In the AIRROC Annual 2022, the authors published “Dancing to the Beat of Divisive Mergers; The ‘Texas Two-Step’ Bankruptcy Strategy,” summarizing the strategy and discussing several recent cases.1 Most notably, the LTL Management, LLC (Johnson & Johnson) case was discussed in detail. In that case, the talc claimants and others filed a motion to dismiss, arguing that the bankruptcy was filed for an improper purpose under Section 1112(b) of the Bankruptcy Code. They argued that J&J utilized the bankruptcy system in bad faith to shield itself from liability and cap recoveries by the claimants. They further argued that the merger was a sham transaction because there was no legitimate business purpose to LTL. Indeed, they pointed out that LTL had virtually no employees, no operations, lenders, bondholders, customers, suppliers, or vendors and was created solely for the purpose of delay and so that LTL could pay the mass tort claimants pennies on the dollar. The New Jersey Bankruptcy Court rejected these arguments. The court refused to dismiss LTL’s Chapter 11 case, finding that it was not filed in bad faith and that LTL was in compliance with Texas’s requirements for implementation of a divisive merger. The Court further determined, more broadly, that a Chapter 11 filing to address mass tort exposure is a valid purpose and is wholly consistent with the aims of the Bankruptcy Code. The talc claimants and others took a direct appeal of that decision to the U.S. Court of Appeals for the Third Circuit.
On appeal, LTL’s Two-Step maneuver has encountered difficulties. On January 30, 2023, the Third Circuit reversed the bankruptcy court’s decision and dismissed LTL’s bankruptcy case on the grounds that the bankruptcy filing did not meet the good faith filing requirement. The three-judge panel concluded that “[w]hat 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 the petition.”2
This decision represents the first time a federal court has rejected the Texas Two-Step on the basis of good faith. However, the Third Circuit did not hold that the Texas Two-Step strategy was per se impermissible in a bankruptcy case. On February 13, 2023, LTL filed a petition for an en banc rehearing of the case supported by four amicus briefs from various parties, including a group of bankruptcy law professors, the U.S. Chamber of Commerce, the American Tort Reform Association, the National Association of Manufacturers, and Washington Legal Foundation. In an uncommon move, the Third Circuit then entered an order directing the talc claimants and others to file a response to the petition for rehearing. The substance of LTL’s en banc petition draws attention to the consequences of the Third Circuit ruling, if allowed to stand. Namely, the petition argues that the ruling is contrary to prior Third Circuit precedent and Fourth Circuit cases; creates a novel and unworkable standard for financial distress; and seemingly created a new standard of imminent financial collapse.
On March 22, 2023, the Third Circuit denied LTL’s petition for rehearing. The one-paragraph order simply states that the petition for rehearing “having been submitted to the judges who participated in the decision of this Court and to all the other available circuit judges of the circuit in regular active service, and no judge who concurred in the decision having asked for rehearing, and none of the eligible judges of the circuit in regular service having voted for rehearing, the petition for rehearing by the panel and the Court en banc is denied.”
Immediately following the entry of the Third Circuit’s order, LTL filed a motion to stay entry of the mandate that would otherwise direct the bankruptcy court to dismiss the bankruptcy proceedings. In the motion to stay the mandate, LTL indicated that it is filing a writ of certiorari with the U.S. Supreme Court. LTL seeks entry of the stay of the mandate to “avoid the chaos that would occur if LTL’s petition were dismissed by the Bankruptcy Court, then reinstated by the Supreme Court.” The Third Circuit ordered the talc claimants and others to file responses to the motion to stay the mandate on or before March 28, 2023. As of the time of press, the motion to stay the mandate has not been ruled, nor has the mandate been issued.
1See AIRROC Annual 2022, pages 34-37.
2In re LTL Management LLC, Case No. 22-2003.