A newly formed subsidiary of Johnson & Johnson recently filed Chapter 11 to handle 38,000 pending talc-related lawsuits and future talc-related claims. There is nothing particularly new about the use of Chapter 11 to deal with mass tort litigation. Over the past three decades, thousands of businesses, dozens of faith-based organizations, and even the Boy Scouts of America have filed Chapter 11 due to mass liability claims.
However, the Johnson & Johnson (“J&J”) case represents a new twist in the high-stakes game of Chapter 11 mass tort cases. In short, J&J used an obscure provision of Texas corporate law to split into two new companies: one which owns talc-related liabilities and the other which holds non-talc assets and liabilities. The new company with talc-related responsibilities then filed for Chapter 11 protection. Some legal commentators have called J&J’s strategy “two-step Texas.” J&J frankly admits that the strategy was “to comprehensively resolve talc claims through a Chapter 11 reorganization without submitting the entire package. [J&J enterprise]to bankruptcy proceedings. “
With a few exceptions which are not relevant here, it is a fundamental principle of bankruptcy law that all assets and liabilities of a bankrupt entity are subject to administration in the event of bankruptcy. For example, in the high-profile case of Purdue Pharma, the company’s Chapter 11 plan included profitable non-opioid assets, which will be sold or exploited for the benefit of opioid creditors. As a result, Purdue Pharma, as it was incorporated prior to the bankruptcy, will cease to exist.
Naturally, J&J wanted to avoid the fate of Purdue Pharma. But J&J faces a dilemma. While Chapter 11 was a proven strategy for managing mass tort liability, a filing would subject J&J talc-free businesses to the risks and uncertainties of the bankruptcy process. J & J’s talc-related product sales represented a tiny fraction of J & J’s total business, accounting for only half a percent (0.5%) of J & J’s total consumer health product sales in 2020.
Separative merger: the potential solution
J & J’s potential solution begins with an unusual provision in the Texas Business Organization Code. Like all other similar corporation laws, Texas law recognizes conventional mergers – that is, the combination of two or more companies into a single surviving entity. But since 1989, Texas has also recognized so-called “separative mergers” (sometimes referred to as “divisional mergers”) where a company splits into two companies and allocates assets and liabilities between the two new companies as it sees fit.
Until recently, conflicting mergers were discussed, if at all, by tax professionals in esoteric corporate tax journals. The terms “separative merger” and “divisional merger” have never appeared in a reported case in Texas and have only appeared a few times in cases reported by the federal government. But bankruptcy practitioners have questioned whether separative mergers might offer companies facing massive tort liability the best of all possible worlds: access to bankruptcy courts to handle thousands of tort claims without exposing all of the tort defendant’s assets. to the bankruptcy process.
The corporate restructuring of J&J
On October 12, 2021, J&J completed a complex corporate restructuring that included a separate merger under Texas law. In summary, Johnson & Johnson Consumer Inc. (“Old JJCI”) amalgamated into a newly formed Texas limited liability company, and the surviving entity (a Texas entity) then entered into a separative merger under of Texas law. As a result of the separative merger, (a) the old JJCI ceased to exist, (b) two new Texas limited liability companies were formed; (c) Former JJCI assigned its talc liabilities and certain assets to one of the new LLCs (the “Debtor LLC”) and the remaining non-talc liabilities and assets to the other LLC (the “ LLC non-debtor ”). The Debtor LLC then converted to a North Carolina limited liability company and changed its name to LTL Management LLC. All of these actions took place between 9:00 a.m. and 1:00 p.m. on October 12. Two days later, Debtor LLC filed for Chapter 11 protection in North Carolina. In the meantime, Non-Debtor LLC has merged with a newly formed New Jersey company and changed its name to Johnson & Johnson Consumer Inc. (“New JJCI”).
When the dust settled, Debtor LLC was responsible for all talc-related liabilities, and New JJCI owned all non-talc assets and was responsible for non-talc liabilities. Certainly, the divisive merger did not leave Debtor LLC grappling with all talc liabilities without any assets. Debtor LLC estimated in its bankruptcy filing that it held $ 373.1 million in assets as a result of the allocation made in the break-up merger. Additionally, New JJCI has agreed to fund Debtor LLC’s Chapter 11 business and put $ 2 billion into a talc claimant settlement trust as part of a Chapter 11 reorganization plan.
Challenges of deposit linked to J&J
While J&J is by far the largest company to use the Texas Two-Step strategy, it is not the first. As far as the author has been able to determine, J&J is the fourth company to resort to a merger that divides Texas before filing for bankruptcy.1 None of the other Texas Two-Step cases have yet resulted in a confirmed reorganization plan. Nonetheless, these other cases suggest that the newly filed case will face at least three major issues.
- Question n ° 1: Dismissal for bad faith.
Even though the four Texas Two-Step cases used Texas law to accomplish their divisive mergers, they all filed for bankruptcy in the Western District of North Carolina, despite minimal contact with that state. The popularity of this forum is probably due to the Fourth Circuit standard for the bad faith rejection of a Chapter 11 case. In order to dismiss a Chapter 11 case in the Fourth Circuit, the reorganization must be both (a ) objectively frivolous and (b) filed in subjective bad faith. Carolin Corp. vs. Miller, 886 F.2d 693, 700-01 (4th Cir. 1989). In fact, the Fourth Circuit dismissal standard has been described as “one of the strictest set out by federal courts.” In re Dunes Hotel Assoc., 188 BR 162, 168 (Bankr. DSC 1995). Indeed, the official committee of product liability claimants in one of Texas Two-Step’s other cases failed in its efforts to dismiss the Chapter 11 filing due to the strict Fourth Circuit standard. Regarding Bestwall LLC, 605 BR 43 (Bank. WDNC 2019). If the Debtor LLC business remains in North Carolina, we can expect Debtor LLC to rely on Caroline and Bestwall defend against any unsuccessful classification attempt.
However, it is far from clear that Debtor LLC’s case will remain in North Carolina. The bankruptcy administrator (comparable to the US trustee) has already filed a petition to transfer the location to the District of New Jersey. And on October 26, the bankruptcy court issued an ex officio order justifying the denial of the transfer of the case. If the matter is transferred to the District of New Jersey, the standard for a bad faith termination will be governed by the standard more favorable to Third Circuit creditors. See In re Rent-A-Wreck of America, Inc. 596 BR 122 (Bankr. D. Del. 2019) (Third Circuit courts focus on two questions: whether the petition serves a valid bankruptcy purpose and whether the petition is filed solely to gain a tactical advantage).
- Issue n ° 3: Fraudulent transfer.
The biggest problem, however, is the risk that the bankruptcy court will overturn the October 12 transactions because they constitute fraudulent transfers. These transfers can arguably be avoided under Section 544 of the Bankrutpcy Code (which incorporates state fraudulent transfer law) or Section 548 (which establishes a federal standard). Many observers believe the Oct. 12 corporate restructuring constitutes a fraudulent transfer under one or both of sections 544 or 548. However, another quirk of Texas law comes into play. The Texas Business Organization Code says explicitly that a business merger does not result in “any transfer or assignment”. If there is no “transfer” under state law, logic dictates that there can be no fraudulent transfer of state law and therefore no claim under state law. article 544 of the Bankrutpcy Code.
However, transactions could still be contested under Article 548 of the Bankrutpcy Code. to dispose of or dispose of property. “) So the original provision of the Texas corporations law is not necessarily the end of the story. October 12 can be overruled using federal fraudulent transfer law.
Judge Craig Whitley, who is presiding over Debtor LLC’s bankruptcy case, said in a recent hearing that Texas’ two-step strategy is either “brilliant” or “grossly unfair”, depending on one’s perspective. The bankruptcy community will be watching the outcome very closely. One thing’s for sure: If J&J’s Texas Two-Step works, bankruptcy professionals across the country will start taking dance lessons.
1 The others are In re Bestwall LLC, Case No. 17-31795 (Bankr. WDNC); DBMP Case, LLC, Case No. 20-30080 (Bankr. WDNC); Aldrich Pump LLC Case, Case No. 20-30608 (Bankr. WDNC);
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