Companies looking for solutions on how to address liability under mass tort claims are watching Johnson & Johnson’s (“J&J”) ongoing bankruptcy attempts closely. The company is on its third attempt at filing bankruptcy, using a “Texas Two-Step” maneuver to offload liability for victims who claim they developed cancer after using the company’s baby powder, which contains talc. The recent newsworthiness of bankruptcy cases involving solvent companies like J&J (as well as 3M and Purdue Pharma) are bringing academic and congressional interest to the Texas Two-Step. But given that no company has yet successfully navigated bankruptcy using the strategy, other corporate actors are wondering if the maneuver is viable or if it will fall subject to future legislative scrutiny.

The Two-Step is so named because it involves two major undertakings: completing a divisive merger and having one of the surviving entities files for bankruptcy. First, the solvent company facing tort liability divides itself into two new companies – one bearing the liabilities, and one consolidating the assets of the original company. Second, the liability entity files for Chapter 11 bankruptcy and enters into a funding agreement with the asset-holding company. This agreement provides the cash to fund the bankruptcy and to settle the tort claims while shielding the original company’s assets within a separate, discrete entity. J&J has completed its own divisive merger but has been unable to successfully file for Chapter 11. The 3rd Circuit prevented the filing by finding that the liability company was overly indemnified and did not meet the financial distress bar required for entry into bankruptcy. J&J now must secure votes in favor of the bankruptcy plan from 75% of claimants in order to satisfy requirements for a judge to approve the Chapter 11 petition.

Assuming that J&J has finally garnered enough votes to enter bankruptcy, prior companies attempting to use the Two-Step have taught that the struggle does not stop there. J&J will then face two issues that are yet to be clearly resolved among bankruptcy courts: overcoming fraudulent transfer claims and approving a plan of reorganization.

Asbestos-related mass torts have been pioneering the Texas Two-Step and are broadcasting possible pitfalls for subsequent filers. Georgia-Pacific was the first such company to have its liability subsidiary, Bestwall LLC, file for chapter 11 back in 2017. The case has been fraught with arguments from plaintiffs’ attorneys filing motions to dismiss, including the novel argument that the Constitution does not give bankruptcy courts jurisdiction over these well-funded shell companies. Georgia-Pacific and its subsidiary are still dragging through the initial rounds of the bankruptcy system, with the judge rejecting a fourth call to dismiss the case in February of this year. In another example, DBMP LLC, the liability-laden subsidiary of the former CertainTeed Corporation, faced allegations from plaintiffs that the divisive merger constituted a fraudulent transfer in an attempt to insulate assets of the designated operating company. To date, the bankruptcy court has only ruled that the Official Committee of Asbestos Personal Injury Claimants and the future claimants’ representative have standing under state law to pursue fraudulent transfer claims. The court notably rejected DBMP’s argument that provisions of the Texas Business Organizations Code (“TBOC”) preclude these claims from attaching to a divisive merger. The court has not yet had to rule on whether the divisive merger is, in fact, a violation of fraudulent transfer statutes. If the case is not otherwise settled between the parties, the court’s ruling on this question will have impacts on future cases, including J&J’s.

Beyond the concerns over surviving motions to dismiss and courts deciding whether a divisive merger may be held to constitute a fraudulent transfer, there remains the issue that no company has successfully exited bankruptcy via a plan of reorganization following a Texas Two-Step maneuver. It remains to be seen if a company is able to successfully navigate the complex hurdles in order to discharge mass tort liabilities.

Due to the prevalence of companies like J&J, 3M, and Purdue Pharma filing bankruptcy following mass torts, the Texas Two-Step has garnered both social and legislative interest. Plaintiffs fear the tactic abuses the bankruptcy system to force unjust settlements. Meanwhile, the Senate Judiciary Subcommittee conducted a hearing in 2022 to hear expert testimony regarding this controversial use of Chapter 11 bankruptcy. The outcome of J&J’s latest attempt to get into bankruptcy court will shed additional light on how this corporate strategy may (or may not) offer a viable solution for companies seeking to effectively manage mass tort liability. 

Emiley Hatten is a second-year law student at Wake Forest University School of Law. She holds a B.A. in History with a minor in Professional Education from the University of North Florida. Emiley plans to practice transactional law in Charlotte, NC following graduation.

Reach Emiley here:

LinkedIn: https://www.linkedin.com/in/emiley-hatten-498950164/

Email: [email protected]