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JANUARY
**31, 2023**
Dayen on TAP
Johnson & Johnson's Texas Two-Step Dies
But companies still have life to use the bankruptcy process to avoid
accountability.
A couple of years ago, Maureen Tkacik wrote for the
**Prospect**
<[link removed]>
about the ways in which large companies, picking up a tactic pioneered
by the private equity industry, avoid accountability and stiff untold
victims of illegal business practices. One of the more popular
innovations in this arena is called the "Texas Two-Step." Using Texas
law, a company splits into two entities: one with all of the liability
claims, and one with all of the productive assets. Then the entity
saddled with liability files for bankruptcy, shortchanging the victims
for pennies on the dollar while the rest of the company moves on.
Johnson & Johnson was the most notable practitioner of the two-step,
attempting to extinguish claims that, for a century, it sold talc baby
powder laced with asbestos, which victims say caused tens of thousands
of cases of ovarian cancer and mesothelioma. But yesterday, the Third
Circuit Court of Appeals invalidated J&J's two-step
<[link removed]>
in a unanimous ruling. If upheld-the company has promised to
appeal-over 38,000 ovarian cancer cases and over 400 mesothelioma
cases could go forward to jury trials, without getting in line for
whatever scraps came out of the bankruptcy.
I'd like to say that this has implications that go well beyond Johnson
& Johnson. But I've read the ruling
<[link removed]>, and unfortunately
it does not shut down the Texas Two-Step, only the way in which J&J set
it up. Companies in the future would simply have to ensure that the
"bad" company due for bankruptcy is truly bad, and unable to continue as
a going concern.
To file bankruptcy legally, an entity must be in financial distress.
LTL, the "bad" entity created by Johnson & Johnson in 2021, did indeed
have all of the liabilities of the talc claims and none of the assets.
But LTL also held a funding support agreement from Johnson & Johnson and
its consumer subsidiary equal to the value of the subsidiary on the date
of the split: $61.5 billion. The court called this "not unlike an ATM
disguised as a contract."
The Third Circuit panel does some quick math to show that this sum would
be more than sufficient to handle future claims. Since 2017, Johnson &
Johnson has spent about $4.5 billion in jury awards, settlements, and
legal costs fighting the talc claims. J&J's own financial disclosures
suggested that the expected loss for the next two years would be about
$2.4 billion. At that run rate, LTL would not exhaust the $61.5 billion
to which it was legally entitled for decades. Maybe that could change
with a few enormous jury awards, but LTL would only be able to file for
bankruptcy at that time, not before the fact to preempt those large
payouts.
In other words, while J&J attempted to split off the bad company from
the good one, the funding agreement still connected the two. Therefore,
it was an illegal bankruptcy, because LTL still could have made all
payments for a long time. If Johnson & Johnson had set up the split
differently, without a funding backstop for LTL, it almost certainly
would have survived the court challenge.
Indeed, the court writes in its conclusion: "We mean not to discourage
lawyers from being inventive and management from experimenting with
novel solutions." They do not fully invalidate the two-step, which has
been used by many companies
<[link removed]>
to avoid liability for cancer and other harms, and they do not challenge
J&J's claim that such a tactic is more equitable and efficient. "This
is a call that awaits another day and another case," the court writes.
So thousands or potentially millions more consumers and their families
must endure the strategies multibillion-dollar companies use to evade
justice, and hope that their perpetrator's lawyers don't learn from
J&J's mistake. The court could have simply called the two-step
antithetical to the bankruptcy process, and barred large, profitable
companies (Johnson & Johnson leaked $13 billion in profits to
shareholders in 2020, and again in 2021) from even attempting it. But
sadly, two-step practitioners can still try to dance.
~ DAVID DAYEN
Follow David Dayen on Twitter <[link removed]>
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