Bankruptcy Law

3rd Circuit tosses talc defendant's 'Texas two-step' bankruptcy

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A federal appeals court has dismissed a petition for Chapter 11 bankruptcy filed by a new unit of Johnson & Johnson that was formed to assume liabilities in litigation over talc contained in its baby powder.

The 3rd U.S. Circuit Court of Appeals at Philadelphia dismissed the case because the new unit, LTL Management, was not in financial distress, a factor that is needed to satisfy the Bankruptcy Code’s requirement for good faith in a filing.

How Appealing links to the Jan. 30 decision.

Before forming LTL Management, Johnson & Johnson Consumer Inc. was facing tens of thousands of lawsuits alleging that traces of asbestos could be found in Johnson & Johnson’s baby powder, causing ovarian cancer and mesothelioma. Some suits produced verdicts, some failed and others settled. One jury awarded $4.69 billion to 22 ovarian cancer patients, which was reduced on appeal to $2.24 billion to 20 plaintiffs still in the litigation.

Johnson & Johnson Consumer Inc. formed LTL Management, along with a second company also named Johnson & Johnson Consumer Inc. At that point, the old Johnson & Johnson Consumer Inc. no longer existed.

The new Johnson & Johnson Consumer Inc. held business assets formerly owned by the old company of the same name.

The 3rd Circuit explained how such a merger works.

“In simplified terms,” the 3rd Circuit wrote, “the merger splits a legal entity into two, divides its assets and liabilities between the two new entities, and terminates the original entity. While some pejoratively refer to it as the first step in a ‘Texas two-step’ when followed by a bankruptcy filing, we more benignly call it a ‘divisional merger.’”

When LTL Management filed for bankruptcy, it held the liabilities for talc litigation, but it also had a funding agreement entitling it to indemnity from Johnson & Johnson and the new Johnson & Johnson consumer company for talc costs. The amount available was based on the value of the new consumer company, which was estimated at $61.5 billion.

“Most important,” the appeals court said, “the payment right gave LTL direct access to J&J’s exceptionally strong balance sheet.”

Judge Thomas L. Ambro wrote the opinion. He was joined by Judge L. Felipe Restrepo and Judge Julio M. Fuentes.

“Some may argue any divisional merger to excise the liability and stigma of a product gone bad contradicts the principles and purposes of the Bankruptcy Code,” Ambro wrote. “That is a call that awaits another day and another case. For here, the debtor was in no financial distress when it sought Chapter 11 protection. To ignore a parent (and grandparent) safety net shielding all liability then foreseen would allow tunnel vision to create a legal blind spot. We will not do so.”

Publications with coverage of the decision include, Reuters, Axios, Law360 and Bloomberg Law.

Johnson & Johnson told in a statement that it will seek a rehearing en banc.

LTL Management “initiated this process in good faith and our objective has always been to equitably resolve claims related to the company’s cosmetic talc litigation,” the statement said. “Today’s ruling does not reflect the facts established during the bankruptcy court’s trial regarding the appropriateness of LTL’s formation and filing nor the company’s intention to efficiently resolve the cosmetic talc litigation for the benefit of all parties, including current and future claimants.”

See also:

ABA Journal: “Gaming the System? Inside the ‘Texas two-step’ strategy profitable companies use to file for bankruptcy”

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