Third Circuit to Consider Validity of J&J’s Use of Bankruptcy to Handle Asbestos Claims

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On September 19, 2022, a panel of three judges for the Third Circuit heard oral argument in In re LTL Management LLC, Case No. 22-2003.  Before the Court is Johnson & Johnson’s (J&J) use of Chapter 11 to resolve asbestos-related litigation.  The appeal to the Third Circuit follows a ruling by the U.S. Bankruptcy Court for the District of New Jersey in February 2022, in which Judge Michael Kaplan declined to dismiss the bankruptcy case on bad faith grounds.  

Last year, J&J created a new entity, LTL Management LLC (LTL).  J&J subsequently transferred its tort liabilities to LTL, and then placed LTL into bankruptcy.  In doing so, J&J took advantage of Texas’s divisive merger statute allowing companies to manage exposure to liabilities, a legal strategy commonly known as the “Texas Two-Step.”  

The principal argument of the appellants is that there is not a proper bankruptcy purpose here.  That is, J&J structured this so that dividends and equity can be paid, while “one category of claimants, talc creditors, sit in bankruptcy and don’t get paid.”  This argument reflects what the appellants argue is a violation of the “absolute priority rule,” which dictates the order by which creditors and shareholders are to be compensated.  In sum, rather than placing a financially “distressed tortfeasor” into bankruptcy, which is historically how other companies such as Johns Manville have proceeded, J&J shifted only the talc claimants to bankruptcy, while J&J’s operating business remains outside bankruptcy.  In other words, it is a “bankruptcy designed to avoid the purposes and principles of bankruptcy.”

According to LTL, bankruptcy provides a “system wide resolution” and protects future claimants.  In addition, LTL referred to Judge Kaplan’s findings, which included, in part, that each case involves enormous defense costs — money that could be going to the claimants rather than attorneys, and that bankruptcy provides a more efficient way to manage the claims than the tort process.  

We will follow the Third Circuit’s ruling closely as it will likely impact other companies seeking to curb mass tort liability, and in particular to avoid juries in those lawsuits.  Regardless of the outcome, an appeal to the U.S. Supreme Court is expected to be filed.  In addition, the case may serve as an impetus for Congress to take legislative action in order to limit use of the Texas Two-Step.