Rise and fall of Renegade: taking on big tobacco and the taxman, Calvin Phelps saw the business he built go up in smoke.

• Author: Otterbourg, Ken
• Position: Dialogue with company owner - Company overview - Interview

Calvin Phelps could often be found praying in his office. He served the holiday meal to his employees. He could fix just about anything that had an electric cord or an engine. But in the end, being a generous boss who was good with his hands wasn't enough. He also fought the state and federal government over taxes and other payments. He treated his companies like personal piggy banks. He bought a mansion, then lost it after his companies filed for bankruptcy. He went to federal prison this year after pleading guilty to fraud charges.

Phelps owned a tangle of companies known to the public as Renegade Tobacco Co. They were based in Farmington, between Winston-Salem and Mocksville. Started from nothing in 1994, in their heyday they had sales of more than $50 million and employed nearly 140 people. The factory is closed. The companies are nearly dissolved. The jobs are gone. The lawyers and consultants have spent the better part of six years squabbling over how to divide the assets and, in the process, collected more than $2.6 million in fees. Renegade Tobacco's rise and fall is a messy tale of greed and ambition, competition and regulation. It's about the search for the next loophole and what happens when small companies make enemies of larger ones. In the end, it's about cigarettes and the forces that make these exquisite little packages of paper and tobacco the perfect device for delivering nicotine, profits and tax revenue.

Phelps, who declined to be interviewed, is 52. He grew up the son of millworkers in what is now the outskirts of Clemmons in western Forsyth County. His father, Arthur, was a decorated war veteran who worked 45 years for Winston-Salem-based Hanes Corp. His mother, Mary, worked there 25 years, then became a licensed practical nurse. They died--she of breast cancer, he of pneumonia--the same day, March 22,2005. At the time, Arthur was honorary chief executive of Renegade Tobacco.

Their son earned an associate's degree in engineering and electronics technology from Forsyth Technical Community College in 1981 and two years later went to work for Winston-Salem-based R.J. Reynolds Tobacco Co. Starting as a technician, he became a maintenance planner, taking care of the making-and-packing machines, which can produce thousands of cigarettes a minute. He left Reynolds in 1990 and, four years later, started PTM Technologies Inc., which bought, sold and repaired used making-and-packing equipment. He began manufacturing herbal cigarettes, including a product called "Cannabis Free," under a second company, Alternative Brands Inc. But you can only make so much money selling fake joints. His big break was about to happen, courtesy of his old employer and the rest of Big Tobacco.

The Master Settlement Agreement between the nation's largest tobacco companies, 46 states and six other jurisdictions was signed Nov. 23,1998. The states agreed not to bring lawsuits against the tobacco companies to recover health-related expenses, and the tobacco companies agreed to pay the states more than $200 billion through 2025. The payment, which was $7.6 billion last year, is prorated to the states through a formula calculated out seven places past the decimal point. They are collected through an assessment on each carton; the current level is more than $5.

At the time of the MSA, the four major cigarette manufacturers controlled about 95% of the domestic market, and their concern was that companies that weren't parties to the agreement--and didn't have to make the payments--could undercut their prices. So part of the deal created a separate category of tobacco companies, known as nonparticipating manufacturers--NPMs. Instead of making payments to the MSA, they had to put a similar per-carton amount into escrow accounts in the states where they operated and keep it there for 25 years, in case these states decided to bring additional health claims. Though many of the country's top lawyers helped draft the MSA, the final document was flawed, creating a gift for Little Tobacco. These small manufacturers were allowed a substantial rebate on their escrow payments based on the difference between the percent of their sales in a single state and that state's share of the whole MSA pie.

Renegade Tobacco Co. began in 1999 with a brand called Tucson. Phelps was the only shareholder. Eventually, the corporate structure became more convoluted: Phelps owned Compliant Tobacco Co., which in turn owned Renegade Holdings. Renegade Holdings owned four companies: Renegade Tobacco, Alternative Brands, PTM Technologies and Dogwood Winery and Vineyards. Besides buying and selling tobacco-manufacturing equipment, PTM also owned the equipment used by Alternative Brands. And despite its name, Dogwood wasn't in the wine business; it made filters, which were then sold to Alternative Brands and other small manufacturers.

Phelps concentrated his business in North Carolina. Along with the escrow advantage, it was also easier to distribute his products in a smaller geographic area. Other little manufacturers --such as S&M Brands Inc. in Keysville, Va., and Farmers Tobacco Co. of Cynthiana, Ky.--used the same tactic to great success. From 1999 to 2003, the NPM share of the cigarette market more than doubled, soaring from 3.8% to 8.4%.

NOT EVERYBODY WAS CHEERING. The big tobacco companies were watching their volumes drop, and the states faced a different problem, because their payments--used by individual states to do everything from improve public health to balance budgets--were tied to the majors' market share. The solution was to close the escrow loophole, and states began amending their tobacco-settlement statutes in 2003. North Carolina's law was changed in 2005. "As a result," according to a pleading by an attorney for Phelps, "Alternative Brands' regulatory costs rose dramatically. To make matters worse, these amendments were applied retroactively. Like many other NPMs, Alternative Brands was faced with...