WASHINGTON (Legal Newsline) - Members of the U.S. Senate stopped short of crafting legislation at a hearing this week that was focused on the treatment of mass tort defendants who consider declaring bankruptcy.
The Subcommittee on Federal Courts, Oversight, Agency Action, and Federal Rights heard testimony that scrutinized the ability of companies like Johnson & Johnson to limit personal injury liabilities by creating a system in bankruptcy courts to pay claimants. Doing so minimizes plaintiff attorney fees, which can make up one-third or more of settlements and verdicts.
Subcommittee Chairman Sheldon Whitehouse, a former Rhode Island attorney general who was closely aligned with plaintiffs lawyers (he even nominated a lawyer he hired for a failed lawsuit against the paint industry for a federal judgeship), opened the hearing, by questioning the use of a Texas law to split embattled corporations into two separate entities for the purposes of bankruptcy.
“Company one is saddled with the claims while company two takes the corporate assets,” Whitehouse said. “The company saddled with the claims then files for bankruptcy, perhaps in North Carolina where the Fourth Circuit makes it nearly impossible for victims to have the company's filing dismissed for bad faith. Victims harmed by the corporation are left in bankruptcy proceedings that can take years to resolve, condemned to receive only a fraction of what they're owed.”
Company two, that holds the assets, was referred to as "GoodCo" throughout the hearing while the company saddled with claims was referred to as "BadCo."
“The so-called ‘Texas Two-Step’ has mired tens of thousands of claims in bankruptcy proceedings,” Whitehouse added. “It’s bankruptcy’s aim to grant honest but unfortunate debtors a fresh start while doing the utmost to make creditors whole but in recent years, large corporations on solid financial footing have found a bankruptcy trick to shirk responsibility for hurting Americans.”
Bankruptcy attorney Kevin C. Maclay, an expert witness, noted that the use of the "Texas Two Step" has been limited to five companies since 2017 - Johnson & Johnson, Georgia Pacific, CertainTeed, Ingersoll-Rand, Trane and their affiliates.
Johnson & Johnson created LTL Management LLC in October 2021 as a separate subsidiary to manage claims under Chapter 11 bankruptcy protection in Baby Powder talc litigation with a $2 billion settlement fund, according to a press release.
“All five were and are out-of-state companies whose existence as Texas corporations lasted mere hours in a brazen attempt to exploit what they viewed as a loophole under federal bankruptcy law,” Maclay alleged before the subcommittee.
The strategy is based on Section 10.901 of the Texas Business Organizations Code.
“Within a matter of days, BadCo files for Chapter 11 bankruptcy with the U.S. Bankruptcy Court for the Western District of North Carolina,” Maclay said. “As a result of the Chapter 11 filing, all tort suits and collection actions by tort claimants against BadCo are automatically stayed. Thereafter, the bankruptcy court overseeing BadCo’s Chapter 11 case grants a preliminary injunction and/or rules that the automatic stay indefinitely enjoins tort claimants from suing GoodCo.”
But Paul H. Zumbro, a bankruptcy practitioner and expert witness, defended the use of the strategy as an appropriate use of bankruptcy.
“While the transaction involves two steps — the separation of entities and a bankruptcy filing — it does not involve the side-stepping of accountability or financial responsibility for the asbestos-related claims,” Zumbro said. “The law should not and would not allow that.”
Other expert witnesses included former Western District of Pennsylvania Bankruptcy judge Judith K. Fitzgerald, and David A. Skeel, Jr., a professor of corporate law at the University of Pennsylvania Law School and author of "True Paradox: How Christianity Makes Sense of Our Complex World."
“The strategy of shuffling assets and liabilities prior to bankruptcy in ways that can harm the company’s current creditors—whether they be tort victims as in the Johnson & Johnson case or financial creditors—is not new,” Skeel said.
Skeel argued in favor of allowing courts to dismiss cases that abuse divisive merger bankruptcies and against legislation.
“Courts may fail to adequately police divisional mergers,” he added. “If they do, legislative intervention would be warranted. But I do not believe it is currently warranted and I worry that any legislation may have unfortunate unintended consequences.”
Senator Mazie Hirono (D-HI), who was undeterred by the notion of potential unintended consequences of legislation, was adamant about holding courts accountable for automatic stays, which are granted to all parties in an adversary proceeding or when a debtor files a motion requesting an extended stay.
“That really sounds like an abuse of process to basically stop plaintiffs at the courthouse door,” Hirono said. “What if we consider legislation that will prevent these kinds of situations from any kind of a stay that completely insulates ‘GoodCo’?”
Under a Chapter 11 bankruptcy, the automatic stay serves to give debtors time to sort through financial difficulties with negotiations and to reorganize while being protected from creditor lawsuits. Bankruptcy has been used by dozens of once-popular asbestos defendants in order to pay claimants without the costs involved in civil lawsuits and to keep the companies operating, in some instances.