The 5-4 ruling was a victory for Altria Group Inc.'s Philip Morris USA, which contested an Oregon Supreme Court decision upholding the verdict.
In the majority opinion, written by Justice Stephen Breyer, the court said the verdict could not stand because the jury in the case was not instructed that it could punish Philip Morris only for the harm done to the plaintiff, not to other smokers whose cases were not before it.
States must "provide assurances that juries are not asking the wrong question ... seeking, not simply to determine reprehensibility, but also to punish for harm caused strangers," Breyer said.
The decision did not address whether the size of the award was constitutionally excessive, as Philip Morris had asked. Philip Morris USA is based in Richmond, Va.
"This is a big-deal decision," said CBS News legal analyst Andrew Cohen. "It goes beyond tobacco cases and will help corporations and other defendants to avoid huge punitive damage awards in the future. It does not eliminate them, but it does make it harder for plaintiffs and judges to impose awards that are way beyond what's needed to compensate victims."
Punitive damages are money intended to punish a defendant for its behavior and to deter repetition.
Chief Justice John Roberts and Justices Samuel Alito, Anthony Kennedy and David Souter, joined with Breyer.
Dissenting were Justices Ruth Bader Ginsburg, Antonin Scalia, John Paul Stevens and Clarence Thomas.
The dissents in this case were heated, reports CBS News correspondent Wyatt Andrews. Justice Stevens said that harm to other people needs to be considered. He wrote: "A murderer who kills ... (with) ... a bomb that injures dozens ... should be punished more severely than one who ...(only) ... harms ... his intended victim."
Mayola Williams sued Philip Morris for fraud on behalf of her husband, a two-pack-a-day smoker of Marlboros for 45 years. Jesse Williams died of lung cancer more than nine years ago. Philip Morris makes Marlboros.
She argued the jury award was appropriate because it punishes Philip Morris' misconduct for a decades-long "massive market-directed fraud" that misled people into thinking cigarettes were not dangerous or addictive.
Williams, according to his widow, never gave any credence to the surgeon general's health warnings about smoking cigarettes because tobacco companies insisted they were safe. Only after falling sick did Williams tell his wife: "Those darn cigarette people finally did it. They were lying all the time."
The cigarette maker, however, said a jury can punish the company only for the harm done to Williams, not to other smokers. The jury should have been told explicitly that other smokers, no matter how tragic their stories, would have to prove their own cases, the company said.
The Chamber of Commerce, National Association of Manufacturers and trade associations representing car and drug makers have weighed in on behalf of tighter restrictions on damage awards.
The case also was watched closely as a test of whether the new makeup of the Supreme Court would lead to changes in its prior rulings limiting punitive damages.
Roberts and Alito, the two newest members, were in the majority Tuesday, giving no hint of a change in the court's approach to punitive damages.
The case is Philip Morris USA v. Williams, 05-1256.