Johnson & Johnson’s ‘Texas Two-Step’ Bankruptcy Gets Challenge From Talc Plaintiffs

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Although Johnson & Johnson was successful in its attempt to split off talcum liabilities via a so-called “Texas Two-Step” bankruptcy filing, the dance isn’t over as plaintiffs are vowing to appeal the denial of their motion to dismiss.

The chapter 11 petition was filed after Johnson & Johnson was sued by multiple plaintiffs alleging that its baby powder caused women to develop ovarian cancer.

“The rate of filing suggests that tens of thousands more cases are on their way and the few cases that have gone to verdict have had varied outcomes from zero to four billion,” said Anthony Casey, professor at the University of Chicago Law School. “In response to the company facing thousands of cases with a huge range of expected outcomes, Johnson and Johnson initiated a series of restructuring transactions to resolve the liabilities and that plan is what ultimately gets us into the LTL bankruptcy.”

On Feb. 25, Chief Bankruptcy Judge Michael B. Kaplan of the U.S. District Court of New Jersey upheld Johnson & Johnsons’ bankruptcy claim through subsidiary LTL Management.

“The Court’s comments are not intended to dismiss or discredit the inarguable benefits of our tort system and the essential work of our plaintiffs’ bar in bringing about corporate transparency and vindicating the rights of those victims who are ill-equipped to pursue their rights against large corporate defendants,” Judge Kaplan said in his 56-page opinion. “In this vein, we can all point to concrete illustrations where such litigation has been responsible for necessary safety reforms and health measures. What the Court regards as folly is the contention that the tort system offers the only fair and just pathway of redress and that other alternatives should simply fall by the wayside.”

The Texas Two-Step refers to Section 1.002(55)(A) of the Texas Business Organizations Code which is used to split embattled corporations into two separate entities for the purposes of bankruptcy.

“It’s a very clever idea,” said Peter Chapman, CEO of Bankruptcy Creditors’ Service. “Some really smart people sat down and found a way to globally resolve these insoluble liabilities.”

After a corporation is split into two, the first company is saddled with the legal claims, while second company takes on the corporate assets. The first company then files for bankruptcy.

“The Texas-Two Step is used to level payouts,” Mr. Chapman told PacerMonitor News. “If you died of mesothelioma, you get a certain amount of money. If you had cervical cancer for a certain number of years, you get a certain amount of money, and everybody gets paid the same. In theory, the payouts will happen faster and with greater predictability.”

In Johnson & Johnson’s bankruptcy, LTL Management was saddled with the legal claims, and Johnson & Johnson Consumer Inc. (JJCI) kept the corporate assets.

“There’s this funding agreement that says the liabilities will be paid up to the value before this merger divided the two entities,” Mr. Casey said. “In that way, the asset value of JJCI is not separated from the liabilities because the funding agreement brought it with.”

The funding agreement in the J&J bankruptcy provided for $60 billion.

However, Majed Nachawati, a partner in the Fears Nachawati Law Firm in Dallas, which represents some 4,000 talc plaintiffs, said J&J offered only to fund the $60 billion agreement with $2 billion.

“It wouldn’t be a problem for Johnson & Johnson parent to pay $60 billion,” Mr. Nachawati said. “It’s a problem for the subsidiary, LTL Management, that they created overnight. That is the issue. From our perspective, this litigation has been going on for eight years. The plaintiff, who used their product and trusted them, ends up, in many cases, dying. Now, they filed for bankruptcy and if the case is in bankruptcy court, it could be another four or five years.”

J&J had $93.8 billion in sales last year, and the consumer products company has a market capitalization of $450 billion.

“The funding agreement says that as long as LTL Management is out of bankruptcy, which it no longer is, then Johnson &Johnson will kick in whatever is necessary, but in bankruptcy, there are limits and they are all negotiable with the committees and future claimant’s representative,” Mr. Chapman added. “The final amount of funding of a trust will be subject to an estimation hearing, which is a court proceeding that will stretch over a couple of days where lots of experts will testify about the course of progression of illness, the different types of cancers and the value of the liability.”

While J&J gained court approval, the maneuver is drawing scrutiny from Congress. If legislation that is currently being crafted by the Senate Judiciary Committee passes, a company’s attempt to unburden legal claims through subsidiaries would be limited.

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