The Texas-Two Step: The Latest Dance Craze?

How Johnson & Johnson Dodged Liability with a Legal Shuffle

The Supreme Court passed on a case that addresses the controversial Texas two-step bankruptcy strategy, legalizing that technique, for now.

As part of its bankruptcy, the manufacturing giant Georgia-Pacific wanted to extend the litigation shield to Bestwall LLC, an affiliate it created to handle asbestos lawsuits. After Georgia-Pacific placed Bestwall into bankruptcy in 2017, it obtained a court order protecting itself from liability.

An old corporate playbook to avoid liability

The litigation shield is a core benefit of the Texas Two-Step, a legal strategy in which a company creates a corporate entity, transfers liability to it and places it into bankruptcy, thereby obtaining a pause on litigation. The bankruptcy judge denied that request, the U.S. Court of Appeals for the Fourth Circuit upheld that ruling, and the Supreme Court let that ruling stand.

Specifically, the claimants asked the Supreme Court to consider whether bankruptcy courts have the jurisdiction to grant litigation shields to companies, like Georgia-Pacific, that aren’t themselves bankrupt. They also asked the court to determine if bankruptcy courts have the authority to take action not specifically granted to them by the bankruptcy code.

Bankruptcy judges in the Western District of North Carolina, where multiple two-step cases are pending, have repeatedly asked higher courts to consider the unique legal questions raised by the strategy.

Breaking Down the Texas Two-Step

Briefly, the Supreme Court can pick and choose its own cases. Fewer than 10 percent of the appeals submitted to the Supreme Court are enticing enough for the Justices to consider them.

Woe be unto do-it-yourself consumer debtors who try to use bankruptcy as a sword, not a shield. Officials almost always charge these individuals with bankruptcy fraud. But a bankruptcy lawyer protects consumers and maximizes their fresh starts, just like an asbestos exposure lawyer obtains the compensation and justice these victims deserve. More on that below.

Perceived misuse of the Automatic Stay prompts most sword/shield consumer bankruptcy fraud charges. Some people file bankruptcy multiple times in a clear attempt to frustrate a creditor. For example, after Jim files bankruptcy, Jim’s wife might file bankruptcy, followed by Jim, LLC.

A company that files a Texas Two-Step bankruptcy creates a bogus corporate entity to absorb liability lawsuits. The Johnson & Johnson Texas Two-Step is a good example. By happy coincidence, it’s also an asbestos litigation-related example.

Class action lawsuit claims J&J knew about asbestos-contamination in its baby powder.

The saga began in 2010, when several people filed a class-action lawsuit against Johnson & Johnson. According to court documents, the talc in Johnson’s Baby Powder contained traces of asbestos and could cause ovarian cancer and mesothelioma.

A single fiber could cause these illnesses. Regular exposure to multiple fibers over many years multiplies the risk exponentially.

Things got worse, at least for J&J. In 2020, the Missouri Court of Appeals awarded $2.24 billion to a class of 22 plaintiffs who developed ovarian cancer after their continued use of Johnson’s Baby Powder. That finding opened the litigation floodgates. By the end of 2021, the company faced over 38,000 ovarian cancer lawsuits and over 400 mesothelioma lawsuits.

In desperation, Johnson & Johnson filed bankruptcy, so the aforementioned Automatic Stay would pause these lawsuits. Then, the company transferred its talcum powder business to LTL Management. Afterwards, company lawyers argued that LTL Management, a shell company with zero assets, was legally responsible for damages in these cases, while Johnson & Johnson, which had over $300 billion in assets, wasn’t responsible for anything.

The Third Circuit Court of Appeals dismissed the bankruptcy, because LTL Management was not in financial distress. This holding didn’t invalidate the Texas Two-Step strategy. Only the Supreme Court can do that.

Nevertheless, the Third Circuit’s ruling makes it harder for companies like Georgia-Pacific to argue that they filed bankruptcy in good faith. In this context, this amorphous standard requires the court to “examine the totality of facts and circumstances and determine where a petition falls along the spectrum ranging from the clearly acceptable to the patently abusive.”

Asbestos exposure lawyers sometimes call this standard the straight face test. If you can make the argument to a judge with a straight face, you’re in the clear.

Why It All Matters

Sometimes, analyzing legal minutiae such as this is like asking how many angels can dance on the head of a pin, as one of our law school professors was fond of saying. However, in this case, the discussion matters a lot.

Mesothelioma, the illness mentioned above, may be the most devastating form of a devastating disease, both physically and emotionally.

The latency of mesothelioma and asbestos diseases

Usually, mesothelioma tumors lurk in the thick membranes of the mesothelium (layer between the lungs and heart) for decades before the victims show any outward signs of lung cancer, such as radical weight loss, trouble breathing, or chest tightness. The extended latency period takes the early treatment option off the board. Usually, early cancer treatment is the key to a successful outcome.

Instead of treating tumors when they’re small and haven’t metastasized, doctors must treat them when they’re large and after the cancer has spread. The odds are against a successful outcome at that point.

Heavy smokers diagnosed with cancer in middle age know what’s coming. But an environmental cancer diagnosis, which usually no one saw coming, blows a victim over, especially if that diagnosis comes late in life. This emotional pain accelerates physical deterioration, trapping victims, and their families, in downward spirals.

Even the best asbestos exposure lawyer cannot change what happened. But a lawyer can obtain compensation and justice.

Cancer treatments are very expensive. A lawsuit settlement gives victims the financial resources they need to fight their illnesses. Lawsuits also impose a very basic “you break it, you buy it” responsibility on asbestos providers like Georgia-Pacific.

Bankruptcy and Asbestos Exposure

GP certainly isn’t the first asbestos provider that tried to take the easy way out and file bankruptcy rather than face the music in civil court. These bankruptcies were especially common in the 1980s, during a wave of asbestos liability lawsuits. Rather than dance the two-step, bankrupt companies did the avoid-dance. Or, at least they thought they were doing that dance.

Instead of creating shell corporations, these companies ceased operations when they filed bankruptcy, hoping they’d have enough cash left over to begin again when the judge discharged the bankruptcy.

That strategy often works. This time, it didn’t. Judges ordered these companies to place most of their assets into victim compensation funds.

Bankruptcy VCF claims are much easier to prepare than court claims. That’s especially true if the victim qualifies for expedited review. In these cases, the Fund Administrator doesn’t look at the paperwork too closely. In all cases, the Fund Administrator accepts the victim’s contentions and evidence at face value. An adverse lawyer doesn’t challenge them.

That’s the good news. The bad news is that bankruptcy VCF settlement negotiations are often long and protracted. Inexperienced lawyers often look for easy ways out in these situations. Only an experienced asbestos exposure lawyer is with you until the end of the line.