Johnson & Johnson Texas Two-Step Bankruptcy Gets Booted by Federal Court: Third Circuit Vacates Bid to Split Talc Liabilities Into Separate Company


Whether a class action case alleging Johnson & Johnson’s baby powder causes ovarian cancer can move forward will depend on whether a current stay is extended.

On Feb. 2, after the U.S. Court of Appeals for the Third Circuit ruled against J&J’s bankruptcy, plaintiffs’ lawyers asked for relief from an automatic stay filed by J&J offshoot LTL Management LLC last year.

A hearing is scheduled for Feb. 14 at 10 a.m. ET in New Jersey Bankruptcy Court.

“When the court issues its mandate, that will lift the bankruptcy, but there’s going to be an En Banc appeal petition, and I imagine LTL will litigate to stay the mandate so that they’re not faced with a lifting of the bankruptcy stay and the cases proceeding,” said Ted Frank, senior attorney and director of litigation with the Hamilton Lincoln Law Institute.

The possibility that plaintiffs can finally move forward with their claims emerged after the Third Circuit appellate court in Pennsylvania mooted a New Jersey bankruptcy court’s decision that would have allowed LTL to manage and pay J&J’s class action debts.

“Our decision dismisses the bankruptcy filing of a company created to file for bankruptcy,” the Jan. 30 decision states. “It restricts J&J’s ability to move thousands of claims out of trial courts and into bankruptcy court so they may be resolved, in J&J’s words, “equitably” and “efficiently.”

Underlying the U.S. Court of Appeals for the Third Circuit’s decision is Western District of New Jersey Chief Bankruptcy Judge Michael B. Kaplan’s denial of the plaintiff’s Motion to Dismiss alleging J&J Baby Powder’s “Texas Two-Step” chapter 11 bankruptcy claim was filed in bad faith.

J&J is valued at $61.5 billion, according to an LTL Management LLC expert, and the Third Circuit decided the consumer products company is too healthy to claim bankruptcy.

“Good intentions— such as to protect the J&J brand or comprehensively resolve litigation—do not suffice alone,” the Third Circuit Court of Appeals stated in its ruling. “What counts to access the Bankruptcy Code’s safe harbor is to meet its intended purposes. Only a putative debtor in financial distress can do so. LTL was not.”

As previously reported in PacerMonitor News, the Texas Two-Step refers to a  maneuver under the Texas Business Organizations Code to split corporations into two separate entities for the purposes of bankruptcy. After the split, the first company is saddled with the legal claims, while the second company takes on the corporate assets. In this case, the first company is LTL Management LLC, which filed In re LTL Management, LLC.

J&J, which plans to appeal, has argued that Johnson’s Baby Powder is safe, doesn’t contain asbestos and doesn’t cause cancer.

“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,” J&J said in a Jan. 30 statement.

The appellate court’s opinion stopped short of taking a position on the use of the Texas Two-Step in future cases.

“The decision kicks the can down the road,” Mr. Frank told PacerMonitor News. “There’s nothing precluding LTL, once it exhausts all its appellate remedies here, from doing a new Texas Two-Step filing and trying to satisfy the court’s test.”

The test requires proving financial distress but not insolvency, according to the opinion.

“There’s danger in this, because the only thing missing for LTL is that they weren’t insolvent so a lower court could say you’ve got to be insolvent or on the brink, and that creates a precedent to wait until it’s too late to file,” said Anthony Casey, professor at the University of Chicago Law School.

When the bankruptcy petition was filed in October 2021, J&J was facing over 38,000 ovarian cancer lawsuits and some 400 mesothelioma lawsuits, according to data listed in the opinion. Since 2018, damages in monetary awards to plaintiffs averaged about $39.7 million per claim.

“Our ground for dismissal is LTL’s lack of financial distress,” the ruling states. “No ‘reasonable justification’ validates that missing requirement in this case. And we cannot currently see how its lack of financial distress could be overcome. For these reasons, we go counter to the Bankruptcy Court’s conclusion that ‘unusual circumstances’ sanction LTL’s Chapter 11 petition.”

The Third Circuit opinion, however, conflicts with a Fourth Circuit Court of Appeals decision called Carolin Corp. v. Miller from 1989, according to John M. Masslon II, senior litigation counsel with the Washington Legal Foundation.

The Fourth Circuit Court of Appeals, in Richmond, Va., serves North Carolina, Virginia, West Virginia, Maryland and South Carolina.

“The Third Circuit is saying you cannot file in good faith unless you’re financially insolvent but in the Fourth Circuit, the bankrupt entity doesn’t need to be in financial distress so the Third Circuit added this new prong requiring immediate financial distress,” Mr. Masslon told PacerMonitor. “They admit that it’s nowhere in the bankruptcy code but that it’s implied from within the bankruptcy code.”

The landmark decision is controlling in the Third Circuit, which serves Pennsylvania, New Jersey, Delaware and the Virgin Islands.

“If I’m a claimant, I go back to where I was before the filing and depending on where I am in the process, I’m either happy because I’m going to speed up or unhappy because I’m at the back of the line still,” Mr. Casey told PacerMonitor.

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