Enforcing the Compact Clause

Guest Blogger

Michael Greve

A pending cert petition in S&M Brands v. Caldwell presents, among other salient issues, the question of whether the Constitution’s Compact Clause still has independent force and meaning. The Court should review that question and answer it in the affirmative, for reasons summarized below and explained at much greater length in Greve, Compacts, Cartels, and Congressional Consent, 68 Mo. L. Rev. 285 (2003). By way of disclosure: I serve as Chairman of the Competitive Enterprise Institute (CEI), which represents the plaintiff-petitioners in the case. However, this post reflects my own views and not necessarily the plaintiffs’ litigation position.

S&M Brands urges the Court to revisit the Constitution’s prohibition against "any Agreement or Compact" among states, without congressional consent, U.S. Const. Art. I §10 cl.3. The petition petition, authored principally by Erik Jaffe and Michael McConnell, challenges the Master Settlement Agreement (MSA) on tobacco litigation, signed in 1998 between the major tobacco firms and state attorneys general. It urges review both on the Compact Clause question and on a closely related question, the MSA’s Parker immunity from the Sherman Act. An amicus brief by Alan Morrison, on behalf of himself, Richard Epstein, and brief by antitrust experts supports petitioners on the Parker question. Respondents’ brief in opposition and petitioners’ reply appear here and here.

No circuit split exists on either question. However, the Roberts Court has shown a commendable willingness to recover long-ignored and seemingly marginal constitutional clauses. Two years ago, for example, the justices unearthed the Compact Clause’s immediate constitutional neighbor—the Tonnage Clause, last adjudicated in 1935. In Polar Tankers v. City of Valdez, the justices read the prohibition against "any [state] Duty of Tonnage" without the consent of the Congress "in light of its purpose" and invalidated a state duty that, while nominally declared a "property tax," operated as a de facto tax on the privilege of entering a port. The ruling in the case—yanked up without a circuit split—reflects the conviction, which still commands near-universal assent, that every clause of the Constitution must retain some independent force and meaning. The tobacco agreement provides a pristine test of that same bedrock principle. If the MSA does not require congressional consent, no state compact can violate the Compact Clause unless it is already unlawful for some other, independent reason.

The MSA

The MSA has its origin in state-initiated liability lawsuits, ostensibly to recoup state expenses for smoking-related illnesses. By 1997, more than 30 states had filed suit, and tobacco manufacturers felt compelled to settle four cases for some $40 billion. As is common in products liability suits, however, the defendants had no way of internalizing those costs to the settling states. (Conversely, the non-settling states had no way of protecting their own citizen-consumers from the attendant costs.) The inherent extraterritorial dynamics drove the creation of the MSA.

The "Majors" (who at the time supplied close to 99 percent of the U.S. cigarette market) had a potent incentive to settle with all states. They had an equally potent incentive for Using Tort Settlements to Cartelize (Ian Ayres). State-by-state settlements entailed a risk of rewarding hold-out states and, more importantly, a price advantage for producers that had not been sued and for new market entrants. Put differently, continued price competition would have meant that the payments would come substantially off the producers’ hide—the intended result of liability litigation, one would think, but not one that was likely to procure the industry’s consent or, for that matter, to ensure its ability to pay. Thus, the Majors offered states a settlement under which consumers would pay virtually all of the costs, and more, of a comprehensive agreement, in return for a release from future liability and a reliable revenue stream. An agreement along these lines was presented to Congress. When Congress failed to give its consent, the parties—states, the Majors, and the trial bar—negotiated a somewhat more limited but, in all relevant respects, identical agreement—the MSA.

The MSA is an agreement between and among the states and the participating manufacturers. It is an outright, naked cartel to limit output and raise prices.

First, the MSA allocated the manufacturers’ share of the payments not (as in a genuine liability settlement) in proportion to the producers’ contributions to the alleged harms but rather in proportion to current and future market share. A higher market share means higher payments, rendering price competition pointless. Second, the MSA provided the Majors with protection against competition by smaller producers and new market entrants. Smaller manufacturers were permitted to join the MSA without incurring proportionate payment obligations, provided that they agreed to stabilize their sales at pre-MSA levels. And, to suppress new market entrants, an MSA "Model Statute," to be enacted by all member-states, requires Non-Participating Manufacturers to make payments, equivalent to roughly 150 percent of the "damage" payments they would incur under the MSA into an escrow account, supposedly in anticipation of future costs and liabilities.

The MSA enforces this order through a regime of interstate transfer payments. If the participating manufacturers suffer sales losses exceeding two percent of their aggregate market share as a result of the MSA, they may reduce their base payments to the states by three percent for each percent market share loss above that level. In other words, a 10 percent decline in aggregate market share entitles the participating manufacturers to a 24 percent reduction in (adjusted) base payments to the states. The entire reduction is imposed on states that have failed to enact a Model Statute that "fully and effectively neutralizes" the participating manufacturers’ cost disadvantages attributable to the MSA. Such states may lose their entire allocable share. These incentives guaranteed prompt and universal state enactment of the MSA Model Statute. Over the years, most states have also enacted various laws, urged by the National Association of Attorneys General (which administers the MSA), to protect the MSA’s design against evasion by renegade manufacturers and cost-conscious consumers.

Two points of agreement have emerged from S&M Brands and earlier litigation: (1) the MSA is clearly a state "compact" in the constitutional sense; (2) but for the states’ involvement, the MSA would constitute a criminal, per se violation of the Sherman Act. The defense is that (1) the MSA is not a compact requiring congressional approval under the leading modern case, Parker v. Brown immunity. Lower courts have accepted those defenses, typically without much analysis. Here’s to hoping that the Supreme Court will correct their glaring errors.

The Compact Clause: Structure, Scope, and Purpose

Article I, Section 10 consists entirely of prohibitions against states. While some prohibitions (e.g., against state treaties or against impairments of the obligation of contract) are absolute, others take the form of the "Negative" James Madison had urged—in lieu of the Supremacy Clause—on the Conventions: state law requires the consent of Congress. The intended point and effect of this arrangement is to invert the Constitution’s ordinary legislative default rule. The Supremacy Clause leaves state law in place until and unless Congress, or the courts, say "no." States laws that fall under the qualified prohibitions of Section 10 remain inoperative until and unless Congress says "yes."

Just what, and how much, is captured by the prohibitions? The raw text ("duties of tonnage," "compacts") is a starting point and irreducible baseline, but it cannot be the whole answer. For example, a literal reading of the prohibition against "any Agreement or Compact" would require congressional consent for a meeting of the National Governors Association. That cannot be right. Clause-bound textualism can resolve some of the difficulty: e.g., one could insist that the prohibition covers only binding agreements among states. Eventually, though, the boundary-defining inquiry has to go to the purpose of the prohibition, understood in light of the constitutional structure.

The common reference point is Virginia v. Tennessee (1893), involving a border dispute between the two states. "[L]ooking at the object of the constitutional provision" rather than its text, Justice Field’s opinion pronounced that the clause requires congressional consent only for state agreements "directed to the formation of any combination tending to the increase of political power in the states, which may encroach upon or interfere with the just supremacy of the United States," as distinct from agreements "to which the United States can have no possible objection or have any interest in interfering with." While these passages are dicta (a later part of Field’s opinion held that Congress had in fact approved the state agreement at issue), the MTC Court heavily relied on them and converted them into a Compact Clause "rule."

The purpose-based "rule"—compacts require congressional consent if and when they may interfere with the supremacy of the United States—is not a bad one. However, it has to be understood in harmony with the constitutional text and structure. When it is so understood, it is blazingly obvious that the MSA requires consent. I’ll divide the analysis into two parts: supremacy, and horizontal effects.

Supremacy

The operative word in the Viginia v. Tennessee/MTC test is may. If compacts could go into effect without consent unless they actually interfere with federal supremacy, the Compact Clause would forbid nothing that is not already unlawful under a conventional preemption analysis. The point of the consent requirement, however, is to invert the ordinary Supremacy Clause arrangement, not to replicate it. Any plausible Compact Clause interpretation must give force to that constitutional decision. Hence, may.

The S&M Brands plaintiffs argue persuasively that the MSA is an affirmative violation of the Sherman Act. Parker immunity cannot possibly shield a naked cartel to which states are a party. Moreover, while Parker may protect a single state’s (regulatory) cartel with extraterritorial effects, it cannot shield a multi-state attempt to create a cartel, and market power, on a nationwide basis. Even if one (wrongly) views this question as close as a matter of antitrust and preemption law, the Compact Clause settles it. The scope of Parker immunity ipso facto implicates the supremacy of the United States. And whatever economists and antitrust mavens may think of transporting Parker’s (federalism-based) single-state exemption into a multi-state context, the Compact Clause must mean that some state actions, while okay when done alone, are not okay—without consent—when done in concert.

Horizontal Federalism: Settlement Dynamics and Lock-In

In some formulations, the Virginia v. Tennessee/MTC test suggests a simple, "vertical" dichotomy: the states, collectively, on one side; the national government on the other. However, the national government’s prerogatives, as embodied in the congressional consent requirement, must be understood to encompass the protection of federalism’s "horizontal" rules among the states, on the principles of state equality and mutual non-aggression. How do we know this?

Overwhelmingly, the prohibitions of Section 10 are directed against mutual state aggression—physical aggression, but also economic exploitation, such as debtor relief laws (the Contract Clause) and the abuse of a monopolistic or bottleneck position (the Import-Export Clause, the Tonnage Clause). These horizontal threats are not somehow different from direct, vertical state assaults on the "just supremacy" of the United States: they are that assault. They require consent, as opposed to the exertion of ex post preemption, precisely because the protection is too important to be left to a dilatory, distracted Congress, operating under otherwise commendable supermajoritarian rules and arrangements.

Throughout the nineteenth century, the Supreme Court understood the Compact Clause as a horizontal protection for the states. As Chief Justice Taney wrote in Florida v. Georgia, 58 U.S. 478, 494 (1854), its point is "to guard the rights and interests of the other States, and to prevent any compact or agreement between any two States, which might affect injuriously the interest of the others." Modern-day apostles of a "cooperative" federalism have challenged that understanding. Unlike the overtly hostile acts prohibited elsewhere in Section 10, they say, state compacts may generate gains that might fail to materialize under alternative modes of resolving interstate disputes (litigation, or federal regulation). However, wholly apart from the wisdom of setting aside the Constitution’s explicit norms and presumptions in light of utilitarian calculations, substantive considerations in fact militate in favor of treating compacts as especially troublesome. First, some states may collude to exploit other states. Second, Coasean enthusiasm must be tempered by a recognition that states are not principals but agents. The agents are hard to monitor even when acting alone, within the sphere of their respective jurisdictions. When their responsibilities are commingled or transferred to a third party (such as a compact commission with independent regulatory authority), the monitoring costs increase exponentially. The MSA provides an alarming illustration of both points.

As for collusion and exploitation, consider the MSA settlement dynamics: once the MSA bargain had taken shape and a critical number of state AGs had signaled their support, dissident state AGs no longer had an independent choice between signing and not signing—only a choice between signing and not signing, while leaving the state’s MSA share on the table and their domestic consumers, still exposed to "their" share of MSA payments. Likewise, state legislatures "accepted" the MSA and enacted the required Model Statute under duress. Each state’s supposedly valuable claim against the merchants of death had already been surrendered by its AG; and, legislators could opt out only of the MSA’s proceeds, not their citizen-consumers’ payments into the pool. Just as no state could withhold "consent" ex ante, moreover, so none can defect ex post: the only consequence would be a unilateral surrender of revenues. Any attempt to prompt a concerted or for that matter a congressional (re-)examination is foreclosed: the MSA, including an anti-disparagement clause that prohibits any assistance to MSA challenges, binds all state officials in perpetuity. Thus, far from enhancing state autonomy and "federalism," the MSA fatally undermines those principles.

As for the monitoring issue: the MSA establishes a compact authority to make binding decisions for all member states. Concerns over such ill-defined authorities, somewhere between the states and the nation and unprovided-for in the Constitution, are not specifically contemplated by Justice Field’s formulation of the Compact Clause inquiry. (The one-shot border demarcation in Virginia v. Tennessee did not involve the question.) But the notion of single-purpose confederacies on American soil, operating outside public view and the constitutionally specified modes and means of political representation, would surely have offended a justice of Stephen Field’s rigid "dual federalism" orientation. In fact, it is sufficiently insane to offend any plausible federalism understanding. Modern Supreme Court decisions such as Printz v. United States have encompassed the relevant considerations under the heading of "accountability." Should the Compact Clause inquiry come down to this overarching principle of the Supreme Court’s federalism, the MSA is dead meat.

Are You Serious?

The MSA created a national de facto tax, in excess of a quarter-trillion dollars, that no legislator, state or federal, ever voted on. And it granted the nastiest industry in America a uniquely favored status—that of a public utility without any supervision of, or constraint on, pricing and profits. Both the Tea Party and the dailykos crowd should recoil at the arrangement, if for somewhat different reasons. Supreme Court review in this case might help both to train their metaphorical guns on a real and readily destructible target.

At a more rarified level, a cert grant in S&M Brands might help to bring clarity to an often arid and abstract constitutional debate. Strict textualists would have to explain why "any" might not actually mean literally any. More latitudinarian theorists would have to explain whether they actually believe what they still profess to teach: "It cannot be presumed that any clause in the constitution is intended to be without effect." Marbury v. Madison, 5 U.S. 137, 174 (1803).


Michael Greve is the John G. Searle Scholar at the American Enterprise Institute. You can reach him by e-mail at MGreve at AEI.org
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