In In re LTL Management, LLC, No. 22-2003 (Jan. 30, 2023), the U.S. Court of Appeals for the Third Circuit had occasion to consider whether an entity that was created solely to house liabilities and file for bankruptcy could, in fact, file for bankruptcy where another entity was contractually obligated to pay those liabilities. The Court dismissed the bankruptcy petition, reasoning that this contractual obligation meant the former entity was not in financial distress and thus could not avail itself of the bankruptcy process.   

Facing significant liability from tens of thousands of lawsuits alleging that its talc-based Baby Powder product caused certain cancers, Johnson & Johnson Consumer, Inc. (Old Consumer), a subsidiary of Johnson & Johnson, sought to leverage the bankruptcy system to prevent that liability from sinking its business enterprise. Under Texas bankruptcy law, Old Consumer first split itself into two entities: LTL Management, LLC (LTL), to which it transferred virtually all talc-related liability, and New Consumer, to which it transferred its productive business assets. Critically, LTL also acquired a right to a payment from New Consumer and Johnson & Johnson of up to $61.5 million to cover that liability.

In a move known as the "Texas Two-Step," LTL then filed a bankruptcy petition, which ultimately wound up in the Bankruptcy Court for the District of New Jersey. The Official Committee of Talc Claimants moved to dismiss the petition as not being filed in good faith, which the Bankruptcy Court denied principally on the ground that the talc-related liabilities posed a real, substantial threat to the viability of LTL’s business. Under such circumstances, bankruptcy is an appropriate mechanism to give LTL a fresh start and resolve its liabilities in an equitable, efficient manner.

On appeal, the Third Circuit reversed. The Court emphasized that financial distress is a component of good faith in bankruptcy. The Court explained that while it can be difficult to determine when an entity’s financial condition is sufficiently poor, in the case at bar, there was no such difficulty because New Consumer and Johnson and Johnson contractually backstopped Old Consumer’s liabilities. The Court doubted that liability for the talc claims would exceed the $61.5 million cap; indeed, the lawsuits have had a mixed track record at best, with many being dismissed or plaintiff's losing at trial. Because Old Consumer had a sizeable safety net from New Consumer and Johnson & Johnson, it was not in a position to file for bankruptcy, and thus doing so was not in good faith.

In the context of environmental law, liabilities can be significant enough that a company determines its best course of action is to file for bankruptcy. Or, like Johnson & Johnson, it might decide to utilize favorable bankruptcy laws to isolate its liabilities such that its other lines of business can proceed unaffected. The Third Circuit’s decision here should be read and understood by any company in that position. Without true financial distress, bankruptcy may not be an appropriate avenue to obtain relief.

Share | Email| Print| Comments|  Topics: Bankruptcy, Class Actions, Toxic Torts