An illinois court recently ruled against cigarette maker Philip Morris in a consumer fraud case. But the real losers may have been the states.

The court found that Philip Morris misled consumers about the relative health of its "light" cigarettes and ordered the company to pay $10.1 billion in damages. As is common with big verdicts against tobacco companies, Philip Morris immediately decided to appeal. But the machinations surrounding that appeal have revealed how dependent states are on the tobacco industry as a ready source of revenue--to fund programs or to back bonds.

The states settled lawsuits with four tobacco companies in 1998 for payments over 25 years then estimated to total $246 billion. In addition, 21 states increased their taxes on tobacco products last year. All told, states collected $20.3 billion in tobacco-related revenue this year, up 9 percent from the year before.

The lion's share of that money, the settlement portion, was put in jeopardy by the Illinois court's action. Madison County Judge Nicholas Byron ordered Philip Morris to post a $12 billion bond so that it could appeal (covering both damages and legal fees). The company claimed that posting a bond of such size would force it into bankruptcy.

Some of the tobacco industry's many critics argued that the hugely profitable company could easily raise the money. But Wall Street analysts backed the company's claims. That was enough to taint the market for tobacco-related bonds.

In the past couple of years, about a dozen states converted their promised settlement dollars into bond money. States that hoped to follow that route this year are finding that the market for tobacco- backed bonds has been weakened--investors are not keen to buy bonds where the source of repayment is no longer solid.

Virginia canceled its sale of $767 million in tobacco bonds in April. New York Governor George Pataki had been squabbling with the legislature about the wisdom of securitizing future tobacco payments, but current uncertainties rendered that argument moot. The Illinois decision jeopardized the plans of several other states, including Missouri, Oregon and California, which had been working on a $2.3 billion bond offering.

In addition, states worried that Philip Morris would default on about $2.5 billion in settlement payments due in April. Given the stakes involved, perhaps it's not surprising that 37 states and territories and the National Conference of State Legislatures filed an amicus brief with Byron's court asking him to reduce the size of the bond Philip Morris would have to post. "It was solely because of the fiscal stress that the states find themselves in right now, which would be compounded if the settlement payments would be missed," says Bill Pound, executive director of NCSL.

Mike Renner, executive director of the Ohio Tobacco Use Prevention and Control Foundation, concedes that there is a certain irony in the fact that states are openly pleading against the bankruptcy of a company they themselves have sued for public health reasons. But Renner argues it is better to keep Philip Morris afloat, not only for financial reasons but to keep its products under the regulatory restrictions agreed to in the state settlements.

Meanwhile, the Illinois judge halved the Philip Morris bond in mid- April, and the tobacco company met its scheduled payment to the states. But continuing legal exposure may hurt states in the long run.