What do Alex Jones, Purdue Pharma, and Johnson & Johnson have in common? They all used bankruptcy to try to get out of mass tort claims.[1] Alex Jones filed for bankruptcy when he lost the Sandy Hook case and was ordered to pay $50 million dollars to the parents of the victims in Sandy Hook.[2] Purdue Pharma filed for bankruptcy when it faced the opioid crisis, allowing the Sackler family to be protected from the lawsuits. Like Purdue Pharma, Johnson & Johnson attempted to do something similar, but used the Texas two-step to avoid huge liabilities.
In October of 2021, Johnson & Johnson created a subsidiary called LTL Management, LLC.[3] Johnson & Johnson created this subsidiary as part of a strategy to avoid more than 40,000 lawsuits filed against it regarding talc with asbestos in its baby powder products, which may have caused ovarian cancer or mesothelioma, cancer that occurs in the thin layer of tissue that covers your internal organs.[4] This strategy is known as the Texas two-step.[5]
The Texas Two-Step
Class action lawsuits cost companies a large amount of money, time, and reputation.[6] Corporations use the Texas two-step in these situations to avoid legal and financial responsibilities.[7] The first step is to create a new corporation, usually in a business friendly state like Texas or Delaware.[8] The second step is to then transfer the tort liabilities into the new corporations.[9]
This strategy derives from a unique provision in the Texas Business Code.[10] The Texas Code allows “divisive mergers.” The “divisive merger” allows a company to split a company into two and allocate the assets and liabilities among the two new companies however they want.[11] This transfer of liability allows a company to bankrupt its new corporation without having access to the full assets of the original company.[12]
Johnson & Johnson
Johnson & Johnson used the Texas two-step to avoid tort liabilities regarding its talc claims.[13] It created LTL Management LLC and transferred all of the talc claims into it, along with a 2-billion-dollar trust to pay for any potential claims against LTL Management.[14] Judge Michael Kaplan of the Bankruptcy Court for the District of New Jersey supported the strategy.[15] He stated that, “[J]ustice will best be served by expeditiously providing critical compensation through a court-supervised, fair, and less costly settlement trust arrangement.”[16]
In response, the talc claimants appealed and won in the Third Circuit.[17] Judge Ambro of the Third Circuit stated that a Chapter 11 bankruptcy needs to be filed with good faith.[18] Also, for there to be good faith, the debtor needs to be in financial distress.[19] The court overturned the Bankruptcy Court’s decision because the “value and quality of its assets, which include a roughly $61.5 billion payment right against J&J and New Consumer, make this holding untenable.”[20]
What’s next?
Johnson & Johnson can appeal to the Supreme Court, but there is no circuit split yet.[21] Also, there are more cases involving the Texas two-step involving Georgia Pacific and Trane Technologies in the Fourth Circuit and 3M in the Seventh Circuit. If those courts came to a different conclusion, there may be a higher chance that the Supreme Court would review the Texas two-step. This is interesting, since the decision by Judge Ambro even states in the Third Circuit that, “a court can only dismiss a bankruptcy petition for lack of good faith on a showing of the debtor’s ‘subjective bad faith’ and the ‘objective futility of any possible reorganization.’” [22]
Furthermore, Democratic Senators have proposed legislation that severely limits the Texas two-step. [23] Democratic Senator Sheldon Whitehouse, stated that “bankruptcy is meant to give honest debtors in unfortunate circumstances a fresh start,” not to allow “large, highly profitable corporations.” [24] But for now, the Third Circuit decision will terminate the preliminary injunction and enable more than 40,000 tort suits to go forward.[25]
[1] Scripps News Staff, How Bankruptcy Can Protect Companies From Lawsuits, Scippsnews (Oct. 12, 2022), https://scrippsnews.com/stories/purdue-pharma-to-j-j-bankruptcy-can-protect-from-lawsuits/.
[2] Id.
[3] Dentons, Third Circuit Dismisses LTL Mass Tort Chapter 11 Cases, Rejecting Johnson & Johnson’s “Texas Two-Step” Bankruptcy Strategy, Dentons (Feb. 3, 2023), https://www.dentons.com/en/insights/alerts/2023/february/3/third-circuit-dismisses-ltl-mass-tort-bankruptcy-rejecting-johnson-and-johnsons-texas-two-step.
[4] Id.
[5] Kevin Dunleavy, Court rejects Johnson & Johnson’s Texas two-step bankruptcy ploy for talc claims, FiercePharma (Jan. 30, 2023, 6:14 PM), https://www.fiercepharma.com/pharma/court-says-no-johnson-johnsons-bankruptcy-ploy-talc-claims.
[6] Jason Fernando, Texas Two-Step Bankruptcy Definition, Investopedia (Jan. 4, 2023), https://www.investopedia.com/texas-two-step-bankruptcy-definition-5225888.
[7] Id.
[8] Id.
[9] Id.
[10] David Warfield, Johnson & Johnson: The Texas two-step and talc-related liabilities, Thompson Coburn LLP (Nov. 3, 2021), https://www.thompsoncoburn.com/insights/blogs/credit-report/post/2021-11-03/johnson-johnson-the-texas-two-step-and-talc-related-liabilities.
[11] Id.
[12] Fernando, supra note 6.
[13] Dentons, supra note 3.
[14] Fernando, supra note 6.
[15] Dunleavy, supra note 5.
[16] Id.
[17] Dentons, supra note 3.
[18] In re LTL Mgmt., LLC, 58 F.4th 738, 753 (3d Cir. Jan. 30, 2023).
[19] “[A] debtor who does not suffer from financial distress cannot demonstrate its Chapter 11 petition serves a valid bankruptcy purpose supporting good faith.” Id. at 754.
[20] Id. at *759.
[21] Max Kennerly, Johnson & Johnson’s Scheme to Avoid Cancer Lawsuits Just Fell Apart in Court, Slate (Jan. 31, 2023, 1:55 PM), https://slate.com/news-and-politics/2023/01/johnson-talc-baby-powder-cancer-bankruptcy.html.
[22] Supra note 16, at 764, n.8.
[23] Tom Hales et al., U.S. court rejects J&J bankruptcy strategy for thousands of talc lawsuits, Reuters (Jan. 31, 2023, 8:43 AM), https://www.reuters.com/legal/jjs-ltl-units-bankruptcy-dismissed-by-us-appeals-court-filing-2023-01-30/.
[24] Id.
[25] Id.
