuant to paragraph (b)(ii) of section 11, in keeping with Canons I, II and III of the Code of Ethics. SECTION 5. Additional Rules and Procedures. The Panel may adopt such rules and procedures as it deems necessary and appropriate for the discharge of its duties under the STATE Fee Payment Agreement and this Protocol, subject to the terms of the STATE Fee Payment Agreement and this Protocol. SECTION 6. Majority Rule. In the event that the members of the Panel are not unanimous in their views as to any matter to be determined by them pursuant to the STATE Fee Payment Agreement or this Protocol, the determination shall be decided by a vote of a majority of the three members of the Panel. SECTION 7. Application for Fee Award and Other Materials. (a) The Application of STATE Outside Counsel and any materials submitted to the Director relating thereto (collectively, “submissions”) shall be forwarded by the Director to each of the members of the Panel in the manner and on the dates specified in the STATE Fee Payment Agreement. (b) All materials submitted to the Director by either Party (or any other person) shall be served upon all Parties. All submissions required to be served on any Party shall be deemed to have been served as of the date on which such materials have been sent by either (i) hand delivery or (ii) facsimile and overnight courier for priority next-day delivery. (c) To the extent that the Panel believes that information not submitted to the Panel may be relevant for purposes of determining those matters committed to the decision of the Panel under the terms of the STATE Fee Payment Agreement, the Panel shall request such information from the Parties. SECTION 8. Hearing. Any hearing held pursuant to section 12 of the STATE Fee Payment Agreement shall not take place other than in the presence of all three members of the Panel upon notice and an opportunity for the respective representatives of the Parties to attend. SECTION 9. Miscellaneous. (a) Each member of the Panel shall be compensated for his services by the Original Participating Manufacturers on a basis to be agreed to between such member and the Original Participating Manufacturers. (b) The members of the Panel shall refer all media inquiries regarding the arbitration proceeding to the respective Parties to the STATE Fee Payment Agreement and shall refrain from any comment as to the arbitration proceedings to be conducted pursuant to the STATE Fee Payment Agreement during the pendency of such arbitration proceedings, in keeping with Canon IV(B) of the Code of Ethics. P-1 EXHIBIT P NOTICES [Intentionally Omitted] Q-1 EXHIBIT Q 1996 AND 1997 DATA (1) 1996 Operating Income Original Participating Manufacturer Operating Income Brown & Williamson Tobacco Corp. $801,640,000 Lorillard Tobacco Co. $719,100,000 Philip Morris Inc. $4,206,600,000 R.J. Reynolds Tobacco Co. $1,468,000,000 Total (Base Operating Income) $7,195,340,000 (2) 1997 volume (as measured by shipments of Cigarettes) Original Participating Manufacturer Number of Cigarettes Brown & Williamson Tobacco Corp.* 78,911,000,000 Lorillard Tobacco Co. 42,288,000,000 Philip Morris Inc. 236,203,000,000 R.J. Reynolds Tobacco Co. 118,254,000,000 Total (Base Volume) 475,656,000,000 (3) 1997 volume (as measured by excise taxes) Original Participating Manufacturer Number of Cigarettes Brown & Williamson Tobacco Corp.* 78,758,000,000 Lorillard Tobacco Co. 42,315,000,000 Philip Morris Inc. 236,326,000,000 R.J. Reynolds Tobacco Co. 119,099,000,000 * The volume includes 2,847,595 pounds of “roll your own” tobacco converted into the number of Cigarettes using 0.0325 ounces per Cigarette conversion factor. R-1 EXHIBIT R EXCLUSION OF CERTAIN BRAND NAMES Brown & Williamson Tobacco Corporation GPC State Express 555 Riviera Philip Morris Incorporated Players B&H Belmont Mark Ten Viscount Accord L&M Lark Rothman’s Best Buy Bronson F&L Genco GPA Gridlock Money No Frills Generals Premium Buy Shenandoah Top Choice Lorillard Tobacco Company None R.J. Reynolds Tobacco Company Best Choice Cardinal Director’s Choice Jacks Rainbow Scotch Buy Slim Price Smoker Friendly Valu Time Worth S-1 EXHIBIT S DESIGNATION OF OUTSIDE COUNSEL [Intentionally Omitted] T-1 EXHIBIT T MODEL STATUTE Section __. Findings and Purpose. 1 (a) Cigarette smoking presents serious public health concerns to the State and to the citizens of the State. The Surgeon General has determined that smoking causes lung cancer, heart disease and other serious diseases, and that there are hundreds of thousands of tobacco-related deaths in the United States each year. These diseases most often do not appear until many years after the person in question begins smoking. (b) Cigarette smoking also presents serious financial concerns for the State. Under certain health-care programs, the State may have a legal obligation to provide medical assistance to eligible persons for health conditions associated with cigarette smoking, and those persons may have a legal entitlement to receive such medical assistance. (c) Under these programs, the State pays millions of dollars each year to provide medical assistance for these persons for health conditions associated with cigarette smoking. (d) It is the policy of the State that financial burdens imposed on the State by cigarette smoking be borne by tobacco product manufacturers rather than by the State to the extent that such manufacturers either determine to enter into a settlement with the State or are found culpable by the courts. (e) On _______, 1998, leading United States tobacco product manufacturers entered into a settlement agreement, entitled the “Master Settlement Agreement,” with the State. The Master Settlement Agreement obligates these manufacturers, in return for a release of past, present and certain future claims against them as described therein, to pay substantial sums to the State (tied in part to their volume of sales); to fund a national foundation devoted to the interests of public health; and to make substantial changes in their advertising and marketing practices and corporate culture, with the intention of reducing underage smoking. (f) It would be contrary to the policy of the State if tobacco product manufacturers who determine not to enter into such a settlement could use a resulting cost advantage to derive large, short-term profits in the years before liability may arise without ensuring that the State will have an eventual source of recovery from them if they are proven to have acted culpably. It is thus in the interest of the State to require that such manufacturers establish a reserve fund to guarantee a source of compensation and to prevent such manufacturers from deriving large, short-term profits and then becoming judgment-proof before liability may arise. Section __. Definitions. (a) “Adjusted for inflation” means increased in accordance with the formula for inflation adjustment set forth in Exhibit C to the Master Settlement Agreement. (b) “Affiliate” means a person who directly or indirectly owns or controls, is owned or controlled by, or is under common ownership or control with, another person. Solely for purposes of this definition, the terms “owns,” “is owned” and “ownership” mean ownership of an equity interest, or the equivalent thereof, of ten percent or more, and the term “person” means an individual, partnership, committee, association, corporation or any other organization or group of persons. (c) “Allocable share” means Allocable Share as that term is defined in the Master Settlement Agreement. (d) “Cigarette” means any product that contains nicotine, is intended to be burned or heated under ordinary conditions of use, and consists of or contains (1) any roll of tobacco wrapped in paper or in any substance not containing tobacco; or (2) tobacco, in any form, that is functional in the product, which, because of its appearance, the type of tobacco used in the filler, or its packaging and labeling, is likely to be offered to, or purchased by, consumers as a cigarette; or (3) any roll of tobacco wrapped in any substance containing tobacco which, because of its appearance, the type of tobacco used in the filler, or its packaging and labeling, is likely to be offered to, or purchased by, consumers as a cigarette described in clause (1) of this definition. The term “cigarette” includes “roll-your-own” (i.e., any tobacco which, because of its appearance, type, packaging, or labeling is suitable for use and likely to be offered to, or purchased by, consumers as tobacco for making cigarettes). For purposes of this definition of “cigarette,” 0.09 ounces of “roll-your-own” tobacco shall constitute one individual “cigarette.” (e) “Master Settlement Agreement” means the settlement agreement (and related documents) entered into on _______, 1998 by the State and leading United States tobacco product manufacturers. (f) “Qualified escrow fund” means an escrow arrangement with a federally or State chartered financial institution having no affiliation with any tobacco product manufacturer and having assets of at least $1,000,000,000 where such arrangement requires that such financial institution hold the escrowed funds’ principal for the benefit of releasing parties and prohibits the tobacco product manufacturer placing the funds into escrow from using, accessing or directing the use of the funds’ principal except as consistent with section ___(b)-(c) of this Act. (g) “Released claims” means Released Claims as that term is defined in the Master Settlement Agreement. (h) “Releasing parties” means Releasing Parties as that term is defined in the Master Settlement Agreement. 1 [A State may elect to delete the “findings and purposes” section in its entirety. Other changes or substitutions with respect to the “findings and purposes” section (except for particularized state procedural or technical requirements) will mean that the statute will no longer conform to this model.] T-2 (i) “Tobacco Product Manufacturer” means an entity that after the date of enactment of this Act directly (and not exclusively through any affiliate): (1) manufactures cigarettes anywhere that such manufacturer intends to be sold in the United States, including cigarettes intended to be sold in the United States through an importer (except where such importer is an original participating manufacturer (as that term is defined in the Master Settlement Agreement) that will be responsible for the payments under the Master Settlement Agreement with respect to such cigarettes as a result of the provisions of subsections II(mm) of the Master Settlement Agreement and that pays the taxes specified in subsection II(z) of the Master Settlement Agreement, and provided that the manufacturer of such cigarettes does not market or advertise such cigarettes in the United States); (2) is the first purchaser anywhere for resale in the United States of cigarettes manufactured anywhere that the manufacturer does not intend to be sold in the United States; or (3) becomes a successor of an entity described in paragraph (1) or (2). The term “Tobacco Product Manufacturer” shall not include an affiliate of a tobacco product manufacturer unless such affiliate itself falls within any of (1) - (3) above. (j) “Units sold” means the number of individual cigarettes sold in the State by the applicable tobacco product manufacturer (whether directly or through a distributor, retailer or similar intermediary or intermediaries) during the year in question, as measured by excise taxes collected by the State on packs (or “roll-your-own” tobacco containers) bearing the excise tax stamp of the State. The [fill in name of responsible state agency] shall promulgate such regulations as are necessary to ascertain the amount of State excise tax paid on the cigarettes of such tobacco product manufacturer for each year. Section __. Requirements. Any tobacco product manufacturer selling cigarettes to consumers within the State (whether directly or through a distributor, retailer or similar intermediary or intermediaries) after the date of enactment of this Act shall do one of the following: (a) become a participating manufacturer (as that term is defined in section II(jj) of the Master Settlement Agreement) and generally perform its financial obligations under the Master Settlement Agreement; or (b) (1) place into a qualified escrow fund by April 15 of the year following the year in question the following amounts (as such amounts are adjusted for inflation) -- 1999: $.0094241 per unit sold after the date of enactment of this Act;2 2000: $.0104712 per unit sold after the date of enactment of this Act;3 for each of 2001 and 2002: $.0136125 per unit sold after the date of enactment of this Act; for each of 2003 through 2006: $.0167539 per unit sold after the date of enactment of this Act; for each of 2007 and each year thereafter: $.0188482 per unit sold after the date of enactment of this Act. (2) A tobacco product manufacturer that places funds into escrow pursuant to paragraph (1) shall receive the interest or other appreciation on such funds as earned. Such funds themselves shall be released from escrow only under the following circumstances -- (A) to pay a judgment or settlement on any released claim brought against such tobacco product manufacturer by the State or any releasing party located or residing in the State. Funds shall be released from escrow under this subparagraph (i) in the order in which they were placed into escrow and (ii) only to the extent and at the time necessary to make payments required under such judgment or settlement; (B) to the extent that a tobacco product manufacturer establishes that the amount it was required to place into escrow in a particular year was greater than the State’s allocable share of the total payments that such manufacturer would have been required to make in that year under the Master Settlement Agreement (as determined pursuant to section IX(i)(2) of the Master Settlement Agreement, and before any of the adjustments or offsets described in section IX(i)(3) of that Agreement other than the Inflation Adjustment) had it been a participating manufacturer, the excess shall be released from escrow and revert back to such tobacco product manufacturer; or (C) to the extent not released from escrow under subparagraphs (A) or (B), funds shall be released from escrow and revert back to such tobacco product manufacturer twenty-five years after the date on which they were placed into escrow. (3) Each tobacco product manufacturer that elects to place funds into escrow pursuant to this subsection shall annually certify to the Attorney General [or other State official] that it is in compliance with this subsection. The Attorney General [or other State official] may bring a civil action on behalf of the State against any tobacco product 2 [All per unit numbers subject to verification] 3 [The phrase “after the date of enactment of this Act” would need to be included only in the calendar year in which the Act is enacted.] T-3 manufacturer that fails to place into escrow the funds required under this section. Any tobacco product manufacturer that fails in any year to place into escrow the funds required under this section shall -- (A) be required within 15 days to place such funds into escrow as shall bring it into compliance with this section. The court, upon a finding of a violation of this subsection, may impose a civil penalty [to be paid to the general fund of the state] in an amount not to exceed 5 percent of the amount improperly withheld from escrow per day of the violation and in a total amount not to exceed 100 percent of the original amount improperly withheld from escrow; (B) in the case of a knowing violation, be required within 15 days to place such funds into escrow as shall bring it into compliance with this section. The court, upon a finding of a knowing violation of this subsection, may impose a civil penalty [to be paid to the general fund of the state] in an amount not to exceed 15 percent of the amount improperly withheld from escrow per day of the violation and in a total amount not to exceed 300 percent of the original amount improperly withheld from escrow; and (C) in the case of a second knowing violation, be prohibited from selling cigarettes to consumers within the State (whether directly or through a distributor, retailer or similar intermediary) for a period not to exceed 2 years. Each failure to make an annual deposit required under this section shall constitute a separate violation.4 4 [A State may elect to include a requirement that the violator also pay the State’s costs and attorney’s fees incurred during a successful prosecution under this paragraph (3).] U-1 EXHIBIT U STRATEGIC CONTRIBUTION FUND PROTOCOL The payments made by the Participating Manufacturers pursuant to section IX(c)(2) of the Agreement (“Strategic Contribution Fund”) shall be allocated among the Settling States pursuant to the process set forth in this Exhibit U. Section 1 A panel committee of three former Attorneys General or former Article III judges (“Allocation Committee”) shall be established to determine allocations of the Strategic Contribution Fund, using the process described herein. Two of the three members of the Allocation Committee shall be selected by the NAAG executive committee. Those two members shall choose the third Allocation Committee member. The Allocation Committee shall be geographically and politically diverse. Section 2 Within 60 days after the MSA Execution Date, each Settling State will submit an itemized request for funds from the Strategic Contribution Fund, based on the criteria set forth in Section 4 of this Exhibit U. Section 3 The Allocation Committee will determine the appropriate allocation for each Settling State based on the criteria set forth in Section 4 below. The Allocation Committee shall make its determination based upon written documentation. Section 4 The criteria to be considered by the Allocation Committee in its allocation decision include each Settling State’s contribution to the litigation or resolution of state tobacco litigation, including, but not limited to, litigation and/or settlement with tobacco product manufacturers, including Liggett and Myers and its affiliated entities. Section 5 Within 45 days after receiving the itemized requests for funds from the Settling States, the Allocation Committee will prepare a preliminary decision allocating the Strategic Contribution Fund payments among the Settling States who submitted itemized requests for funds. All Allocation Committee decisions must be by majority vote. Each Settling State will have 30 days to submit comments on or objections to the draft decision. The Allocation Committee will issue a final decision allocating the Strategic Contribution Fund payments within 45 days. Section 6 The decision of the Allocation Committee shall be final and non-appealable. Section 7 The expenses of the Allocation Committee, in an amount not to exceed $100,000, will be paid from disbursements from the Subsection VIII(c) Account. [THIS PAGE INTENTIONALLY LEFT BLANK] APPENDIX C PROPOSED FORM OF OPINION OF TRANSACTION COUNSEL [THIS PAGE INTENTIONALLY LEFT BLANK] April 12, 2006 The Bank of New York Trust Company, N.A., as Indenture Trustee 10161 Centurion Parkway Jacksonville, FL 32256 Ladies and Gentlemen: We have acted as transaction counsel to Tobacco Settlement Financing Corporation (the "Corporation"), a special purpose, independent instrumentality of the United States Virgin Islands (the "Virgin Islands"), created by Act No. 6428 of the Twenty-Fourth Legislature of the Virgin Islands, the Tobacco Settlement Financing Act of 2001 (the "Act"). In connection therewith, we have examined a record of proceedings relating to the issuance of $7,290,008.85 aggregate principal amount of Tobacco Settlement Asset-Backed Bonds, Subordinate Series 2006 Turbo Capital Appreciation Bonds consisting of the $4,764,709.50 aggregate principal amount of Tobacco Settlement Asset-Backed Bonds, Subordinate Series 2006A Turbo Capital Appreciation Bonds, the $512,471.35 aggregate principal amount of Tobacco Settlement Asset-Backed Bonds, Subordinate Series 2006B Turbo Capital Appreciation Bonds, the $867,690.00 aggregate principal amount of Tobacco Settlement Asset-Backed Bonds, Subordinate Series 2006C Turbo Capital Appreciation Bonds and the $1,145,138.00 aggregate principal amount of Tobacco Settlement Asset-Backed Bonds, Subordinate Series 2006D Turbo Capital Appreciation Bonds (collectively, the "Series 2006 Bonds"). The Series 2006 Bonds are issued under and pursuant to an Indenture, dated as of November 1, 2001, as amended and supplemented by an Amended and Restated Indenture as of March 15, 2006 and as supplemented by the Series 2006 Supplement dated as of March 15, 2006 (collectively, the "Indenture"), between the Corporation and The Bank of New York Trust Company, N.A., as Indenture Trustee. Terms used herein and not otherwise defined have the meanings ascribed thereto in the Indenture. The Series 2006 Bonds are dated the date hereof and accrete interest, mature, are subject to redemption and are secured as set forth in the Indenture. The net proceeds of the Series 2006 Bonds will be provided to the Virgin Islands to finance various health care capital projects. The Corporation and the Virgin Islands have entered into a Purchase and Sale Agreement, dated as of November 1, 2001 (the "Purchase and Sale Agreement"), pursuant to which the Virgin Islands sold to the Corporation all of its right, title and interest to certain payments to be made to it under the Master Settlement Agreement that was entered into by participating cigarette manufacturers, forty-six states and five other United States jurisdictions in November 1998 in settlement of certain smoking-related litigation. We C-1 assume, for the purpose of this opinion, that the parties will perform their respective covenants in the Indenture and the Purchase and Sale Agreement in all material respects. We have examined the law and such certified proceedings and other papers as we deem necessary to render the following opinions. In rendering the following opinions we have assumed the genuineness of all signatures, the authenticity of all documents tendered to us as originals and the conformity to original documents of all documents submitted to us as certified or photostatic copies. As to questions of fact material to our opinion, we have relied upon the certified proceedings and other certifications of public officials furnished to us without undertaking to verify the same by independent investigation. We have not been engaged or undertaken to review the accuracy, completeness or sufficiency of the offering circular or other offering material relating to the Series 2006 Bonds, and we express no opinion related thereto. Based upon the foregoing and under existing law, we are of the opinion: 1. The Corporation is duly organized and existing under the laws of the Virgin Islands with the righ