A corporate strategy that drew attention with the bankruptcy of a Johnson & Johnson spinoff continues to face uncertainty despite a refusal to dismiss the Chapter 11 case.
The maneuver, known as the Texas Two-Step because it draws on Texas corporate law, involves a company spinning off an entity and transferring its liability for tort to that entity. The spin-off is then bankrupted to manage those liabilities without bringing the assets of the original company into play.
New Jersey Bankruptcy Judge Michael Kaplan refused to dismiss J&J Talk Liability spinoff LTL Management LLC’s Chapter 11 case, finding it was not filed in bad faith. This decision is being appealed to the US Court of Appeals for the Third Circuit.
But a North Carolina bankruptcy judge last week challenged the Texas Two-Step, allowing a group of asbestos victims to proceed with a lawsuit aimed at undermining a reverse merger in a separate bankruptcy case.
The victims are seeking a “substantial consolidation” that would combine the assets of debtors Aldrich Pump LLC and Murray Boiler LLC with those of industrial manufacturer Trane Technologies Plc, which is not bankrupt. This would undo the Texas two-step maneuver that Trane used in founding Aldrich Pump and Murray Boiler and bankrupting them.
North Carolina’s decision and others like it suggest the Texas Two-Step strategy may not stand up in all courts, said Charles Tatelbaum, an attorney at Tripp Scott PA who specializes in corporate restructuring cases.
“It reinforces the lack of confidence that many of us have in decency, and it’s just another crack in the armor,” Tatelbaum said. “I don’t think that one decision alone is enough. But it expresses what many people think: that it is not right.”
Judge J. Craig Whitley of the US Bankruptcy Court for the Western District of North Carolina did not rule on the merits of the consolidation when he denied Aldrich Pump and Murray Boiler’s motion to dismiss on April 1. But Whitley also said he was not bound by Kaplan’s decision in the J&J case.
“Bankruptcy judge opinions vary across the country on various fronts, and no one here is going to rely on the opinion of a bankruptcy judge,” Whitley said during a hearing. “The merger challenges will be resolved further up, either by an appeals court, maybe the Supreme Court, maybe they will be resolved in Congress,” he said.
Last month, Whitley also gave the green light to a group of asbestos victims to file a lawsuit to consolidate the assets of building materials maker CertainTeed LLC with those of its bankrupt spinoff unit DBMP LLC.
Whitley “was very keen” not to be bound by Kaplan’s decision, said Mark Lanier of the Lanier Law Firm, a plaintiffs attorney who represents asbestos victims.
“Bankruptcy can be a black hole for claims, and it’s good that judges don’t automatically let a result or two dictate it across the country,” he said.
The rulings allow asbestos victims to “peer behind the curtain” to find the “real motivations” behind the divisive mergers, said Jon Ruckdeschel of Ruckdeschel Law Firm LLC, an attorney with experience litigating asbestos cases.
Those victims could eventually file claims to reverse the Texas Two-Step and bring the parent companies’ assets into the bankruptcy case, creating a larger pool for recovery, he said. In the meantime, asbestos victims can study the details of how the spin-offs formed during the discovery, he said.
“If successful, these claims could force the profitable parents to bankrupt their entire business if they want to reap the benefits of bankruptcy,” Ruckdeschel said.
“Rare Appropriate Cure”
But Whitley’s decision is not a complete victory for asbestos victims, said Anthony Casey, professor of business law, finance and corporate bankruptcy at the University of Chicago Law School. The judge is just letting the case proceed and has not yet made a decision on the matter, he said.
The ruling could also just be a strategy to put pressure on both sides to reach an agreement, Casey said.
“Material consolidation is supposed to be a rare just means and these are strange cases for material consolidation,” he said. “Courts often emphasize the point of rarity and say it is an extreme remedy.”
Analysts have said the J&J ruling increases the chances that other companies facing costly product liability claims could pursue the same bankruptcy strategy through reverse mergers.
But the J&J case continues to raise doubts.
Kaplan has not ruled on all matters relating to the Texas Two Step, only that its use is not sufficient reason to dismiss the case for lack of good faith, said Melissa Jacoby, professor of bankruptcy law at the University of North Carolina at Chapel Hügel .
The judge also allowed the appeal to go directly to the Third Circuit because of the importance of the issue.
“Opinion has been rosy that bankruptcy is a good place to start addressing talc liability issues, but that doesn’t preclude other types of challenges,” Jacoby said.
With Kaplan’s decision going to the Third Circuit and Whitley saying an appeals court or Congress must weigh, the appropriateness of the Texas Two-Step may be in doubt for some time.
“The key takeaway is that we still have a long way to go before these issues are finally resolved,” Casey said.