Escaping Liability: Texas Two-Step’ Under Scrutiny

Depending on whom you ask, the pejoratively titled “Texas two-step” is either a strategic, viable defense to mass tort claims or an unfair abuse of the Bankruptcy Code.  

“The term is clearly meant to be an amusing reference to country line dancing, which is popular in Texas, as well as many other Southern states,” said Durham attorney Tom Wilmoth of the Law Offices of James Scott Farrin. “However, the ramifications of this legal maneuver are anything but amusing.”   

The litigation strategy got its name from a Texas law that defines a merger as either two companies coming together or one company dividing into two or more companies, called a divisive merger. The tactic is often used to defend claims such as those arising from asbestos and talc exposure, and looks something like this when a company faces tort liabilities: The company creates a spinoff entity — divisive merger — to which it assigns assets and liabilities. The spinoff can then file for bankruptcy while the primary business continues doing business as usual.  

Some attorneys, like Wilmoth, believe this is a means of gaming the system.    

“This absolves the original company of all liabilities and limits the total amount of money that can be used to settle claims,” Wilmoth said. “For example, (Johnson & Johnson) is worth approximately $470 billion. When it created LTL, it transferred about $2 billion in assets. J&J now contends that it is not liable for any talc claim; rather, LTL is the sole responsible party. If this is true, then J&J has effectively limited its maximum payouts for these lawsuits to LTL’s net worth — $2 billion.” 

Boston attorney Michael Shepard is involved in four bankruptcy cases before the U.S. District Court for the Western District of North Carolina, cases involving Bestwall (formerly part of Georgia Pacific), DBMP (Certainteed), Aldrich (Ingersoll Rand), and Murray (Trane). The LTL matter was also in Charlotte before being moved to New Jersey, where J&J is headquartered, in 2021.  

Shepard told Massachusetts Lawyers Weekly that while the Texas two-step affects only asbestos and talc victims today, it could one day affect any number of products — pharmaceuticals and vehicles, for instance — on the market that hurt people.  

“You’re essentially removing one of the great safeguards that we have in this country from corporate negligence or malfeasance, and that is the right to a jury trial, the right to hold that company accountable,” Shepard said.  

Wilmoth agreed, calling it a “legal loophole” and saying that he believes lawmakers intended for the law to be an efficient way to spin off new companies and grow the economy, not to exploit the system.  

“By placing these claims in Bankruptcy Court, the focus is taken off the merits of the claims,” he said. “The plaintiff is no longer entitled to have a jury of her peers decide whether she is due compensation, and if so, how much. Instead, accountants and lawyers calculate the number of legal claims and average out the amounts needed to settle them out of a much smaller pot of money. Bankruptcy courts are designed to fairly distribute money from a failing company to its creditors. It was never designed to forcefully settle personal injury and wrongful death claims against a solvent defendant.”  

Not passing the buck 

Charlotte attorney Garland Cassada of Robinson Bradshaw, who is involved in the litigation, disagreed, saying that a divisive merger does not eliminate or reduce a company’s liability for asbestos claims or impair the company’s ability to pay for them. Instead, it allows the company to file a Chapter 11 case to resolve the liability while ensuring the company has the same ability to pay claims that existed before the merger. It does that, he said, by implementing an uncapped funding agreement in favor of the company assigned the liability requiring the spinoff company to pay the liability as it becomes necessary.  

“Attempting to resolve asbestos litigation in a Chapter 11 case is a valid reorganizational purpose, even for a solvent company,” Cassada said. “Rather than ‘absolving’ a company of liability, a divisional merger and bankruptcy filing enables a company to consensually resolve all pending and future claims and pay them through an adequately funded settlement trust. The trusts operate through administrative procedures approved by representatives for claimants that are designed to pay valid claims fairly, equitably and promptly.”  

Why Charlotte?  

A decade-old ruling in In re Garlock (filed in 2010) might partially explain why companies have filed their cases in North Carolina. Garlock Sealing Technologies was a subsidiary of Enpro Industries, which is based in Charlotte. Garlock manufactured coated asbestos gaskets, and the Garlock plaintiffs included thousands of mesothelioma victims and an undisclosed number of future victims. The district court held that Garlock’s total liability should be reduced from more than a billion dollars to $125 million, finding that Garlock’s “legal responsibility for causing mesothelioma is relatively de minimis.”  

“The Garlock case is important because it resulted in a successful plan of reorganization, permanently resolving all pending and future asbestos litigation against the company,” Cassada said. “The plan was approved by a large majority of asbestos claimants, as well as a legal representative representing the interests of future asbestos claimants. Under the plan, Garlock created and funded a $480 million trust that assumed sole responsibility for paying valid present and future asbestos claims against Garlock.” 

Cassada added that Garlock was important because it led to a precedent-setting opinion estimating the extent of the company’s liability for asbestos claims based partly on findings that asbestos plaintiffs and their lawyers often failed to disclose significant information about their exposures to other companies’ asbestos products. Based on these findings, Cassada said, the court concluded that Garlock’s past settlements were not an accurate gauge of its current and future liability.  

But add J. David Butler of Rogers, Patrick, Westbrook & Brickman in Aiken, South Carolina, to the list of attorneys who believe that the tactic is an abuse of the bankruptcy system by corporations not really in financial distress.  

“It is a strategy employed by otherwise profitable companies to isolate liabilities and deny victims of corporate wrongdoing their day in front of a jury,” Butler said. “It is an effort by corporate America to end-run the constitutional right to trial by jury in this country through the misuse of the bankruptcy system.”  

Litigation as far as the eye can see 

Cassada noted that in 2021, the bankruptcy and district courts confirmed a reorganization plan in a case involving Kaiser Gypsum Co., saying that the plan received overwhelming consent from asbestos claimants and the support of a future claimants’ representative. That plan was upheld by the 4th U.S. Circuit Court of Appeals earlier this year.  

In the LTL matter, tens of thousands of lawsuits claimed that J&J’s baby powder caused ovarian cancer and mesothelioma. Talc claimants moved for the Bankruptcy Court for the District of New Jersey to dismiss LTL’s bankruptcy case, arguing that it was not made in good faith. The court denied those motions, but in January, the 3rd U.S. Circuit Court of Appeals dismissed LTL’s bankruptcy petition, finding that Chapter 11 is appropriate only for entities facing financial distress and that LTL was well-funded to “manage and defend thousands of talc-related claims” and was highly solvent to comfortably meet its liabilities as they came due.  

In his ruling, District Judge Thomas Ambro, a former bankruptcy judge, wrote that good intentions, such as protecting J&J’s brand or comprehensively resolving litigation, alone do not suffice.  

“What counts to access the Bankruptcy Code’s safe harbor is to meet its intended purposes,” he wrote. “Only a putative debtor in financial distress can do so. LTL was not. “Thus, we dismiss its petition.”  

Ambro added that some might argue “any divisional merger to excise the liability and stigma of a product gone bad contradicts the principles and purposes of the Bankruptcy Code,” but that it is a call to be made on another day, in another case.  

From Butler’s perspective, that day and case can’t come soon enough. He said that there is no reason the defense strategy cannot extend to pharmaceutical companies, automakers or any other corporate citizen “facing a reckoning over dangerous products or conduct” and looking to avoid those liabilities in court.  

“If the misuse of the bankruptcy system through the Texas two-step is permissible, financially viable corporations can dodge accountability in the jury system and hide behind bankruptcy laws designed to protect those who are actually in financial distress,” he said. “The Texas two-step blunts accountability and therefore also provides a disincentive to corporations to make their products safer.”  

Cassada said that if a company is not allowed to “two-step,” it would remain in Chapter 11 and be sued in state and federal courts nationwide for decades to come. This would benefit no one, he said, as litigation is expensive, time-consuming, and highly uncertain for all parties.  

“Individuals with similar claims often obtain substantially different results, ranging from no recovery to wildly disparate recoveries,” Cassada said. “Future claims may receive no recovery at all. A successful bankruptcy reorganization, in contrast, establishes an asbestos trust that promptly and efficiently pays claims through administrative procedures that ensure equivalent treatment of similar claims, including future claims, thereby avoiding the expense, delay, and uncertainty of litigation in the tort system.”  

Exactly how this litigation plays out is anyone’s guess, but the ongoing cases are highly contested and will likely be so for some time.  

“It’s going to be a soap opera for sure,” Shepard said.