30 Contingent liabilities and financial commitments

There are contingent liabilities in respect of litigation, overseas taxes and guarantees in various countries.

Product liability litigation

Group companies, notably Brown & Williamson Holdings, Inc. (formerly Brown & Williamson Tobacco Corporation) (B&W), as well as other leading cigarette manufacturers, are defendants, principally in the US, in a number of product liability cases. In a number of these cases, the amounts of compensatory and punitive damages sought are significant.

Indemnity

On 30 July 2004, B&W completed transactions combining its US tobacco business assets, liabilities and operations with R.J. Reynolds Tobacco Company. A new company called R.J. Reynolds Tobacco Company (RJRT) was created as a result of the combination transactions. These transactions (the Business Combination) were accomplished through a publicly traded holding company Reynolds American Inc. (RAI), which is the indirect parent corporation of RJRT. As a result of the Business Combination: (a) B&W discontinued the active conduct of any tobacco business in the US; (b) B&W contributed to RJRT all of its assets other than the capital stock of certain subsidiaries engaged in non-US businesses and other limited categories of assets; (c) RJRT assumed all liabilities of B&W (except liabilities to the extent relating to businesses and assets not contributed by B&W to RJRT and other limited categories of liabilities) and contributed subsidiaries or otherwise to the extent related to B&W's tobacco business as conducted in the US on or prior to 30 July 2004; and (d) RJRT agreed to indemnify B&W and each of its affiliates (other than RAI and its subsidiaries) against, among other matters, all losses, liabilities, damages, expenses, judgments, attorneys' fees, etc, to the extent relating to or arising from such assumed liabilities or the assets contributed by B&W to RJRT (the RJRT Indemnification). The scope of the RJRT Indemnification includes all expenses and contingent liabilities in connection with litigation to the extent relating to or arising from B&W's US tobacco business as conducted on or prior to 30 July 2004, including smoking and health tobacco litigation, whether the litigation is commenced before or after 30 July 2004 (the tobacco litigation).

Pursuant to the terms of the RJRT Indemnification, RJRT is liable for any possible judgments, the posting of appeal bonds or security, and all other expenses of and responsibility for managing the defence of the tobacco litigation. RJRT has assumed control of the defence of the tobacco litigation involving B&W and RJRT is also a party in most (but not all) of the same cases. Accordingly, RJRT uses or plans to use the same law firm or firms to represent both B&W and RJRT in any single or similar case (except in certain limited circumstances) as RJRT's interests are typically aligned with B&W's interests, and RJRT has substantial experience in managing recognised external legal counsel in defending tobacco litigation, and external counsel have independent professional responsibilities to represent the interests of B&W. In addition, in accordance with the terms of the RJRT Indemnification, affiliates of B&W have retained control of the defence in certain tobacco litigation cases with respect to which such affiliates are entitled to indemnification.

US litigation

The total number of US product liability cases pending at 31 December 2006 involving B&W and other Group companies was approximately 3,492 (2005: 3,810). At 31 December 2006, UK-based Group companies have been named as co-defendants in some seven of those cases (2005: 965). The reduction in this figure is primarily in consequence of the dismissal of B.A.T Industries p.l.c. as a defendant in the West Virginia consolidated smoking and health cases (see below under UK-based Group companies). Only one case against B&W was tried in 2006 (VanDenBurg), which resulted in a defence verdict. No US cases involving the UK-based Group companies were tried in 2006. Only perhaps five cases are likely to come to trial in 2007, some involving amounts ranging possibly into the hundreds of millions and even billions of dollars. Since many of these pending cases seek unspecified damages, it is not possible to quantify the total amounts being claimed, but the aggregate amounts involved in such litigation are significant. The cases fall into four broad categories:

(a) Medical reimbursement cases

These civil actions seek to recover amounts spent by government entities and other third party providers on healthcare and welfare costs claimed to result from illnesses associated with smoking. Although B&W continues to be a defendant in healthcare cost recovery cases involving plaintiffs such as hospitals, Native American tribes, and foreign governments, the vast majority of such cases have been dismissed on legal grounds.

At 31 December 2006, one reimbursement suit was pending against B&W by an Indian tribe, and no suits were pending against B&W by county or other political subdivisions of the states. The Master Settlement Agreement (MSA) with the 46 states includes a credit for any amounts paid in suits brought by the states' political subdivisions; nevertheless, RJRT intends to defend and is defending these cases vigorously. Based on somewhat different theories of claim are two non-governmental medical reimbursement cases and health insurers' claims. One third party reimbursement case (City of St. Louis), consists of more than 60 public and non-profit hospitals in Missouri seeking reimbursement of past and future alleged smoking related healthcare costs. No trial date is currently set for this case.

At 31 December 2006, B&W was named as a defendant in two (2005: two) cases brought by foreign government entities in a single US court (Republic of Panama and State of São Paulo) seeking reimbursement of medical costs which they incurred for treatment for persons in their own countries who are alleged to have smoked imported cigarettes, including those manufactured by B&W. These two cases, originally filed in state court in Louisiana, were consolidated and then dismissed by the trial court on the basis that Louisiana was the inappropriate forum. These plaintiffs filed new cases in the Superior Court for the State of Delaware on 19 July 2005. On 13 July 2006, the Delaware Superior Court granted defendants' motion to dismiss. Plaintiffs filed notices of appeal to the Supreme Court of Delaware on 19 July 2006. Oral argument on plaintiffs' appeal was heard on 6 December 2006 by the Supreme Court of Delaware, which reserved decision.

b) Class actions

At 31 December 2006, B&W was named as a defendant in some 15 (2005: 15) separate actions attempting to assert claims on behalf of classes of persons allegedly injured or financially impacted through smoking or where classes of tobacco claimants have been certified. Even if the classes remain certified and the possibility of class-based liability is eventually established, it is likely that individual trials will still be necessary to resolve any actual claims. Class-action suits have been filed in a number of states against individual cigarette manufacturers and their parent corporations, alleging that the use of the terms 'lights' and 'ultralights' constitutes unfair and deceptive trade practices. A class action complaint (Schwab) was filed in the US District Court for the Eastern District of New York on 11 May 2004 against B&W and certain UK-based Group companies. The complaint challenges the practices of defendants with respect to the marketing, advertising, promotion and sale of 'light' cigarettes. The court granted plaintiffs' motion for class certification on 25 September 2006. By order dated 17 November 2006, the Second Circuit Court of Appeals granted defendants' motion to stay the district court proceedings in this case, and further granted defendants' petition for leave to appeal the district court's class certification order. Other types of class-action suits assert claims on behalf of classes of individuals who claim to be addicted, injured, or at greater risk of injury by the use of tobacco or exposure to environmental tobacco smoke, or the legal survivors of such persons.

In Engle (Florida), one jury awarded a total of US$12.7 million to three class representatives, and in a later stage of this three phase trial process, a jury assessed US$17.6 billion in punitive damages against B&W. In November 2000, B&W posted a surety bond in the amount of US$100 million (the amount required by Florida law) to stay execution of this punitive damages award. On 21 May 2003, the intermediate appellate court reversed the trial court's judgment and remanded the case to the trial court with instructions to decertify the class. On 16 July 2003, plaintiffs filed a motion for rehearing which was denied on 22 September 2003. On 12 May 2004, the Florida Supreme Court agreed to review this case and, on 6 July 2006, it upheld the intermediate appellate court's decision to decertify the class, and vacated the jury's punitive damages award. Further, the Florida Supreme Court permitted the judgments entered for two of the three Engle class representatives to stand, but dismissed the judgment entered in favour of the third Engle class representative. Finally, the Court has permitted putative Engle class members to file individual lawsuits against the Engle defendants within one year of the Court's decision. The Court's order precludes defendants from litigating certain issues of liability against the putative Engle class members in these individual actions. On 7 August 2006, defendants filed a motion for rehearing before the Florida Supreme Court, which was granted in part, and denied in part, on 21 December 2006. The Florida Supreme Court's 21 December 2006 ruling did not amend any of the earlier decision's major holdings, which included decertifying the class, vacating the punitive damages judgment, and permitting individual members of the former class to file separate suits. Instead, the ruling addressed the claims on which the Engle jury's phase one verdict will be applicable to the individual lawsuits that were permitted to stand.

In the first 'phase three' trial of an individual Engle class member (Lukacs), the jury awarded the plaintiff US$37.5 million in compensatory damages (B&W's share: US$8.4 million). On 1 April 2003, the jury award was reduced to US$25.125 million (B&W's share: US$5.65 million) but no final judgment will be entered until the Engle appeal is fully resolved. Therefore the time to appeal this case has not yet begun to run.

In a Louisiana medical monitoring case brought on behalf of Louisiana smokers (Scott), on 28 July 2003, the jury returned a verdict in favour of defendants on the medical monitoring claim but made findings against defendants with respect to claims relating to fraud, conspiracy, marketing to minors and smoking cessation. On 21 May 2004, the jury returned a verdict in the amount of US$591 million on the class's claim for a smoking cessation programme. On 1 July 2004, the court upheld the jury's verdict and entered final judgment. On 29 September 2004, defendants posted a US$50 million bond (legislation in Louisiana limits the amount of a bond to prevent execution upon such a judgment to US$50 million collectively for signatories to the MSA). RJRT posted US$25 million (i.e. the portions for RJRT and B&W) towards the bond. On 12 April 2006, the Louisiana Fourth Circuit Court of Appeal heard argument on defendants' appeal. The appellate court issued a decision on 7 February 2007 that affirmed class certification and upheld the smoking cessation programme for certain smokers who began smoking before 1988, but reduced the US$591 million jury award by US$312 million and rejected any award of prejudgment interest. Defendants are in the process of seeking further review of this decision.

A federal judge in New York certified a nation-wide punitive-damages-only class (Simon II) in September 2002. Defendants sought reconsideration of the certification ruling, which was denied on 25 October 2002. On 14 February 2003, the US Court of Appeals for the Second Circuit granted defendants' petition to review the class certification decision. Oral argument was heard on 20 November 2003. On 6 May 2005, the Second Circuit Court of Appeals vacated the district court's class certification order. The district court permitted plaintiffs to voluntarily dismiss this action on 8 December 2005. The district court entered its final judgment dismissing this case on 20 March 2006.

c) Individual cases

Approximately 3,471 cases were pending against B&W at 31 December 2006 (2005: 3,767) filed by or on behalf of individuals in which it is contended that diseases or deaths have been caused by cigarette smoking or by exposure to environmental tobacco smoke (ETS). Of these cases: (a) approximately 75 per cent are ETS cases brought by flight attendants who were members of a class action (Broin) that was settled on terms that allow compensatory but not punitive damages claims by class members; (b) approximately 20 per cent of the individual cases against B&W are cases brought in consolidated proceedings in West Virginia; and (c) only about 5 per cent are cases filed by other individuals.

Of the individual cases that went to trial or were decided or remained on appeal during 2006, several resulted in verdicts against B&W:

In November 2003, a Missouri jury (Thompson) awarded US$210,000 damages against B&W. A notice of appeal was filed on 8 March 2004. Oral argument before the Missouri Court of Appeals was heard on 3 November 2005. The Missouri Court of Appeals affirmed the judgment on all points on 22 August 2006. B&W moved before the Missouri Court of Appeals to transfer this appeal to the Missouri Supreme Court on 6 September 2006. B&W's motion was denied by the Missouri Court of Appeals on 26 September 2006. On 10 October 2006, B&W filed an application with the Missouri Supreme Court for transfer of this action to the Missouri Supreme Court. The Missouri Supreme Court denied B&W's application on 19 December 2006.

In December 2003, a New York jury (Frankson) awarded US$350,000 compensatory damages against B&W and two industry organisations. In January 2004, the same jury awarded US$20 million punitive damages. On 22 June 2004, the trial judge granted a new trial unless the parties agreed to an increase in compensatory damages to US$500,000 and a decrease in punitive damages to US$5 million, of which US$4 million would be assigned to B&W. Plaintiffs agreed to a decrease in punitive damages, but B&W has not agreed to an increase in compensatory damages. On 25 January 2005, B&W appealed to an intermediate New York State appellate court. Oral argument was heard on 8 May 2006. The appellate court affirmed the judgment on 5 July 2006. B&W filed a motion for leave to reargue, or in the alternative, for leave to appeal to the New York Court of Appeals, on 3 August 2006. The intermediate appellate court denied this motion on 5 October 2006. On 8 December 2006, the trial judge granted plaintiff's application for entry of judgment, and granted plaintiff's motion to vacate that part of the 2004 order granting a new trial unless the parties agreed to an increase in compensatory damages to US$500,000. B&W intends to seek further appellate review of the trial court's judgment.

On 1 February 2005, a Missouri jury (Smith) awarded US$500,000 in compensatory damages against B&W and then, on 2 February 2005, awarded US$20 million in punitive damages, also against B&W. On 1 June 2005, B&W filed its notice of appeal. B&W filed its opening appellate brief on 28 April 2006. Oral argument was heard on 31 August 2006 and a decision is awaited.

On 18 March 2005, a New York jury (Rose) awarded US$1.7 million in compensatory damages against B&W. On 18 August 2005, B&W filed its notice of appeal. RJRT posted a bond in the approximate amount of US$2.058 million on 7 February 2006. Oral argument on this appeal was heard on 12 December 2006 by an intermediate New York appellate court, which reserved decision.

d) Other claims

The Flintkote Company (Flintkote), a US asbestos production and sales company, was included in the acquisition of Genstar Corporation by Imasco in 1986 and became a Group subsidiary following the restructuring of Imasco Limited (now Imperial Tobacco Canada Limited (Imperial)) in 2000. Soon after this acquisition, and as part of the acquisition plan, Genstar began to sell most of its assets, including the non-asbestos related operations and subsidiaries of Flintkote. The liquidation of Flintkote assets produced cash proceeds and, having obtained advice that sufficient assets would remain to satisfy liabilities, Flintkote and Imasco authorised the payment of two dividends. In 2003, Imperial divested Flintkote and then, in 2004, Flintkote filed for bankruptcy in the United States Bankruptcy Court for the District of Delaware. In 2006, Flintkote, certain representatives of both the present and future asbestos claimants as well as certain individual asbestos claimants were permitted by the bankruptcy court to file a complaint against Imperial and numerous other defendants for the recovery of the dividends and other compensation under various legal theories. The parties are presently engaged in case management discussions to establish the scope and manner of discovery in this case. This litigation is expected to take several years to proceed to trial.

At 31 December 2006, no cases (2005: 1) were pending against B&W on behalf of asbestos companies. In these cases, certain asbestos companies sought reimbursement for costs and judgments paid in litigation brought by third parties against them. These companies claimed that, but for the smoking of the claimants, their damages would have been less. The final asbestos contribution claim (Fibreboard) was voluntarily dismissed by plaintiffs on 28 July 2006.

In Wisconsin, the authorities have identified potentially responsible parties to fund the clean up of the Fox River, Wisconsin. The pollution was caused by discharges of toxic material from paper mills operating close to the river. The cost of the clean up work is currently estimated to be in the order of US$600 million. Among the potentially responsible parties are NCR Corporation and Appleton Papers Inc. who may be liable for a proportion of the clean up costs. B.A.T Industries p.l.c. purchased what was then NCR's Appleton Papers Division from NCR Corporation and spun off this business in 1990, obtaining full indemnities from Appleton Papers Inc. for past and future environmental claims. Disputes between NCR Corporation and B.A.T Industries p.l.c. as to the indemnities given and received under the purchase agreement in 1978 have been the subject of arbitration in 1998 and 2006. Under the terms of the arbitration awards, B.A.T Industries p.l.c. has an obligation to share the costs of environmental claims with NCR Corporation, but has never been required to pay any sums in this regard because Appleton Papers Inc. has paid any sums demanded. It is believed that all future environmental liabilities will continue to be met directly by Appleton Papers Inc. by self-funding or insurance cover and no demand will be made upon B.A.T Industries p.l.c. by NCR Corporation.

Settlement of state health care reimbursement cases

During 2003, agreement was reached on certain disputed MSA payments relating to MSA calculations based on 1999 and 2000 sales. This agreement resulted in a benefit of £27 million which is excluded from the 2003 costs shown in the consolidated audited annual accounts of the Company for the financial year ended 31 December 2004. In other developments, after an Independent Auditor found that the terms of the MSA were a 'significant factor' in market share losses experienced by signatories to the MSA in 2003, several US tobacco companies, including B&W, asserted their rights under the NPM (or Non-Participating Manufacturer) Adjustment provision of the MSA to recover a payment credit or offset - against their April 2006 payment obligations - for MSA payments made in April 2004 in respect of cigarettes shipped or sold in the US in 2003. The amount at stake exceeds US$1 billion. The settling states oppose these MSA payment reduction claims and, in late April 2006, began filing motions in MSA courts across the country seeking enforcement of certain MSA provisions and a declaration of the parties' rights under the NPM Adjustment provision of the MSA. Defendants have opposed these motions, arguing that their NPM Adjustment claims must go instead to arbitration. To date, the overwhelming majority of MSA courts to decide these motions have ruled in defendants' favour.

UK-based Group companies

At 31 December 2006, B.A.T Industries p.l.c. was a defendant in the US in one class action, the Schwab case mentioned previously. In that case, B.A.T Industries p.l.c. was substituted for British American Tobacco p.l.c. as a defendant. In the West Virginia consolidated smoking and health cases, the court so-ordered the parties' stipulation and order dismissing B.A.T Industries p.l.c. from the action, with prejudice, on 12 December 2006. This is a significant decision as B.A.T Industries p.l.c. was previously a defendant in around 1,000 consolidated individual cases in West Virginia. British American Tobacco (Investments) Limited has been dismissed from those West Virginia consolidated smoking and health cases in which it was a defendant. British American Tobacco (Investments) Limited had been served in one reimbursement case (City of St. Louis), the Department of Justice case (see below), two class actions (Cleary and Schwab), and three individual actions.

Conduct based claims

On 22 September 1999, the US Department of Justice brought an action in the US District Court for the District of Columbia against various industry members, including RJRT, B&W, B.A.T Industries p.l.c., and British American Tobacco (Investments) Limited. B.A.T Industries p.l.c. was dismissed for lack of personal jurisdiction on 28 September 2000. The Government sought to recover federal funds expended in providing healthcare to smokers who have developed diseases and injuries alleged to be smoking-related, and, in addition, sought, pursuant to the federal Racketeer Influenced and Corrupt Organisations Act (RICO), disgorgement of profits the Government contends were earned as a consequence of a RICO 'enterprise'. On 28 September 2000, the portion of the claim which sought recovery of federal funds expended in providing healthcare to smokers who have developed diseases and injuries alleged to be smoking-related was dismissed. The bench (non-jury) trial of the RICO portion of the claim began on 21 September 2004, and ended on 9 June 2005. On 17 November 2004, the Washington DC Circuit Court of Appeals heard an appeal by defendants against an earlier District Court decision that disgorgement of profits is an appropriate remedy to the RICO violations alleged by the Government. On 4 February 2005, the Court of Appeals allowed the appeal, ruling that the Government could not claim disgorgement of profits. On 17 October 2005, the US Supreme Court declined to hear the appeal by the US Government in respect of the claim for disgorgement of US$280 billion of past profits from the US tobacco industry. The disgorgement claim was a centrepiece of the Government's claim.

On 17 August 2006, the district court issued its final judgment, consisting of some 1,600 pages of factual findings and legal conclusions. The court found in favour of the Government, and against certain defendants, including B&W and British American Tobacco (Investments) Limited. The court also ordered a wide array of injunctive relief, including a ban on the use of 'lights' and other similar descriptors with effect from 1 January 2007. Compliance with the court-ordered remedies may cost RJRT and British American Tobacco (Investments) Limited millions of dollars. In addition, the Government is seeking the recovery of roughly US$1.9 million in litigation costs. Defendants filed a motion to stay enforcement of the judgment shortly after the judgment was issued. The court denied defendants' stay motion on 28 September 2006. Defendants, including B&W and British American Tobacco (Investments) Limited, filed their notices of appeal to the Washington DC Circuit Court of Appeals on 11 September 2006, and filed an emergency motion to stay the judgment before the same court on 29 September 2006. On 31 October 2006, the Court of Appeals granted defendants' motion to stay enforcement of the judgment pending the outcome of the appeal.

Various departments of the Republic of Colombia brought actions against various tobacco companies including B&W and other UK-based Group companies alleging that defendants engaged in cigarette smuggling and money laundering in their territories. Each of these actions sought compensatory, punitive and treble damages. Defendants' motion to dismiss the complaint was granted in 2002 and plaintiffs appealed. The US Court of Appeals for the Second Circuit affirmed the dismissals, and on 9 January 2006, the US Supreme Court denied plaintiffs' petition for a writ of certiorari.

In the Daric Smith case, purchasers of cigarettes in the State of Kansas brought a class action in the Kansas State Court against B&W, British American Tobacco (Investments) Limited and certain other tobacco companies seeking injunctive relief, treble damages, interest and costs. The allegations are that the defendants participated in a conspiracy to fix or maintain the price of cigarettes sold in the US, including the State of Kansas, in violation of the Kansas Restraint of Trade Act. The matter will be defended vigorously.

Product liability outside the US

At 31 December 2006, active claims against Group companies existed in 18 (2005: 19) countries outside the US but the only countries with more than five active claims were Argentina, Brazil, Canada, Chile, Italy and the Republic of Ireland.

At 31 December 2006, there were some 1,142 (2005: 1,097) pending individual cases in Italy. Some 1,113 (2005: 1,077) of these cases are pending before Justice of the Peace courts, the majority of which relate to claims of alleged fraud in connection with 'light' cigarettes. Because of the type of court involved, the most that any individual plaintiff can recover is €1,033. 678 of these cases have been suspended or decisions given in favour of British American Tobacco Italia S.p.A. There are around 27 smoking and health cases pending before Italian Civil Courts, filed by or on behalf of individuals, in which it is contended that diseases or deaths have been caused by cigarette smoking. There are also two labour cases for alleged occupational exposure pending in Italy.

In Canada, the government of the Province of British Columbia brought a claim pursuant to the provisions of the Tobacco Damages and Health Care Costs Recovery Act 2000 against domestic and foreign 'manufacturers' seeking to recover the plaintiff's costs of health care benefits. The constitutionality of the 2000 Act was challenged by certain defendants and, on 5 June 2003, the British Columbia Supreme Court found the Act to be beyond the competence of the British Columbia legislature and, accordingly, dismissed the government's claim. The government appealed that decision to the British Columbia Court of Appeal which, on 20 May 2004, overturned the lower court's decision and declared the Act to be constitutionally valid. Defendants appealed to the Supreme Court of Canada in June and that court gave its judgment in September 2005, dismissing the appeals and declaring the Act to be constitutionally valid.

Non-Canadian defendants challenged the personal jurisdiction of the British Columbia Court and those motions were heard in the Supreme Court of British Columbia. On 23 June 2006, the court dismissed all defendants' motions, finding that there is a 'real and substantial connection' between British Columbia and the foreign defendants. Subsequently, defendants were granted leave to appeal. The appeal was dismissed on 15 September 2006. Defendants filed leave to appeal to the Supreme Court on 10 November 2006. Similar legislation has been enacted, but not yet brought into force, in some other Canadian provinces, and is also being considered by other Canadian provinces.

In addition, there are five class actions and four individual cases in Canada. In the Knight class action, the Supreme Court of British Columbia certified a class of all consumers of cigarettes bearing 'light' or 'mild' descriptors since 1974 manufactured in British Columbia by Imperial, the Group's operating company in Canada. Imperial filed an appeal against the certification which was heard in February 2006. The Appeal Court confirmed the certification of the class but has limited any financial liability, if proved, to the period from 1997. This is a 'lights' class action in which the plaintiff alleges that the marketing of light and mild cigarettes is deceptive because it conveys a false and misleading message that those cigarettes are less harmful than regular cigarettes. Although the claim arises from health concerns, it does not seek compensation for personal injury. Instead it seeks compensation for amounts spent on 'light and mild' products and a disgorgement of profits from Imperial. The motion of the Federal Government to strike out the third party notice issued against them by Imperial was heard in February 2006 and a decision is awaited. A similar 'lights' and 'mild' class action claim has been filed in Newfoundland. Imperial has filed a third party notice against the Federal Government. No hearing date has been set.

There are currently two class actions in Quebec. On 21 February 2005, the Quebec Superior Court granted certification. The court certified two classes, which include residents of Quebec who suffered from lung, throat and laryngeal cancer or emphysema, and residents who were addicted to nicotine at the time the proceedings were filed and who have since remained addicted. There is no right of appeal. Plaintiffs have served a Statement of Claim. This litigation is expected to take several years to proceed to trial. The other class action is an attempt to establish a class claiming for personal injury or damage to property from fires caused by cigarettes that did not automatically extinguish on being dropped or left unattended. Certification of such a class was denied in October 2005. Plaintiffs have appealed. No hearing date has been set for the appeal.

Other litigation outside the US

In November 2004, the Royal Canadian Mounted Police (RCMP) obtained a warrant to search and seize business records and documents at the head office of Imperial Tobacco Canada Ltd. in Montreal. The affidavit filed by the RCMP to obtain the search warrant made allegations in relation to the smuggling of cigarettes in Canada between 1989 and 1994, naming Imperial, British American Tobacco p.l.c., B.A.T. Industries p.l.c., and certain former directors and employees. No charges have yet been laid. Imperial believes that it has conducted itself appropriately at all times, but cannot predict the outcome of any such investigation, or whether additional investigations will occur.

Two actions have been started in Russia by a minority shareholder in OJSC Company British American Tobacco-Yava (BAT-Yava), a Russian incorporated subsidiary of British American Tobacco Holdings (Russia) B.V. The minority shareholder, Branston Holdings, issued a claim in Moscow seeking to have a contract between BAT-Yava and its sister company invalidated, and issued another claim in the Stavropol region alleging that certain of the directors of BAT-Yava, and other parties, took various unlawful steps. The Moscow Court has dismissed the claim and the Stavropol Court has ordered the transfer of the case filed there to Moscow. An appeal of the dismissed Moscow case has been sent to the Moscow Appellate Court. Branston has also threatened actions in the Netherlands and England but has not yet commenced these. The Company considers these actions to be without merit and will defend the claims strenuously.

Conclusion

While it is impossible to be certain of the outcome of any particular case or of the amount of any possible adverse verdict, the Company believes that the defences of the Group companies to all these various claims are meritorious both on the law and the facts, and a vigorous defence is being made everywhere. If an adverse judgment is entered against any of the Group companies in any case, an appeal will be made. Such appeals could require the appellants to post appeal bonds or substitute security in amounts which could in some cases equal or exceed the amount of the judgment. In any event, with regard to US litigation, the Group has the benefit of the RJRT Indemnification. At least in the aggregate, and despite the quality of defences available to the Group, it is not impossible that the results of operations or cash flows of the Group, in particular quarterly or annual periods, could be materially affected by this and by the final outcome of any particular litigation.

Having regard to all these matters, the Directors (i) do not consider it appropriate to make any provision in respect of any pending litigation and (ii) do not believe that the ultimate outcome of this litigation will significantly impair the financial condition of the Group.

Guarantees

Performance guarantees given to third parties in respect of Group companies were £157 million (2005: £167 million).

Operating leases