Definition of Two-Step Bankruptcy in Texas

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What is a two-step bankruptcy in Texas?

A two-step bankruptcy in Texas is a controversial legal maneuver that can be used to manage a company’s exposure to potential lawsuits. When pursuing a two-step bankruptcy in Texas, a company first creates a new legal entity into which it transfers its tort liabilities, while transferring a relatively small portion of the original company’s assets. The newly created company then files for bankruptcy, effectively protecting the original company from the cost of tort liability.

Texas’ two-step bankruptcy is controversial, with critics saying it allows companies to shirk their legal responsibilities. The method has drawn criticism from parts of the legal community and the general public, as well as from Congress. Therefore, it is possible that future laws or court rulings could compromise the viability of the Texas Two Step Bankruptcy strategy.

Key points to remember

  • A two-step bankruptcy in Texas is a legal defense used by companies sued for tort liabilities.
  • The practice is commonly associated with the legal defenses recently filed by Johnson & Johnson (JNJ) regarding the alleged presence of asbestos in some of their baby powder products.
  • Some politicians have taken steps to potentially ban the practice, while it has so far been largely upheld by the courts.

How a Two-Step Bankruptcy Works in Texas

As the name suggests, there are two essential steps to completing a two-step bankruptcy in Texas, the first being to form a new corporation. Businesses will typically register this new corporation in a jurisdiction, such as Texas, whose corporate law system is considered business-friendly. Once created, the company then transfers the tort liabilities in question to this newly created company. This process of creating a new society and transmitting liabilities of a corporation is known as a “split merger” and is sometimes also referred to as a “reverse merger”.

Once this process is complete, the next step in the Texas Two Step process is for the newly created company to file for Chapter 11 bankruptcy. In practice, this means that the tort dispute will need to be resolved through the bankruptcy process. , and without necessarily having recourse to all of the assets held by the original company, which is now a separate legal entity. In contrast, a typical court proceeding might instead involve taking the case to a jury or settling the plaintiffs out of court.

Texas Two-Step Bankruptcy Example

Perhaps the most famous example of a two-step bankruptcy in Texas is the strategy employed by pharmaceutical and consumer goods giant Johnson & Johnson. In recent years, the company has been the subject of lawsuits in which plaintiffs have alleged that some of its talc-based baby powder products contain asbestos, contributing to cancer cases.

In June 2021, one such lawsuit led to the company being ordered by a Missouri appeals court to pay plaintiffs $2.1 billion. Later that year, the company used a divisional merger to create a new subsidiary called LTL Management LLC, transferring its talc liabilities to this subsidiary along with a $2 billion trust to fund any future claims. potential against LTL.

Since the talc liabilities are now held in the new subsidiary, the plaintiffs theoretically can no longer sue the JNJ for damages, but are instead required to sue LTL. Since LTL’s $2 billion trust is significantly less than the total assets available to JNJ, this could effectively limit the maximum damages future plaintiffs could seek, thereby shielding JNJ from potentially unlimited liability.

This JNJ strategy received fairly widespread media attention, where it was cited as a clear example of a two-step bankruptcy in Texas. Critics of the approach have argued that it wrongly limits plaintiffs’ ability to receive damages and that, by forcing the legal dispute to be resolved through bankruptcy proceedings, it could potentially delay and hinder the prosecution. compensation for victims. Defenders of Texas’ two-step bankruptcy process argue that the bankruptcy process will ultimately determine whether the company’s actions are right and that this process protects companies from the risk of unreasonable punitive jury verdicts.

Going forward, it remains to be seen to what extent Texas’ two-step bankruptcy will be upheld by the courts. In February 2022, Judge Michael Kaplan of the District of New Jersey Bankruptcy Court supported the strategy by ruling against a motion to dismiss the bankruptcy filing of JNJ’s subsidiary, LTL Management LLC. In that decision, Judge Kaplan determined that JNJ’s maneuver and its subsidiary was a legitimate use of the Bankruptcy Code and added that the bankruptcy system would be a superior method of resolving JNJ’s outstanding claims regarding its baby powder products.

In his closing remarks, Justice Kaplan noted that “the Court remains firmly of the view that justice will be best served by providing prompt and critical compensation through a court-supervised, fair and less costly settlement trust agreement.” .

Similar decisions that seem to confirm the Texas two-step bankruptcy that has already been concluded in North Carolina. Yet there is also opposition to the practice. Senator Dick Durbin, who is currently Chairman of the Senate Judiciary Committee, has publicly criticized the practice and recently called for legislation to ban it. By talking to FinancialTimes in February 2022, Durbin derided the legal strategy, calling it a “free get out of jail card”.

Why is Texas two-step bankruptcy named after Texas?

The word “Texas” in Texas Two Step Bankruptcy is included for technical and informal reasons. The technical reason is that the strategy relies on a split merge (also known as a reverse merge), which is a widely accepted technique in Texas. But the name is also partly a reference to “Texas two step”, a popular dance associated with traditional country music.

Is Texas Two-Step Bankruptcy Only Used In Asbestos Cases?

Although Texas two-step bankruptcy is most commonly associated with asbestos-related legal cases such as JNJ’s, this technique could in principle be used to resolve any type of tort liability. For this reason, individual court rulings regarding this technique have significance beyond the specific legal cases involved, as these rulings could lead to similar strategies employed by companies in a wide variety of industries. Similarly, any potential legislation prohibiting this practice would likely restrict its use in a wide range of applications, not just those related to asbestos claims.

Why is the Texas two-step bankruptcy controversial?

Some critics of Texas Two Step Bankruptcy argue that it offers wealthy defendants a way to escape their legitimate legal obligations, essentially viewing the practice as a shrewd legal trick. However, others argue that Texas two-step bankruptcy is a legitimate way to settle outstanding legal disputes, one that could potentially speed up the often lengthy process of jury trials. Although individual judges may have some influence over the acceptance of this practice through the precedents set by their rulings, politicians may ultimately wield even greater influence by passing new laws that maintain or restrict the practice.

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