Court Rejects Johnson & Johnson’s Use of the “Texas Two-Step” to Tackle Baby Powder Liability
Overview
TOPThe Third Circuit recently dismissed the chapter 11 bankruptcy filing of LTL Management, LLC, which is a subsidiary of Johnson & Johnson (“Johnson”).1
See In re LTL Mgmt., LLC, No. 22-2003, 2023 WL 1098189 (3d Cir. Jan. 30, 2023).
Johnson’s subsidiary, J&J Consumer Inc. (“Old Consumer”), produced Johnson’s famous Baby Powder, which contained talc, a mineral mined and milled into a fine powder.2
Id. at *1.
Id. at *2.
Ingham v. Johnson & Johnson, 608 S.W.3d 663 (Mo. Ct. App. 2020)
LTL Mgmt., at *2.
In October 2021, Johnson underwent a restructuring and formed two new entities, LTL Management, and “New Consumer.” Johnson assigned all of Old Consumer's talc liabilities to LTL, while New Consumer retained all of Old Consumer's operating assets. Johnson also entered a funding agreement with LTL, promising to cover any talc and bankruptcy-related expenses up to $61.5 billion. Two days later, LTL filed for Chapter 11 bankruptcy in North Carolina. However, the most recent decision dismissed this bankruptcy filing because the court determined that LTL Management wasn’t in financial distress.6
Id., at *3-4
This strategy for avoiding mass tort liability has been widely known as the “Texas Two-Step,” wherein the corporation creates a subsidiary, transfers all tort lawsuits to the new subsidiary, and then the subsidiary files for bankruptcy. By dismissing this bankruptcy case, the numerous alleged victims of the Baby Powder products preserved their right to sue LTL.7
Samantha Goldstein, The Texas Two-Step: A Controversial Bankruptcy Dance, University of Miami Law Review, https://lawreview.law.miami.edu/the-texas-two-step-a-controversial-bankruptcy-dance/
Good Faith or Patently Abusive?
TOPModern U.S. bankruptcy law is designed to give a “fresh start” to honest but unfortunate debtors by providing them with an opportunity to reorganize their affairs, make amends with their creditors, and “enjoy a new opportunity in life with a clear field for future effort, unhampered by the pressure and discouragement of preexisting debt.”8
Grogan v. Garner, 111 S.Ct. 654 (1991)
Due to the significant benefits of bankruptcy law, struggling businesses sometimes file for bankruptcy solely to take advantage of the bankruptcy process, during which all old financial claims and lawsuits against the debtor are dismissed, and the debtor comes out of the process paying a fraction of their old debt. To prevent this, Chapter 11 bankruptcy petitions are subject to dismissal under 11 U.S.C. § 1112(b) unless they are filed in “good faith.”9
In re 15375 Mem'l Corp. v. BEPCO, L.P., 589 F.3d 605, 618 (3d Cir. 2009) (citing NMSBPCSLDHB, L.P. v. Integrated Telecom Express, Inc. (In re Integrated Telecom Express, Inc.), 384 F.3d 108, 118 (3d Cir. 2004)).
Integrated Telecom, 384 F. 3d at 118.
Id. at 119-20.
The LTL court did not abide by the framework outlined in Integrated Telecom. Instead, the court created a relatively new “financial distress” standard for good faith. To create this new standard, the court relied in part on dicta from Integrated Telecom, which states that “a valid bankruptcy purpose assumes a debtor in financial distress.” The LTL court interpreted this language to mean that a debtor who does not suffer from financial distress cannot demonstrate valid bankruptcy purpose supporting good faith. Because LTL Management had a funding agreement that allowed it payment rights to up to $61 billion, the court held that LTL was not in financial distress and thus could not satisfy the good faith requirements. This decision is most likely misguided. As most scholars and courts have pointed out, the black-letter law emerging from Integrated Telecom is that the focus for good-faith filing is on whether the petition serves a valid bankruptcy purpose of either preserving the going concern or maximizing the value of the estate,12
See e.g. Douglas G. Baird, Anthony J. Casey, Bankruptcy Step Zero, 2012 Sup. Ct. Rev. 203, 231 (2012); 30 Melb. U. L. Rev. 300, 310; In re Am. Cap. Equip., LLC, 296 F. App'x 270, 273 (3d Cir. 2008)
Did the Court Get it Right, Normatively?
TOPWhile the mundane concerns of lawyers and judges are to navigate the line-drawing issues and the technicalities behind the definition of “good faith,” the public is rightfully concerned about the use of the Texas Two-Step by massively profitable corporations to avoid taking responsibility for mass torts. Victims of diseases such as ovarian cancer and mesothelioma often feel that the bankruptcy process allows corporations to swiftly resolve their cases and potentially receive a “bankruptcy discount” on the amount owed to victims.13
Samantha Goldstein, The Texas Two-Step: A Controversial Bankruptcy Dance, https://lawreview.law.miami.edu/the-texas-two-step-a-controversial-bankruptcy-dance.
Id.
On the other side of the dance floor, there is a strong argument in favor of Johnson's use of bankruptcy as a means to resolve the overwhelming litigation they face. Prior to the Texas Two-Step maneuver, Johnson was only able to litigate about ten cases per year, while facing over 40,000 lawsuits by victims of Johnson’s Baby Power product. Bankruptcy provides an alternative to the traditional state tort system, in which the lucky victims, like the ones in Missouri, win a large lump sum, while the others face a strikeout. Hence, bankruptcy may be the only realistic solution that is more comprehensive and streamlined for both Johnson and the victims. Indeed, the lower bankruptcy court bought this argument.15
In re LTL Mgmt., LLC, 637 B.R. 396, 400 (Bankr. D.N.J. 2022), rev'd and remanded, No. 22-2003, 2023 WL 1098189 (3d Cir. Jan. 30, 2023)
In re LTL Mgmt., LLC, 637 B.R. 396, 415 (citing In re Bestwall LLC, 606 B.R. at 257).
But is using the bankruptcy system as a means to reform the mass torts process a proper use of the system? The argument for efficiency can only go so far because reform of the judicial system should be left to the legislators.17
Paige Sutherland, The Texas Two-Step: A Controversial Legal Strategy to Avoid Corporate Liability, WBUR, https://www.wbur.org/onpoint/2022/10/20/the-texas-two-step-a-new-bankruptcy-strategy-to-avoid-corporate-liability.
Numerous large corporations have attempted to use the Texas Two-Step to resolve mass tort lawsuits. For instance, in 2017, Georgia-Pacific spun off Bestwall after facing approximately 64,000 asbestos-related claims.18
In re Bestwall, 605 B.R. 43, 46 (Bankr. W.D. N.C. 2019).
Dan Levine, How a Bankruptcy Innovation Halted Thousands of Lawsuits from Sick Plaintiffs, Reuters, https://www.reuters.com/investigates/special-report/bankruptcy-tactics-two-step.
- 1See In re LTL Mgmt., LLC, No. 22-2003, 2023 WL 1098189 (3d Cir. Jan. 30, 2023).
- 2Id. at *1.
- 3Id. at *2.
- 4Ingham v. Johnson & Johnson, 608 S.W.3d 663 (Mo. Ct. App. 2020)
- 5LTL Mgmt., at *2.
- 6Id., at *3-4
- 7Samantha Goldstein, The Texas Two-Step: A Controversial Bankruptcy Dance, University of Miami Law Review, https://lawreview.law.miami.edu/the-texas-two-step-a-controversial-bankruptcy-dance/
- 8Grogan v. Garner, 111 S.Ct. 654 (1991)
- 9In re 15375 Mem'l Corp. v. BEPCO, L.P., 589 F.3d 605, 618 (3d Cir. 2009) (citing NMSBPCSLDHB, L.P. v. Integrated Telecom Express, Inc. (In re Integrated Telecom Express, Inc.), 384 F.3d 108, 118 (3d Cir. 2004)).
- 10Integrated Telecom, 384 F. 3d at 118.
- 11Id. at 119-20.
- 12See e.g. Douglas G. Baird, Anthony J. Casey, Bankruptcy Step Zero, 2012 Sup. Ct. Rev. 203, 231 (2012); 30 Melb. U. L. Rev. 300, 310; In re Am. Cap. Equip., LLC, 296 F. App'x 270, 273 (3d Cir. 2008)
- 13Samantha Goldstein, The Texas Two-Step: A Controversial Bankruptcy Dance, https://lawreview.law.miami.edu/the-texas-two-step-a-controversial-bankruptcy-dance.
- 14Id.
- 15In re LTL Mgmt., LLC, 637 B.R. 396, 400 (Bankr. D.N.J. 2022), rev'd and remanded, No. 22-2003, 2023 WL 1098189 (3d Cir. Jan. 30, 2023)
- 16In re LTL Mgmt., LLC, 637 B.R. 396, 415 (citing In re Bestwall LLC, 606 B.R. at 257).
- 17Paige Sutherland, The Texas Two-Step: A Controversial Legal Strategy to Avoid Corporate Liability, WBUR, https://www.wbur.org/onpoint/2022/10/20/the-texas-two-step-a-new-bankruptcy-strategy-to-avoid-corporate-liability.
- 18In re Bestwall, 605 B.R. 43, 46 (Bankr. W.D. N.C. 2019).
- 19Dan Levine, How a Bankruptcy Innovation Halted Thousands of Lawsuits from Sick Plaintiffs, Reuters, https://www.reuters.com/investigates/special-report/bankruptcy-tactics-two-step.