Bankruptcy Legislation Around 'Texas Two-Step:'
At a hearing this afternoon members of the Senate Judiciary Committee’s Subcommittee on Federal Courts, Oversight, Agency Action and Federal Rights heard testimony from witnesses (including a former bankruptcy judge, practitioners, a law professor and a Johnson & Johnson mesothelioma claimant) for and against
proposed legislation eliminating the “Texas two-step” chapter 11 strategy.
The Nondebtor Release Prohibition Act
introduced in July 2021 would not only eliminate nondebtor releases in chapter 11 cases but also require bankruptcy judges to dismiss cases filed by entities that have taken on liabilities in a divisional merger within 10 years before the filing. The bill was introduced shortly after Johnson & Johnson
confirmed it was considering a Texas divisional merger and chapter 11 filing to separate its talc liabilities from its consumer division’s operating assets, but before J&J deployed the Texas two-step and placed a new entity designed to hold its talc liabilities, LTL Management,
into bankruptcy.
Talc claimants have asked the LTL bankruptcy court to
dismiss the case as a bad-faith filing with no “valid reorganizational purpose.” The debtor
opposes that request, arguing that the LTL filing is “the only feasible option” to address an “unrelenting and enterprise-threatening deluge of litigation” against Johnson & Johnson.
Prof. David Skeel of the University of Pennsylvania School of Law and Paul Zumbro of Cravath told the subcommittee today that bankruptcy courts are better placed than Congress to determine whether individual Texas two-step cases should be dismissed or allowed to proceed. Skeel acknowledged that bankruptcy remedies for abusive filings are “far from perfect,” but said he believes they are “adequate to the task” and suggested that Congress revisit the issue should bankruptcy judges “fail to adequately police” Texas two-step cases.
Zumbro added that he believes all of the Texas two-step cases filed to date, including LTL Management, have been “an appropriate use of bankruptcy” to equitably resolve claims and spare operating entities a “bankruptcy overhang” that threatens relationships with employees and customers. Zumbro noted that divisional mergers remain subject to avoidance as fraudulent conveyances, and pointed to the funding agreements between operating entities and debtors as evidence that two-step cases are not filed to avoid “financial responsibility for asbestos claims.”
Kevin Maclay of Caplin & Drysdale, counsel for the official committee of asbestos claimants in the DBMP and Aldrich Pump Texas two-step cases, vehemently disagreed with Zumbro, calling the funding agreements “highly contingent” and “illusory” - a conclusion also reached by Judge Craig Whitley in the
DBMP and
Aldrich Pump cases.
Maclay also took aim at the existing judicial remedies including bad-faith dismissal cited by Skeel. Maclay noted that in the Fourth Circuit, where all of the Texas two-step cases have been filed, the prevailing standard allows companies to remain in chapter 11 even if bad faith is proven, so long as a successful reorganization is possible.
Judiciary Committee Chairman Sen. Richard Durbin, D-Ill., also took issue with what he called Zumbro’s “rationalization” of the Texas two-step in a heated exchange. In response to Zumbro’s comment about preserving relationships between operating entities and their employees and customers, Durbin remarked, “I think it might also be about money, going out on a limb here.” Durbin pointed out that the funding agreement between Johnson & Johnson and LTL Management allocates $2 billion to resolve 38,000 claims, whereas one jury awarded just 22 claimants $2 billion in damages against the company.
Zumbro responded that the bankruptcy system prevents one group of plaintiffs from securing a $2 billion “pot of gold” while others get nothing. “The tort system is broken,” Zumbro said, and asserted that bankruptcy is better at resolving mass tort claims because “everybody has to be treated the same” and the process is more efficient. Zumbro also noted that not even Johnson & Johnson could afford to pay $2 billion to every claimant.
Durbin countered that the purpose of the judicial system is justice, not efficiency. Durbin also asserted that Johnson & Johnson is worth $430 billion, and thus $2 billion for 38,000 claimants is hardly “fair apportionment.” “Get real,” Durbin added.
The whole point of the Texas two-step is delay, Maclay argued. According to Maclay, Texas two-step filings are used “to stick disfavored creditors” indefinitely in bankruptcy and “hope they will knuckle under and accept pennies on the dollar” for their claims.
“This is just the beginning,” Maclay warned, hinting that the Texas two-step will “inevitably” be used to allow companies to “get rid” of any disfavored creditors. Maclay called the maneuver a “loophole” that if not closed now “could swallow the entire Bankruptcy Code.” “I don’t know why everyone doesn’t do it,” Maclay said.
In addition to Skeel, Zumbro and Maclay, retired Judge Judith Fitzgerald and mesothelioma claimant Kimberly Naranjo also testified today - both in favor of legislative restrictions on Texas two-step filings.