iIn this space, we have been following the emergence of a controversial bankruptcy maneuver known as the “Texas Two-Step,” which, in 2022, had won praise in a major case involving corporate giant Johnson & Johnson (J&J). A federal appellate court, however, recently dealt a severe blow to J&J’s attempt to use the Texas Two-Step to force thousands of cancer claims into a single bankruptcy case, ruling that bankruptcy was not available to J&J because it was not in “financial distress.” Time will tell whether this latest ruling permanently sidelines the Texas Two-Step as corporate strategy for funneling potentially massive tort liability into one global settlement through bankruptcy.
Background
J&J is currently facing over 38,000 tort cases, each claiming that its talc-based products caused cancer. While the potential liability is practically impossible to estimate, a $4.69 billion verdict against J&J in a just one 2020 case shows the vast sums at stake. J&J has been attempting to force all of these lawsuits into a single bankruptcy case in an attempt to reach one global settlement.
The legal mechanism behind J&J’s push was the controversial Texas Two-Step. The first step involved forming a new subsidiary company — LTL Management, LLC (LTL) — under a unique Texas’ law. LTL then took on all of J&J’s asbestos liability, which was its sole purpose. The second step was for the newly formed LTL to file immediately for Chapter 11 bankruptcy. Meanwhile, parent company J&J, which is not in bankruptcy, is one of the world’s wealthiest corporations with an approximate net worth of $435 billion.
The Texas Two-Step is criticized by plaintiffs’ attorneys and public policy advocates, who assert the maneuver is a corporate attempt to impose an unfavorable settlement dynamic on cancer victims.
Despite the criticism, in February 2022, Judge Kaplan of the Bankruptcy Court for the District of New Jersey gave the Texas Two-Step a clean bill of health when he denied the tort claimants’ motion to dismiss the case.[1] Judge Kaplan rejected the notion that the tort system offered the only just pathway to redress the talc harms, saying that bankruptcy provided a meaningful “opportunity for justice” that can produce “comprehensive, equitable, and timely recoveries” for injured parties.[2] Judge Kaplan then opined that the case had too much value to be wasted and should instead be spent on achieving “some semblance of justice” for talc victims.[3]
The Court of Appeals weighs in
In an opinion entered on March, 31, 2023, a three-judge panel of the Third Circuit Court of Appeals reversed Judge Kaplan, holding that bankruptcy proceedings were only available to companies in “financial distress,” which must not only be apparent, but must be “immediate enough” to justify a bankruptcy filing.[4] Further, the panel ruled that LTL was not in financial distress when it filed its Chapter 11 petition, as the “value and quality” of its assets were high. The appellate panel specifically cited that LTL’s has access to J&J’s “exceptionally strong balance sheet,” which at the time of the Chapter 11 petition listed over $400 billion in equity value with a AAA credit rating and $31 billion in cash and marketable securities.”
After losing a bid to have the case reheard by the full Third Circuit, J&J has appealed to the U.S. Supreme Court, which may decide the ultimate fate of the Texas Two-Step.
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The utility of the Texas Two-Step as a strategy for placing large amounts of tort liability into bankruptcy while shielding the rest of the corporation’s assets from tort claimants is in doubt and awaits further ruling from the U.S. Supreme Court. In light of the Third Circuit’s holding in the J&J case, lenders might have concerns about borrowers facing large tort liability and the prospects that Texas Two-Step will not be an available option for the borrower to mitigate risk.
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[1] In re LTL Mgmt., LLC, No. 21-30589 (MBK), 2022 WL 596617, at *16 (Bankr. D.N.J. Feb. 25, 2022).
