Johnson & Johnson tried to exempt its talc mass tort liability from bankruptcy by using the “Texas two step.” In re LTL Management LLC58 F.4th738 (3d Cir. 2023). This ruling means that 3M faces a similar challenge as its two-step effort to eliminate combat-earplug liability. In re Aero Technologies, No. 22-02890 (Bankr. S.D. Ind. February 25, 2023), ECF Nr. 1198. What is the new mass tort dance trend? And why is it not popular in Minnesota? It’s not because we like the polka.
The Texas two-step, as the name suggests, involves two steps. The first is usually in Texas. Companies facing mass tort liability can use Texas’s divisional merge statute to separate the original company into two companies. The mass tort liabilities are held by the “bad-co”. The going-concern assets are held by the “bad-co”.
LTL was the case of J&J’s subsidiary, which was sued for allegedly causing ovarian cancer and mesothelioma by its talcum powder. LTL was the bad-co that held the talc liabilities. This subsidiary was split. This first step, as you can probably see, is controversial. It likely caused LTL to lose its dance. But we’ll get to that later.
The second step of the dance places the liability-holding poor-co into Chapter 11 bankruptcy. Funded claims are used to resolve and pay tort liabilities. This plan usually includes exulpation clauses or gatekeeping clauses that direct claims to bad co and protect good-co from direct liability. This second step is very similar to the one that The Archdiocese of Saint Paul did in Minneapolis’ chapter 11 bankruptcy (Minnesota bankruptcy number 15-30125). You may have heard that third-party releases are controversial. This is because they are subject to changing case law and congressional review.
The Third Circuit ruled that LTL filed a chapter 11 in bad faith, and therefore the case had to be dismissed. Because LTL was in financial distress, a financing arrangement between good-co and bad-co made it impossible for LTL to file a chapter 11. Accord In re Cedar Shore Resort235 F.3d375, 381 (8th Cir. 2000). It could not be in financial trouble with the full weight of J&J behind LTL.
LTL also claimed that the Texas-two process is better than district court litigation for mass tort cases. This argument was also rejected by the Third Circuit, which stated that claimants do not have any rights that are affected by bankruptcy.
LTL’s bid was rejected by the Fourth Circuit because it accidentally stumbled out of the Fourth Circuit. LTL converted to North Carolina and opened a North Carolina bank account after reorganizing according to Texas law. LTL did this in order to benefit from the favorable bankruptcy case law of the district. The Fourth Circuit uses a different test to determine good faith bankruptcy filings. It does not require that debtors be in financial distress. Carolin Corp. v. Miller, 886 F.2d 693, 700-01 (4th Cir. 1989). However, subjective intention or the ability to reorganize are sufficient. These are two factors LTL may have met.
The North Carolina bankruptcy court ruled that LTL’s venue production was too extensive. The North Carolina bankruptcy court found that New Jersey was a more favorable location for LTL because most of its relevant operations, witnesses and litigation are located in New Jersey. Although North Carolina was technically the proper venue, the bankruptcy court accepted that the case should be transferred to New Jersey.
This is a change to a venue that requires “financial difficulty” and brings us back the controversial divisionary merge, which splits the original target of mass tort litigation in bad-co or good-co. This special type of “merger”, available in Texas or Delaware, may sound unusual, but it still requires something that flew under radar prior to LTL. It is “reasonably equivalent trade in value.” This is how liabilities and assets can be divided into two separate companies, without running afoul Uniform Voidable Transactions laws. The Third Circuit’s LTL decision notes that the financing arrangement that made LTL financially sound likely came from the need for bad co to receive a reasonably equal exchange in value for assets taken by good co. 58 F.4th at 752 n.18. This would suggest that the divisionary merger could not be any different from what is possible under standard corporate laws, such as those in Minnesota.
This means that companies in financial distress due to mass tort litigation may be able dance a two-step here in Minnesota. Some districts are more suited for chapter 11 reorganizations than others. Lynn M. LoPucki Chapter 11’s Descend into Lawlessness, 96 AM. Bankr. L.J. 247 (2022). Large, financially sound companies that want to avoid mass tort liability will likely still need to attempt the fourth circuit, where “financial distress is not an obligation.” LTL also learned that the ability to remain in their preferred district depends on whether it makes sense or if there is another more suitable venue.
This heavily shifting dance floor makes the longevity of this dance craze uncertain–especially with the possibility of the Supreme Court or Congress cutting in.
The post Texas Two Step: New Classic Or Passing Fad? was first published on Attorney at Law Magazine.