In re LTL Management LLC, ___BR___, 21-30589 (Bankr. D.N.J. Feb. 25, 2022)
In re LTL Management LLC, ___BR___, 21-30589 (Bankr. D.N.J. Feb. 25, 2022): Johnson & Johnson Subsidiary Survives a Motion to Dismiss—for being a bad faith bankruptcy filing– the bankruptcy filed by the subsidiary that J& J created, put all the talc claim cancer lawsuits into, and then had subsidiary (LTL Management LLC) filed bankruptcy. J&J created the LTL Management LLC subsidiary, put the talc tort claim suits into the subsidiary, have the subsidiary file bankruptcy and the parent company does NOT file bankruptcy, has come to be referred to as the “Texas 2 Step”, because this procedure was first used in a bankruptcy filed in a bankruptcy court located in Texas. Though the Bankruptcy Court denied the Motion to dismiss, it is the opinion of attorney March of The Bankruptcy Law Firm, PC, that the “Texas 2 Step” is a bad faith violation of bankruptcy law, that the Motion to dismiss for bad faith should have been granted, and that it is only a matter of time until appeal courts hold that the “Texas 2 Step” procedure is a bad faith violation of bankruptcy law.
Not what the Bankruptcy Judge who denied the motion to dismiss the subsidiary bankruptcy for bad faith thought, however, as that Judge (Bankruptcy Judge Michael B. Kaplan of Trenton, New Jersey) found no fault with the “Texas 2 Step” procedure. In fact, Judge Kaplan said chapter 11 is the best alternative in the state and federal legal systems for dealing with mass torts. He found no fault with J&J’s use of the so-called Texas Two-Step to avoid putting the entire enterprise in chapter 11. That is where attorney March of The Bankruptcy Law Firm, PC disagrees. Time will tell how appellate courts rule on this issue.
Judge Kaplan ruled the “Texas Two-Step” procedure was allowable, despite the fact that Judge Kaplan admitted that bankruptcy courts have witnessed serious abuses and inefficiencies, striking at the heart of the integrity of our bankruptcy courts. For instance, the approval of overly broad nonconsensual third-party releases, and the propriety/necessity for twenty-four hour accelerated bankruptcy cases have drawn deserved scrutiny. Likewise, the selection of case venue, as in the matter at hand, has warranted critical attention and debate.
Refusing to dismiss the case after a five-day trial, Judge Kaplan said that the chapter 11 filing “is unquestionably a proper purpose under the Bankruptcy Code.” Still, he had “no expectation that this decision will be the final word on the matters.”
How the Texas Two Step works:
Just before the chapter 11 filing, Johnson & Johnson created two new subsidiaries. LTL was created to be the debtor, and the other took over J&J’s operating businesses.
The debtor was first created as a limited liability company in Texas and converted to a North Carolina limited liability company. On October 14, two days later, the debtor filed a chapter 11 petition in Charlotte.
The debtor was given no business operations of its own but assumed liability for all talc-related claims. The debtor was given some non-operating assets and insurance receivables, plus $6 million in cash. The debtor was also the beneficiary of a so-called funding agreement where the other J&J businesses agreed to supply the funds necessary for emerging from chapter 11, up to about $60 billion, representing the value of the businesses at the time of the restructuring.
In an opinion on November 16, Bankruptcy Judge J. Craig Whitley transferred venue to New Jersey, where the case was assigned to Judge Kaplan. The official committee representing talc claimants filed a motion to dismiss the chapter 11 case under Section 1112(b), contending that the filing was in bad faith. The U.S. Trustee supported either dismissal or appointment of a chapter 11 trustee.
J&J’s Financial Distress:
Judge Kaplan laid out J&J’s financial problems resulting from the 38,000 talc-related lawsuits that have been filed so far, not to mention tens of thousands more that would be filed in the future as cancers manifest themselves.
Judge Kaplan mentioned one case where the jury awarded an individual claimant $4.69 billion that was affirmed on appeal but reduced to $2.25 billion. Based on awards stemming so far from litigation, he roughly calculated liability as exceeding $15 billion, “not including the tens of thousands of ovarian cancer claims and all future cancer claims.”
In sum, Judge Kaplan said that the tort system outside of bankruptcy would result in judgments in favor of a few claimants exhausting all of the value in J&J, leaving nothing for the vast majority of claimants.
The debtor itself said that the corporate restructuring before bankruptcy and the chapter 11 filing together were designed to “globally resolve talc-related claims through a chapter 11 reorganization without subjecting the entire [J&J business] to a bankruptcy proceeding.”
Applying the Facts to the Law:
Arguing for dismissal, talc claimants noted that the debtor had no creditors (aside from talc claimants), no lenders, no customers and no suppliers. They said the bankruptcy had no business purpose but was designed to shed tort liability without subjecting the J&J business to the rigors and inconveniences of chapter 11.
The talc claimants, according to Judge Kaplan, argued that the bankruptcy strategy was “intended to force talc claimants to face delay and to secure a ‘bankruptcy discount’; in Movants’ words, ‘an obvious legal maneuver to impose an unfavorable settlement dynamic on talc victims.’”
To decide whether the bankruptcy strategy justified dismissal for cause under Section 1112(b), Judge Kaplan said that the good faith inquiry examines “the totality of the circumstances.” The general focus, he said, is whether the petition serves a valid bankruptcy purpose or was filed “merely to obtain a tactical litigation advantage.”
Valid Reorganization Purpose:
Judge Kaplan found a valid reorganization purpose because bankruptcy is the only method to “ensure that all present and future tort claimants will share distributions through the court-administered claims assessment process.”
In the Third Circuit, Judge Kaplan said, there must be “some” degree of financial distress to underpin a valid business purpose. In that respect, he said, No public or private company can sustain operations and remain viable in the long term with juries poised to render nine and ten figure judgments, and with such litigation anticipated to last decades going forward.
Judge Kaplan said that J&J “need not have waited until its viable business operations were threatened past the breaking point.”
In reaching his conclusion on valid business purpose, Judge Kaplan examined what he called “a far more difficult issue”: whether there was “a more beneficial and equitable path toward resolving Debtor’s ongoing talc-related liabilities.” In that regard, he said he “simply cannot accept the premise that continued litigation in state and federal courts serves best the interest of [the tort lawyers’] constituency.”
Class actions, Judge Kaplan said, are usually not suitable for mass tort cases. Likewise, multidistrict litigation would produce a few bellwether trials, “at best.” Thereafter, 40,000 tort cases would be sent to district courts for trials throughout the country, where the same issues would be relitigated over and over.
By contrast, Judge Kaplan said that chapter 11 invokes Section 524(g) to “ensure[] that present claimants do not exhaust the debtor’s assets before future claimants have even manifested injuries.” The tort system, on the other hand, “produces an uneven, slow-paced race to the courthouse, with winners and losers.” It was “folly,” he said, to say that “the tort system offers the only fair and just pathway of redress.”
Unfair Tactical Advantage:
With regard to the claim that J&J invoked bankruptcy to obtain an unfair tactical advantage, Judge Kaplan found “no improprieties or failures to comply with the Texas statute’s requirements.” He added, “the interests of present and future talc litigation creditors have not been prejudiced.” He found “nothing inherently unlawful or improper with application of the Texas divisional merger scheme.”
Judge Kaplan was “not prepared to rule that use of the statute as undertaken in this case, standing alone, evidences bad faith.”
With regard to other aspects of good faith, Judge Kaplan said that the funding agreement “will be available upon confirmation of a plan — whether or not the plan is acceptable to [the debtor or J&J], and whether or not the plan offers payors protections under § 524(g).”
Had there been no reorganization to exclude the operating business from chapter 11, Judge Kaplan said, [S]uch filings would pose massive disruptions to operations, supply chains, vendor and employee relationships, ongoing scientific research, and banking and retail relationships — just to name a few impacted areas. The administrative and professional fees and costs associated with such filings would likely dwarf the hundreds of millions of dollars paid in mega cases previously filed — and for what end?
It was not, Judge Kaplan said, “a case of too big to fail . . . rather, this is a case of too much value to be wasted, which value could be better used to achieve some semblance of justice for existing and future talc victims.”
“The potential loss in market value, the disruptions to operations, and the excessive administrative costs associated with independent chapter 11 filings,” Judge Kaplan said, “justify the business decision to employ the divisional merger statute as a means of entering the bankruptcy system.” Bankruptcy, he said, “may indeed accelerate payment to cancer victims and their families.”
In sum, it would be fair to say that Judge Kaplan found that bankruptcy confers benefits on the bulk of existing and future claimants and was not designed to gain an unfair litigation advantage.
The Ruling:
Judge Kaplan denied the motion to dismiss and said that the record did not support the appointment of a chapter 11 trustee. He nonetheless agreed “that there is a need for independent scrutiny of possible claims while the case progresses through the appointment of a Future Talc Claims Representative, mediation and towards the plan formulation process.”
Judge Kaplan said he would take up questions about a future claimants’ committee and mediation at the omnibus hearing on March 8.