By: Franklin Barbosa, Jr., Esq. 

On January 30, 2023, the Third Circuit Court of Appeals dismissed the Chapter 11 bankruptcy case of LTL Management LLC (“LTL”), a Johnson & Johnson (“J&J”) entity holding substantial liabilities arising from consumer use of talcum baby powder, because the entity was not in “financial distress” sufficient to sustain a good faith Chapter 11 bankruptcy filing.

As a result, nearly 40,000 talcum powder lawsuits that were previously stayed as a result of the bankruptcy action, have been given permission to resume. The ruling is subject to any appeal filed by J&J. 

The Texas Two-Step

LTL was created in October 2021 through a controversial corporate maneuver known as the “Texas two-step,” a process designed to help companies jettison mass tort liabilities. The strategy obtained its named from the Texas divisive merger statute that permits a company to essentially split itself into separate entities, placing tort liabilities into one of those entities and shielding valuable assets in the other entity. The entity left holding the tort liabilities is sometimes funded through a support agreement pursuant to which the entity holding valuable assets agrees to provide funding dedicated to settling the tort liabilities. The subsidiary holding liabilities then files for bankruptcy, thereby halting all pending and future tort litigation, in an effort to orderly resolve the tort liabilities.

In this particular case, J&J assigned the assets of Johnson & Johnson Consumer Inc. (“JJCI”) to a new entity and diverted its talc liability to LTL along with nominal assets. Both J&J and the entity holding JJCI’s valuable assets entered into a support agreement with LTL whereby they agreed to fund LTL’s tort liabilities. The value of the funding agreement was estimated to be $61.5 billion. LTL subsequently filed a Chapter 11 petition with the Bankruptcy Court for the Western District of North Carolina, and thereafter the case was transferred to the Bankruptcy Court for the District of New Jersey, because J&J is headquartered in New Jersey. 

At the time of the bankruptcy filing, nearly 40,000 talc lawsuits were pending against J&J entities. Prior to the lawsuit, 20 plaintiffs in a Missouri lawsuit were awarded $2.24 billion. Since 2018, verdicts against J&J entities averaged $39.7 million per claim. The total costs relating to the talc litigation was $4.5 billion. Estimated future losses were $2.4 billion over the next two years. LTL Mgmt., LLC v. Those Parties Listed on Appendix A to Complaint ( In re LTL Mgmt., LLC), 2023 U.S. App. LEXIS 2323, at *10-13 (3d Cir. Jan. 30, 2023).

The “Financial Distress” Requirement

LTL, like any entity with a pending Chapter 11 bankruptcy case, may only sustain its bankruptcy case if it was commenced in “good faith.” In the Third Circuit, a bankruptcy petition is filed in good faith if, among other things, the debtor is genuinely experiencing “financial distress” at the time of its bankruptcy filing. Representatives of plaintiffs for the 40,000 talcum powder cases challenged whether LTL was actually in “financial distress” given the availability of funds to pay claimants.

Judge Thomas Ambro, writing for the Third Circuit and relying upon established Third Circuit precedent, held that LTL’s case must be dismissed because LTL was not in “financial distress” at the time of its bankruptcy filing. The primary factor motivating Court’s decision was the availability to LTL of the $61.5 billion in financing for tort liabilities when compared to LTL’s liabilities. The available financing far exceeded LTL’s litigation-related costs at the time of the bankruptcy filing and, possibly, its future tort liabilities. Given those circumstances, Judge Ambro concluded that LTL:

at the time of its filing, was highly solvent with access to cash to meet comfortably its liabilities as they came due for the foreseeable future. [. . .] The “‘attenuated possibility’ that talc litigation might require it to file for bankruptcy in the future does not establish its good faith as of its petition date. [. . .]  At best the filing was premature.” 

Id. at 45-47.

The Third’s Circuit’s decision reverses the New Jersey bankruptcy court’s earlier decision denying claimants’ motions to dismiss LTL’s bankruptcy case and permitting LTL to proceed based upon its “good intentions.” In correcting the bankruptcy court’s rationale, the Third Circuit stated:

Good intentions – such as to protect the J&J brand or comprehensively resolve litigation – do not suffice alone. What counts to access the bankruptcy code’s safe harbor is to meet its intended purposes.  Only a putative debtor in financial distress can do so. LTL was not.  Thus we dismiss its petition.

Id. at 7.

What Does the Third Circuit’s Decision Mean Going Forward?

The Texas Two-Step is not dead, but debtors in the Third Circuit facing toxic tort liabilities must demonstrate more than just the possibility of significant liabilities. The Third Circuit stopped short of establishing a governing standard for “financial distress.” However, based upon the Court’s rationale we can surmise that while a toxic tort debtor need not establish insolvency, it must demonstrate an inability to satisfy adverse tort judgments. The debtor’s financial distress must be sufficiently immediate to justify a bankruptcy filing.

For more information, contact Franklin Barbosa, Jr. at FB@spsk.com or 973-539-1013.

DISCLAIMER:  This Alert is designed to keep you aware of recent developments in the law. It is not intended to be legal advice, which can only be given after the attorney understands the facts of a particular matter and the goals of the client.