Johnson & Johnson’s Texas Two-Step: the potential up and downsides of attempting to shed liability through a new and evolving bankruptcy maneuver

Facing over 30,000 lawsuits and potentially billions upon billions of dollars in liability over claims that its iconic baby powder and other talc-based powder products contained cancer-causing asbestos, multi-national corporate giant Johnson & Johnson (J&J) is attempting to sever that liability from the rest of its otherwise very healthy corporate body through an increasingly popular business strategy known as the Texas Two-Step. J&J’s attempt involved forming a new subsidiary to hold the asbestos liability, which then immediately filed for Chapter 11 bankruptcy. However, because the parent corporation—one of world’s wealthiest corporations with an approximate net worth of $435 billion—has not filed for bankruptcy, the bankruptcy ostensibly only involves J&J’s asbestos liabilities. Over the concerns of critics who decry this maneuver as an abuse of bankruptcy protection, J&J has asserted that it is merely taking advantage of an established process that allows companies facing “abusive tort systems” to resolve claims efficiently and equitably. Although it is hard to place a dollar figure on the full extent of the asbestos liability, it is undoubtedly massive. And while J&J has successfully defended many asbestos-laced powder lawsuits, it has lost others. Just this year, J&J paid $2.5 billion to 22 women in a single lawsuit. The possibility of similar verdicts in dozens of other cases—let alone hundreds or even thousands—illustrates the vast universe of risk.

Key legal questions loom regarding whether this practice is subject to attacks by creditors on fraudulent transfer grounds and whether bankruptcy filings such as this by subsidiaries will also stay all of the tort cases currently pending against parent companies like J&J.

The Texas Two-Step 

Before placing its asbestos liability into bankruptcy, J&J executed a “divisive merger,” an oddity of Texas business law, through which J&J relocated to Texas and then split into two separate entities. The new entity, LTL Management LLC (LTL Management), was burdened with the responsibility for paying all of J&J’s asbestos-related liability but was given relatively little in terms of assets. A recent press release by J&J states that it has agreed to provide funding to LTL Management for the payment of amounts the Bankruptcy Court determines are owed by LTL Management and will establish a $2 billion trust in furtherance of that purpose. Once LTL Management was spun off on Oct. 14, 2021, it immediately filed for bankruptcy in the Western District of North Carolina. This combination of divisive merger and filing for bankruptcy has come to be known at the “Texas Two-Step.” 
 On its face, J&J’s Texas Two-Step is designed to take the decisions about liability for the tens of thousands of asbestos lawsuits out of the hands of countless jurors and place them before a single bankruptcy judge with the goal of driving a global resolution of the claims. However, J&J’s CEO went further, telling investors on Oct. 19, 2021, that the maneuver is an established process that allows companies facing “abusive tort systems” to resolve claims in an efficient and equitable manner. 

Critics of the move, however, contend that it is an abusive practice used by wealthy companies to derail lawsuits and shield the assets of the parent company by forcing claimants to seek recovery from a significantly—and artificially—poorer entity. Those same critics argue that the Texas Two-Step encourages forum shopping for the most favorable bankruptcy protection. For example, J&J is headquartered in New Jersey but spin-off LTL Management actually filed for bankruptcy in North Carolina following its Texas inception. 

Can creditors fight back?  

Other companies have previously used the Texas Two-Step when faced with similar mass tort exposure and have subsequently met with challenges from tort claimant committees that the divisive merger was actually a fraudulent transfer. Without yet answering that ultimate question, two judges in the Western District of North Carolina Bankruptcy Court have indicated that the risk of committing a fraudulent transfer has not been eliminated completely by the Texas Two-Step. In one case, the judge held that if a debtor used the Texas statute to commit a fraudulent transfer, the Texas version of the Fraudulent Transfer Act would be available to address such a transfer.(1) In the other, Judge Craig Whitley—who is also the judge hearing the recently filed LTL Management bankruptcy case—noted that although the Bankruptcy Code does not preempt the Texas divisive merger law, the Texas Two-Step is potentially prejudicial to the rights of the claimants and is subject to potential legal challenge.(2) Judge Whitley also added that if creditors wanted to attack a specific Texas Two-Step as being fraudulent, they would need the requisite standing to bring those claims.(3)

How much staying power does this dance have?  

Another important and unanswered question concerns the full scope of the cases actually stayed by the bankruptcy filing. Judge Whitley agreed that lawsuits involving bankrupt LTL Management are paused, as being subject to the automatic stay under Chapter 11 rules. Parent company J&J, however, contends that all of the asbestos-laced powder cases against it, even the mature ones now nearing jury trial, should be stayed as well. Thus, the case is shaping up to be a battle over the extent to which even years-old litigation with potentially billions of dollars at stake can be stopped and rolled into the bankruptcy of the newly formed subsidiary. In support of its position, J&J asserts that one of its subsidiaries assumed responsibility for the asbestos claims during a 1978 restructuring.  The Texas Two-Step is an emerging legal strategy being used by companies to place large amounts of tort liability into bankruptcy while shielding the bulk of their assets from claimants. The reach and long-term viability of this strategy will be determined by the courts as Texas Two-Step cases like the J&J one are litigated. In the meantime, this legal maneuver presents both potential benefits and risks for lenders. In some cases, lenders might prefer that a borrower employ the Texas Two-Step, thereby providing for a more secure borrower. In other cases, lenders might have apprehension about the prospect of a significantly reduced recovery from debtors who are attempting to place the bulk of their assets out of legal reach. 
In any event, the Banking attorneys at Chuhak & Tecson can recommend best practices and will offer sound advice to help navigate individual circumstances when dealing with a debtor who is using or may be contemplating the use of this evolving bankruptcy development.  

Client alert authored by Nicholas J. Schuler, Jr. (312 855 4313), Senior Counsel.

(1) Bestwall LLC v. Those Parties Listed on Appendix A to Complain and John and Jane Does 1-1000 (In re Bestwall LLC), 606 B.R. 243, 252 (Bankr. W.D.N.C. Jan 23, 2020).
(2) DBMP v. Those Parties Listed on Appendix A to Complaint and John and Jane Does 1-1000, No. 20-03004, Findings of Fact and Conclusions of Law, p. 34 (Bankr. W.D.N.C. Aug. 11, 2021) [Docket No. 972].
(3)  Id. at 43-44.

Contributing Advisors