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UPDATE 1-U.S. Supreme Court declines to hear tobacco arbitration dispute

(Adds background on case, court action, paragraphs 3-7)

By Lawrence Hurley

WASHINGTON Oct 11 The U.S. Supreme Court on Tuesday let stand lower court rulings allowing Pennsylvania and Maryland to keep tens of millions of dollars in a dispute with tobacco companies involving the massive 1998 settlement over deceptive marketing and advertising of cigarettes.

The justices declined to hear appeals, filed by Reynolds America Inc, Altria Group Inc and other companies that were part of the settlement, of rulings that had favored Pennsylvania and Maryland regarding the amount of the annual payment that those states should receive under the deal.

The dispute centered on the 2003 annual payment that companies that participated in the settlement were required to make to the various states as part of the deal.

An arbitration panel found that six states, including Pennsylvania and Maryland, had not met their side of the bargain to ensure, as required, that companies that were part of the settlement did not disproportionately lose market share as a result of the terms of the deal to competitors that shunned it.

The arbitration panel reduced the amount of money the six states would receive for that year, but state courts in Maryland and Pennsylvania subsequently ruled in favor of those states when they objected. As a result of those rulings, Pennsylvania was able to keep $125 million and Maryland was able to retain $50 million that the companies had demanded be given back.

Under the landmark settlement reached with 46 states, the largest U.S. tobacco companies promised to pay nearly $200 billion over 25 years to states to settle lawsuits over cigarette-related public health costs. Among other provisions, the deal imposed restrictions on the sale and marketing of cigarettes including barring ads targeting youths.

The major tobacco companies worried that they would have to raise prices on their brands in order to fund the settlement. So the 1998 agreement required states to pass laws that prevented cigarette companies that did not sign the agreement from gaining an unfair economic advantage over those that did sign it.

(Reporting by Lawrence Hurley; Editing by Will Dunham)

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