State of Texas v. American Tobacco Co

United States Court of Appeals
Fifth Circuit
F I L E D
September 1, 2006
Charles R. Fulbruge III
Clerk
In the
United States Court of Appeals
for the Fifth Circuit
_______________
m 05-40671
_______________
STATE OF TEXAS,
Plaintiff-Appellant,
VERSUS
AMERICAN TOBACCO CO., ETC.; ET AL.,
Defendants,
BROWN & WILLIAMSON TOBACCO CO.,
Defendant-Appellee.
_________________________
Appeals from the United States District Court
for the Eastern District of Texas
m 5:96-CV-91
_________________________
Before SMITH and STEWART, Circuit Judges,
and HANEN,* District Judge.
ANDREW S. HANEN, District Judge:
The issue before this Court involves the
proper interpretation of the settlement agree-
ment between the State of Texas and five large
cigarette manufacturers. Specifically, this
Court must determine whether Brown &
Williamson Tobacco Corporation n/k/a Brown
& Williamson Holding, Inc. (“B&W”)
breached its obligations under the settlement
agreement by failing to report cigarettes that
* District Judge of the Southern District of
Texas, sitting by designation.

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B&W manufactured for Star Tobacco &
Pharmaceuticals (“Star”) as its own for the pur-
pose of calculating B&W’s annual payments to
Texas. As a consequence of B&W’s alleged
underreporting, the State claims it was deprived
of approximately $16,420,252 in settlement
payments between the years 1999 and 2002.
For the reasons stated below, we affirm.
I. FACTUAL BACKGROUND
On March 28, 1996, the State of Texas sued
several major tobacco companies seeking reim-
bursement for various smoking-related health
care expenditures. Almost two years later, on
January 16, 1998, Texas entered into a settle-
ment agreement with B&W, Philip Morris, Inc.,
R.J. Reynolds Tobacco Co., Lorillard Tobacco
Co., and United States Tobacco Co. (collec-
tivelyreferred to as the “Settling Defendants”).1
The settlement agreement, which was approved
by the district court on January 22, 1998,
released the tobacco companies from all past
and future claims arising out of the use of, or
exposure to, their tobacco products. In return,
the tobacco companies agreed to make annual
payments to Texas and to comply with certain
restrictions, including various marketing restric-
tions. The parties also agreed that the United
States District Court for the Eastern District of
Texas, Texarkana Division, would retain juris-
diction over the parties and subject matter of
the settlement for the purposes of implement-
ing and enforcing the agreement.
Since the parties executed the original
“Comprehensive Settlement Agreement and
Release” (“Original Agreement”), they have
amended it twice.2 On July 24, 1998, the par-
ties entered into the Stipulation of Amendment
to Settlement Agreement and for Entry of
Consent Decree (“1998 Amendment”), and on
June 8, 2001, the parties entered into the
Agreement to Amendment to Settlement
Agreement (“2001 Amendment”).
The 1998 Amendment reflects Texas’ ex-
ercise of its rights under the Original Agree-
ment’s “Most Favored Nation” provision to
adopt the more favorable terms of the settle-
ment agreement reached between the Settling
Defendants and the State of Minnesota on
May 8, 1998. The Original Agreement tied the
formula for calculating the annual payments to
the “respective share of sales of cigarettes by
unit for consumption in the United States.”
Apparently, some of the Settling Defendants
began marketing cigarettes in “two for one” or
“buy two get one free” promotions. “Free”
cigarettes given as part of such promotions
would likely be excluded from the annual
payment calculations of the Original Agree-
ment because they would not have been con-
sidered cigarettes “sold.” Perhaps recognizing
the potential decrease in the amount of the
settlement payments presented by these pro-
motions, the settlement agreement reached
between the State of Minnesota and the Set-
tling Defendants tied the Settling Defendants’
annual payment obligations to shipped ciga-
1 Texas was the third state to reach a major set-
tlement agreement with the major tobacco compa-
nies. The Settling Defendants initially settled with
Mississippi, then followed in order by Florida, Tex-
as, and Minnesota. The Settling Defendants finally
settled with the remaining forty-six (46) states, the
District of Columbia, and the five (5) U.S. Territo-
ries through the Master Settlement Agreement.
Texas attempted to introduce the Master Settlement
Agreement into evidence in the court below; how-
ever, the district court sustained B&W’s objection
thereto and Texas has not appealed that ruling.
2 The Original Agreement along with the two
amendments are collectively referred to as the
“Texas Settlement Agreement.”

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rettes. Texas and the Settling Defendants
thereafter entered into the 1998 Amendment,
which changed the annual payment provisions
by tying the annual payment calculations to the
“number of cigarettes shipped for domestic
consumption.” See 1998 Am., at Appx. A
(emphasis added).3
In late 1999, B&W entered into a Cigarette
Manufacturing Agreement with Star, an inde-
pendent tobacco company that was primarily
engaged in developing reduced-risk tobacco
products. B&W manufactured, sold, and
shipped to Star per Star’s specifications and
requirements over 7.5 billion cigarettes between
late 1999 and December 21, 2002 (“contract-
manufactured cigarettes”). B&W was paid
approximately one cent for each contract-
manufactured cigarette, which resulted in
B&W’s making approximately $4 per thousand
cigarettes.4 Although B&W shipped the con-
tract-manufactured cigarettes to Star, who then
shipped them through its own distribution sys-
tem for consumption, B&W did not include
those cigarettes in its annual payment calcula-
tions to Texas.5 Instead, B&W based its annual
payment calculations on the shipment infor-
mation that it reported to Management Science
Associates, Inc. (“MSA, Inc.”).
MSA, Inc. is an independent third party that
has been collecting information related to
tobacco companies’ shipments to wholesalers
for over thirty years.6 As part of its Cigarette
Research Audit (“CRA”) program, MSA, Inc.
collects and reports information from cigarette
manufacturers concerning shipments to their
wholesalers and distributors. These reports
are sometimes referred to as “Shipments to
Wholesale.” The agreement between MSA,
Inc. and B&W is such that B&W only reports
the cigarettes it ships through its own distribu-
tion system. Therefore, B&W did not include
the contract-manufactured cigarettes in the
shipment information it reported to MSA, Inc.
The MSA, Inc. reports are used by B&W and
other cigarette manufacturers to analyze and
monitor their respective sales and market
shares. MSA, Inc. does not examine or verify
the accuracy of the information that B&W
provides.7
On May 27, 2004, over one year after
B&W had stopped manufacturing cigarettes
for Star, the State of Texas filed a Verified
Motion to Enforce the Settlement Agreement,
For an Accounting, and For a Preliminary In-
junction claiming that B&W breached the
agreement by failing to report as its own, and
make settlement payments with respect to, the
contract-manufactured cigarettes. B&W de-
nied the allegations claiming that it was not
required to include the contract-manufactured
3 The 2001 Amendment clarified terms with re-
spect to the net operating profit provision of Appen-
dix A and is not material to the issues presented by
this appeal.
4 According to the district court, B&W’s gross
margin on its own cigarettes is 10 to 12 times
greater.
5 The district court found that the shipping costs
associated with the contract-manufactured cigarettes
were paid for by Star, risk of loss transferred to Star
when the cigarettes left B&W’s facilities, and all the
taxes on these cigarettes were paid by Star.
6 MSA, Inc. operates pursuant to various con-
tractual agreements it has with private industry.
Texas is not a party to any of those contracts.
7 The parties agree that even though MSA, Inc.
collects cigarette shipment information as part of
its Cigarette Research Audit program, MSA, Inc.
does not “audit” the shipment information, at least
not in the classic financial sense of the term.

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cigarettes in the annual payment calculations.
On June 24, 2004, by agreement of the parties,
the United States District Court for the Eastern
District of Texas, Texarkana Division, heard
argument and received evidence on whether
B&W breached the agreement, and on whether
Texas was entitled to an accounting.8
On March 28, 2005, the district court issued
its Final Judgment in favor of B&W along with
its Findings of Facts and Conclusions of Law.
The court ruled that “under well-settled indus-
try practice,” the contract-manufactured ciga-
rettes “were not B&W’s cigarette shipments,
they were not shipped to B&W’s wholesalers,
and they were properly excluded from B&W’s
shipments reported to MSA, Inc. or the calcula-
tion of B&W’s payments under the Texas Set-
tlement Agreement.” Opinion, at 3. Further-
more, the district court ruled that the words
“cigarettes shipped for domestic consumption”
means those cigarettes shipped for domestic
consumption as reported by MSA, Inc. Id.
at 23.
Even though the court did not rule as to
whether the Texas Settlement Agreement is
ambiguous, the court based its ruling in part
on the parties’ course of performance.9 The
district court found that since its inception, all
of the annual payments due under the Texas
Settlement Agreement have been based on
MSA, Inc.’s “Shipments to Wholesale” re-
ports. It also found that this practice and
course of performance was explicitly recog-
nized by the parties in 2002 when the State
and the Settling Defendants entered into an
engagement letter with PriceWaterhouseCoop-
er (“PWC”). PWC was engaged to collect
“shipment volume data” from each Settling
Defendant and, based on that data, to calculate
the payments due under the Texas Settlement
Agreement. The engagement letter specifically
stated:
By January 15 of each year, request and
collect from each Settling Defendant ship-
ment volume data for the entire preceding
calendar year. Seek and obtain written
confirmation of such shipment volume data
from [MSA, Inc.], and notify each State
and each Settling Defendant if there exists
a discrepancy between the volume data col-
lected from the Settling Defendants and the
confirmation obtained from [MSA, Inc.]. 8 By agreement, the district court deferred con-
sideration of Texas’ motion for an injunction. The
injunction issue involved B&W’s proposed business
combination with R.J. Reynolds Tobacco Co. The
State claimed it would result in an assignment of
B&W’s rights and obligations under the Texas
Settlement Agreement without the State’s consent in
violation of Section 2 of the agreement. The issue
was rendered moot prior to the trial court’s ruling
by the fact that B&W supplied the State with copies
of the agreements affecting the business combina-
tion, which included provisions specifying that
B&W would not assign its rights and obligations as
part of the combination. The parties to the business
combination also entered into an amendment rein-
forcing that position. Thus, the injunction issue is
not material to this appeal.
9 While the court did not expressly find that the
Texas Settlement Agreement is unambiguous, it
stated that it based its ruling in part on “the plain
language of the Settlement Agreement.” Opinion,
at 22. Due to the fact that the trial court used
language normally associated with the interpreta-
tion of an unambiguous contract, but then also re-
lied on course of performance evidence, which is
used only in interpreting ambiguous contracts, this
Court is not certain whether the trial court consid-
ered the settlement agreement to be ambiguous.
Ultimately, since ambiguity is a question of law, it
is immaterial to the ultimate resolution of this
appeal.

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Id. at 13. The court found that the letter re-
flected the parties’ recognition that the “ship-
ment volume data” PWC was engaged to col-
lect would be based on the Settling Defendants’
shipments as reported to MSA, Inc. Id. Thus,
the court concluded that the letter reflected the
parties’ course of performance and their under-
standing that the annual payments to Texas
have always been based on shipments as re-
ported to MSA, Inc. Id. at 14.
The district court also made findings of fact
that the State knew about the Cigarette Manu-
facturing Agreement between B&W and Star
during the approximately six years prior to
filing its Motion to Enforce. The court found
that the evidence was “undisputed that the
State of Texas, including its Attorney General,
were aware of B&W’s contract manufacturing
agreement with Star from its inception” and
never claimed that B&W was obligated to make
settlement payments with respect to the
contract-manufactured cigarettes. Id. at 18.
II. THE ANNUAL PAYMENT
CALCULATIONS
At the heart of this appeal is the interpreta-
tion of the provisions in the Texas Settlement
Agreement establishing the method for calcu-
lating the Settling Defendants’ annual pay-
ments. The annual payment calculations are
based on each Settling Defendant’s share of
7.25% of $4 billion in 1998, $4.5 billion in
1999, $5 billion in 2000, $6.5 billion in 2001,
$6.5 billion in 2002, $8 billion in 2003, and
$8 billion in the years thereafter.10 1998 Am., at
11. These amounts are referred to as the
“Applicable Base Payments.” According to
the State’s witness Gary Wilson, the Applica-
ble Base Payments are subject to two adjust-
ments. The first adjustment takes into account
inflation by increasing the dollar amount in the
applicable year by the greater of three percent
or the consumer price index. The second
involves volume adjustment formulas set out in
Appendix A of the 1998 Amendment.11
One of the main factors taken into consid-
eration in the volume adjustment formulas is
whether “the aggregate number of cigarettes
shipped for domestic consumption by Settling
Defendants in the Applicable Year…(the ‘Ac-
tual Volume’)” exceeds or is less than “the ag-
gregate number of cigarettes shipped for
domestic consumption by Settling Defendants
in 1997 (the ‘Base Volume’).” 1998 Am.,
Appx. A, at (A). The annual payments are
further affected by whether the Settling Defen-
dants’ net operating profits for the applicable
year exceed each Settling Defendants’ net op-
erating profits in 1997. Id. at (B)(ii). Once
the adjustments are applied to the Applicable
Base Payments, the totalannualpayment owed
to Texas from the Settling Defendants collec-
tively is calculated.
After calculating the total annual payment,
it is then necessary to determine each of the
Settling Defendants’ share, which is based on
10 The “share” each Settling Defendant is obli-
gated to pay is “pro rata in proportion to its Market
Share.” The parties agreed that 7.25% reflects
Texas’ share of national health care expenses aris-
(continued...)
10(...continued)
ing out of domestic cigarette consumption.
11 Both the 1998 and 2001 Amendments contain
an “Appendix A” that are slightly different. Al-
though the 2001 Amendment theoretically super-
seded the 1998 Amendment, this Court will cite to
the 1998 Amendment when discussing the Appen-
dix A calculations.

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that defendant’s “Market Share.” “Market
Share” is defined by the 1998 Amendment as:
[A] Settling Defendant’s respective share of
sales of Cigarettes, by number of individual
Cigarettes shipped in the United States for
domestic consumption, as measured by such
Settling Defendant’s audited reports of ship-
ments of Tobacco Products provided to the
U.S. Securities and Exchange Commission
(“SEC”) (or, in the case of any Settling De-
fendant that does not provide such reports
to the SEC, audited reports of shipments
containing the same shipment information as
contained in the reports provided to the
SEC) (“Shipment Reports”).
1998 Am., at 5. Thus, the first step is to calcu-
late the total amount owed to Texas by taking
into account the inflation and volume adjust-
ments, and the second step is to apportion the
amount each Settling Defendant is required to
pay based on its individual market share.
For the first four years of the Texas Settle-
ment Agreement, the Settling Defendants actu-
ally performed the annual payment calculations.
Thereafter, PWC performed the calculations
using data supplied by the Settling Defendants
and confirmed by the MSA, Inc. reports.
According to the testimony, throughout the life
of the Texas Settlement Agreement, the Ap-
pendix A calculations have been based on the
same shipment numbers as used in the Market
Share calculations.
III. SUMMARY OF THE ARGUMENTS
Texas argues that the Texas Settlement
Agreement is unambiguous and that the 7.5
billion cigarettes that B&W manufactured for
Star between 1999 and 2002 should have been
included in the annual payment calculations.
According to Texas, the agreement requires
the Settling Defendants to report, and ulti-
mately make settlement payments on, all “cig-
arettes shipped for domestic consumption.”
B&W shipped the contract-manufactured cig-
arettes to Star, which were then shipped to
Star’s distributors and wholesalers for domes-
tic consumption. Therefore, the State con-
cludes that the contract-manufactured ciga-
rettes were “shipped for domestic consump-
tion.” It further argues that this interpretation
complies with the parties’ intent when they
entered into the settlement agreement (to
compensate Texas for the medical costs in-
curred by its smoking citizens) by focusing on
who manufactures the cigarettes rather than
who ultimately distributes them. Indeed, Tex-
as points out that because Star is not a signa-
tory to the Texas Settlement Agreement, Tex-
as was never compensated for the health care
costs associated with the domestic consump-
tion of the contract-manufactured cigarettes.
Had B&W reported those cigarettes as its
own, Texas claims it would have received an
additional$16,420,252 in settlement payments
for the years 1999 through 2002. Therefore,
B&W’s failure to report as its own the con-
tract-manufactured cigarettes constitutes a
breach of the agreement.
Texas points out that if the Texas Settle-
ment Agreement is unambiguous, the district
court erred by taking into consideration evi-
dence of the parties’ course of performance.12
As will be discussed in more detail below, it
12 Texas did not object or argue during the
bench trial that the course of performance evidence
was inadmissible for the purposes of interpreting
the language of the Texas Settlement Agreement.
The first mention of that argument is in Texas’
brief to this Court.

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also argues that the district court improperly
used the term “Shipment Reports,” which is
found in the definition of Market Share, to
interpret the phrase “cigarettes shipped for do-
mestic consumption,” in Appendix A. 1998
Am., at 5 & Appx. A (A). Texas maintains that
the market share calculations have nothing to
do with the State; rather, they provide a “dis-
pute resolution process” by which the Settling
Defendants divide up their individual portions
of the total annual payment owed to Texas.
B&W, on the other hand, argues that the
contract-manufactured cigarettes were properly
excluded from the annual payment calculations
because they were not B&W’s cigarettes and it
was not required to report those cigarettes to
MSA, Inc. It should be noted that as a subsid-
iary of a British corporation, B&W does not
report to the SEC. Therefore, B&W reported
as its shipments under the Texas Settlement
Agreement the same shipments that it reported
to MSA, Inc. Pursuant to the agreement be-
tween MSA, Inc. and B&W, B&W was not re-
quired to report the Star contract-manufactured
cigarettes as its own. Even though the Texas
Settlement Agreement does not specifically re-
fer to MSA, Inc., B&W argues that the plain
language of the Texas Settlement Agreement
requires the annual payment calculations to be
based on the Settling Defendants “audited”
shipment reports, which are, in turn, the MSA,
Inc. reports. B&W then argues that if there is
any doubt about how the annual payments are
calculated, such doubt is eliminated by the
parties’ course of performance.
According to B&W, the parties’ course of
performance supports their position because
even the Settling Defendants who report to the
SEC base their “Form 10K” reports on their
MSA, Inc. reports. Indeed, according to B&W
and the district court, all payments due under
the Texas Settlement Agreement have been
based uniformly on shipments to wholesalers
as reported to MSA, Inc. Therefore, B&W
concludes that the parties agreed to use MSA,
Inc. reports as the basis for determining the
Settling Defendants’ payment obligations
when they incorporated the phrase “audited
reports of shipments” into the settlement
agreement.
IV. STANDARD OF REVIEW
Whether a contract is ambiguous is a ques-
tion of law that is reviewed de novo. Stinnett
v. Colorado Interstate Gas. Co., 227 F.3d
247, 254 (5th Cir. 2000). While the interpre-
tation of an unambiguous contract is a ques-
tion of law that this Court reviews de novo,
the interpretation of an ambiguous contract is
a question of fact that is reviewed for clear
error. Id. See also, Tarrant Distributors
Incorporated v. Heublein Incorporated, 127
F.3d 375 (5th Cir. 1997).
V. DISCUSSION
Neither of the parties has argued that the
Texas Settlement Agreement is ambiguous,
and the district court did not expressly find
that the agreement is ambiguous.13 However,
the evidence presented to the district court
dealt almost entirely with the parties’ course of
13 It should be noted that although Texas argues
that the Texas Settlement Agreement is unambigu-
ous, it has asserted for the first time on appeal
points of error based on the contingency that this
Court determines that an ambiguity exists. It
argues that should the agreement be found to be
ambiguous, the trial court erred because: (1) it
deviated from the original intent of the agreement;
and (2) it based its ruling on findings of fact which
were clearly erroneous.

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performance. Indeed, the district court’s Find-
ings of Fact and Conclusions of Law expressly
took into consideration the course of perfor-
mance evidence. Therefore, the Court must
first address whether the Texas Settlement
Agreement is ambiguous as a matter of law.14
A. Texas Contract Law
The primary concern of a court in construing
a written contract is to ascertain the true inten-
tions of the parties as expressed in the instru-
ment. Gen. Accident Ins. Co. v. Unity/Water-
ford-Fair Oaks, Ltd., 288 F.3d 651, 653 (5th
Cir. 2002); Forbau v. Aetna Life Ins. Co., 876
S.W.2d 132, 133 (Tex. 1994). Under Texas
law, which the parties agree controls, a contract
is viewed as of the time it was made and not in
light of subsequent events. Ervay, Inc. v.
Wood, 373 S.W.2d 380, 384 (Tex. Civ.
App.—Dallas 1963, writ ref’d n.r.e.). “Wheth-
er a contract is ambiguous is a question of law
for the court to decide by looking at the con-
tract as a whole in light of the circumstances
present when the contract was entered.” Coker
v. Coker, 650 S.W.2d 391, 394 (Tex. 1983). If
a written contract is worded such that it can be
given a definite or certain legal meaning, then it
is not ambiguous. Nat’l Union Fire Ins. Co. of
Pittsburgh v. CBI Indus., Inc., 907 S.W.2d
517, 520 (Tex. 1995). When parties disagree
over the meaning of an unambiguous contract,
“[t]he intent of the parties must be taken from
the agreement itself, not from the parties’
present interpretation, and the agreement must
be enforced as it is written.” Purvis Oil Corp.
v. Hillin, 890 S.W.2d 931, 935 (Tex.
App.—El Paso 1994, no writ).
If the contract’s meaning is uncertain and
doubtful, or it is reasonably susceptible to
more than one meaning, it is ambiguous.
Coker, 650 S.W.2d at 393–94 (Tex. 1983).
Courts interpreting unambiguous contracts are
confined to the four corners of the document,
and cannot look to extrinsic evidence to create
an ambiguity. Sun Oil Co. v. Madeley, 626
S.W.2d 726, 732–33 (Tex. 1982); Unity/Wa-
terford-Fair Oaks, Ltd., 288 F.3d at 657.
“Only after a contract is found to be ambigu-
ous may parol evidence be admitted for the
purpose of ascertaining the true intentions of
the parties expressed in the contract.” Bur-
lington Northern and Santa Fe Ry. Co. v.
South Plains Switching, Ltd. Co., 174 S.W.3d
348, 358 (Tex. App.—Fort Worth 2005, no
pet.); see also, Friendswood Dev. Co. v. Mc-
Dade & Co., 926 S.W.2d 280, 283 (Tex.
1996).
B. The Ambiguity in the Texas
Settlement Agreement
1. Appendix A and the
Definition of Market Share
In order to understand the parties’ disagree-
ment, it is necessary to understand the nexus
between Appendix A and the definition of
Market Share. Appendix A ties the overall
annual payment calculations to “the aggregate
number of cigarettes shipped for domestic
consumption.” See 1998 Am., at Appx. A.
The Market Share calculations are based on
the “individual Cigarettes shipped in the
United States for domestic consumption, as
measured by …[Shipment Reports].” Al-
though there are minor differences in the
14 A court may conclude that a contract is am-
biguous even if the parties do not contend it is.
Hewlett-Packard Co. v. Benchmark Electronics,
Inc., 142 S.W.2d 554, 561 (Tex. App.—Houston
[14th Dist.] 2004, pet. denied); see also J.M. David-
son, Inc. v. Webster, 128 S.W.3d 223, 229 (Tex.
2003).

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9
phrasing, a common sense approach dictates
that both provisions take into account the
number of cigarettes each Settling Defendant
ships for domestic consumption. While Appen-
dix A takes into account the aggregate number
of cigarettes that the Settling Defendants have
collectively shipped for domestic consumption,
the Market Share provision takes into account
the individual cigarettes that each Settling
Defendant ships for domestic consumption.
The key difference between the two provi-
sions, however, is that Appendix A does not
mention “Shipment Reports.” Under the defi-
nition of Market Share, the “individual Ciga-
rettes shipped in the United States for domestic
consumption” are measured by “Shipment
Reports,” which are defined as
such Settling Defendant’s audited reports of
shipments of Tobacco Products provided to
the [SEC] (or, in the case of any Settling
Defendant that does not provide such re-
ports to the SEC, audited reports of ship-
ments containing the same shipment infor-
mation as contained in the reports provided
to the SEC).
1998 Am., at 5 (emphasis added). In other
words, Shipment Reports are “audited reports
of shipments” that contain the type of shipment
information that tobacco companies report to,
or would report to, the SEC. Thus, at least in
the Market Share provision, the “individual”
number of cigarettes that have been shipped for
domestic consumption is determined by Ship-
ment Reports. Appendix A, however, is silent
as to how the “aggregate” number of cigarettes
shipped for domestic consumption is deter-
mined. The district court held that payments
must be made only for shipments that would be
included in the audited reports of tobacco
shipments provided to the SEC. It then con-
cluded that such reports are based on the same
information contained in the MSA, Inc. re-
ports, which are generated pursuant to MSA,
Inc.’s Cigarette Research Audit program.
Texas argues that the Appendix A calcula-
tions are completely separate from the Market
Share calculations; therefore, the district court
acted improperly when it took the defined term
“Shipment Reports” out of the Market Share
provision and applied it to the annual payment
calculations provided for in Appendix A.
Texas supports this argument by pointing out
that the Market Share calculations occur only
after determining the total annual payment
owed Texas by the Settling Defendants collec-
tively. It also points out that the State has
nothing to do with the “dispute resolution
process” provided by the Market Share provi-
sion in apportioning each Settling Defendants’
annual payment. In essence, Texas argues that
even though the number of cigarettes shipped
for domestic consumption is measured by
Shipment Reports under the Market Share
calculations, the “aggregate” number of ciga-
rettes shipped for domestic consumption under
Appendix A are not. We find this argument
untenable.
Contracts are construed in their entirety and
it is the Court’s duty “to consider each part
with every other part so that the effect and
meaning of one part on any other part may be
determined.” Smart v. Tower Land & Inv.
Co., 597 S.W.2d 333, 337 (Tex. 1980); see
also Unity/Waterford-Fair Oaks, Ltd., 288
F.3d at 653. “Indeed, courts must be particu-
larly wary of isolating from its surroundings or
considering apart from other provisions a
single phrase, sentence, or section of a con-
tract.” State Farm Life Ins. Co. v. Beaston,
907 S.W.2d 430, 433 (Tex. 1995).

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10
Because contracts are read in their entirety,
it is irrelevant that the term “Shipment Reports”
is not mentioned in Appendix A. If taken to its
logical conclusion, Texas essentially asks this
Court to ignore the fact that Appendix A is
silent as to how the number of cigarettes
shipped for domestic consumption is deter-
mined. It asks this Court, instead, to presume
that the actual number is based solely on the
plain language of Appendix A, regardless of the
description contained in the Market Share
provision. The Texas Settlement Agreement,
however, provides the means of determining
both the aggregate number of cigarettes
shipped for domestic consumption (under Ap-
pendix A) and the individual number of ciga-
rettes that each Settling Defendant ships for
domestic consumption (under the Market Share
provision)—through the use of Shipment Re-
ports.15
2. Audited Reports of Shipments
Under the plain language of the Texas Set-
tlement Agreement, payments must be made
based on “shipments” of cigarettes that would
be included in “audited reports of shipments of
Tobacco Products provided to the [SEC].”
The district court, however, found that all
settlement payments due under the Texas
Settlement Agreement since its inception have
been based on shipments as reported to MSA,
Inc. Yet it also found that MSA, Inc. shipment
reports are based on unaudited shipment
information.16 Indeed, the MSA, Inc.’s CRA
is essentially an honor system since MSA, Inc.
accepts the information provided to it by each
individual cigarette manufacturer without
verifying whether the information is accurate.
PWC, moreover, does not “audit” the ship-
ment information that the Settling Defendants
provide. Rather, it merely compares the MSA,
Inc. numbers to those provided by the Settling
Defendants, which are essentially the same
numbers.
An ambiguity in a contract can be either
“patent” or “latent.” CBI Indus., Inc., 907
S.W.2d at 520. A patent ambiguity is evident
on the face of the contract while a latent ambi-
guity “arises when a contract which is unam-
biguous on its face is applied to the subject
matter with which it deals and an ambiguity
appears by reason of some collateral matter.”
Id. If a latent ambiguity arises, parol evidence
is admissible for ascertaining the true inten-
tions of the parties as expressed in the agree-
ment. The classic example of a latent ambigu-
ity cited by a variety of authorities is a contract
that calls for goods to be delivered to the
15 While Texas argues that the two provisions are
completely separate, this Court notes that the trial
testimony revealed that the numbers used in the
Appendix A calculations are the same numbers used
in the Market Share calculations. According to the
district court’s findings, those numbers have always
been derived from the MSA, Inc. reports.
16 Texas argued that B&W, by its own admis-
sion, breached the settlement agreement because it
acknowledged that it uses the MSA, Inc. reports to
comply with the agreement and also acknowledged
that the MSA, Inc. reports are unaudited. Texas
raises the argument and glosses over the fact that
every single Settling Defendant uses MSA, Inc.
reports either directly or indirectly to comply with
the Texas Settlement Agreement. Therefore, none
of the annual payments that Texas has collected
throughout the life of the Texas Settlement Agree-
ment have been based on “audited” shipment
information. Even when Texas hired PWC to
perform the annual payment calculations, its
instructions were to use the MSA, Inc. information
as a check on the information provided by the
Settling Defendants.

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“green house on Pecan Street” when there are,
in fact, two or more green houses on Pecan
Street. See, e.g., 11WILLISTON ON CONTRACTS
§ 33.40 (4th ed.). In the instant case, we have
a similar situation, albeit for the opposite rea-
son. Instead of having multiple green houses
or, in this instance, “audited” reports, we have
none.
The classic contractual use of the word
“audit” is to describe a formal examination of
an individual’s or organization’s accounting
records, financial situation, or compliance with
some other set of standards. BLACK’S LAW
DICTIONARY 140 (8th ed. 2004). Stated differ-
ently, an audit is “[a]n examination into ac-
counts or dealings with money or property by
proper officers, or persons appointed for that
purpose.” NEW WEBSTER’S DICTIONARY 65
(1981). Indeed, in other portions of the Texas
Settlement Agreement, when this type of audit
is contemplated, the parties have spelled it out
in detail. When detailing the manner in which
net operating profits should be determined for
the volume adjustments, Appendix A specifi-
cally demands data from “financial statements
prepared in accordance with generally accepted
accounting principles and audited by a nation-
ally recognized accounting firm.” Yet, when
addressing the data contained in the Shipment
Reports, the Settlement Agreement is com-
pletely lacking in detail. As the trial court
noted, no Settling Defendant has ever provided
audited shipment reports to the SEC, nor does
B&W (who is not required to report to the
SEC) maintain or submit audited reports of its
cigarette shipments for the purposes of comply-
ing with the Texas Settlement Agreement.
The phrase “audited reports of shipments” as
used in the agreement is a latent ambigu-
ity—one which appears only by reason of a
collateral matter. As such, the trial court’s use
of extrinsic evidence to determine the parties’
intent was not error. The only audited ship-
ment reports, albeit not audited in the classic
sense, that are submitted in compliance with
the Texas Settlement Agreement are those
generated by MSA, Inc. pursuant to its Ciga-
rette Research Audit program. That being the
case, B&W’s use of MSA, Inc. figures was not
a breach of the Texas Settlement Agreement.
VI. CONCLUSION
Based upon the foregoing, we find that the
district court’s use of extrinsic facts to inter-
pret a latent ambiguity was not error. Further,
we find that its findings of fact are supported
by the evidence and certainly are not subject to
attack under the clear error standard of re-
view. Therefore, the State of Texas shall take
nothing by virtue of its claim of breach of the
Texas Settlement Agreement. Further, this
Court finds that its request for an accounting
was appropriately denied.
The judgment of the district court is AF-
FIRMED.

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