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Speaker 1: This is Bloomberg Law with June Brasso from Bloomberg Radio.

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Speaker 1: Steps Step. The Texas two step is the most popular

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Speaker 1: country dance in the nation. It's two quick steps followed

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Speaker 1: by two slow steps. The Texas two step bankruptcy is

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Speaker 1: not as popular. It's a controversial legal maneuver that a

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Speaker 1: company can use to manage its exposure to potential legal

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Speaker 1: claims in two steps, first spin off a unit and

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Speaker 1: transferred tort liability to that unit, and second put the

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Speaker 1: unit into bankruptcy. Johnson and Johnson tried the Texas two

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Speaker 1: step to resolve more than forty cancer lawsuits by offloading

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Speaker 1: its liability in the TALC litigation to a new entity

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Speaker 1: lt L Management, which declared bankruptcy three days later, But

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Speaker 1: a federal appeals court stopped the music for J and J,

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Speaker 1: rejecting its bankruptcy bid unanimously in the first major repudiation

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Speaker 1: of the Texas two steps strategy. Joining me is bankruptcy

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Speaker 1: law expert Lindsay Simon, a professor at the University of

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Speaker 1: Georgia Law School. Lindsay I believe that Georgia Pacific was

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Speaker 1: the first company to try this Texas two steps strategy.

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Speaker 1: In tell us more about it. Of course, So the

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Speaker 1: Texas two step is a process by which a company

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Speaker 1: that may have valuable assets but also faced some problems.

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Speaker 1: So maybe in the case of Johnson Johnson litigation exposure

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Speaker 1: where they want to separate the assets from the liability,

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Speaker 1: and so under the Texas two steps they use a

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Speaker 1: feature of Texas law called the divisive merger statute where

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Speaker 1: basically they segment off the good from the bad into

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Speaker 1: two separate companies. And the reason that this set matters

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Speaker 1: is under Texas law, when you both a device of margery,

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Speaker 1: there is no transfer. And so after you separate out

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Speaker 1: the two companies, one good, one bad, then in the

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Speaker 1: case of defendants like Johnson Johnson, you put the company

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Speaker 1: with all the liabilities into bankruptcy that step two, and

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Speaker 1: then use bankruptcy to resolve that liability. Does it seem

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Speaker 1: pretty obvious that the reason the companies are doing this

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Speaker 1: is to try to you know, settle and wall off

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Speaker 1: the mass tort claims. In short, yes, right, So the

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Speaker 1: only reason you would go through this mechanism is to

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Speaker 1: create some division between two parts of your company and

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Speaker 1: to streamline where really the liability is. Right, you know,

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Speaker 1: all the explosure for litigation is in one city, and

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Speaker 1: then you put that dentity into bankruptcy. One of the

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Speaker 1: benefits of bankruptcy is that it pulls everyone without any

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Speaker 1: real opt out potential into bankruptcy courts, and so it

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Speaker 1: is a collective to ice right. It forces everyone into

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Speaker 1: one forum. And so for that reason it's very powerful because, eGain,

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Speaker 1: if you're facing litigation and in different courts all around

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Speaker 1: the country, dealing with that can be very expensive, very inefficient,

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Speaker 1: and also can really give a defendant very little leverage

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Speaker 1: to get everyone to a single settlement because oftentimes these

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Speaker 1: different claimants, these different people who are bringing claims, they

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Speaker 1: may want different things, they may not all agree, and

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Speaker 1: they may not want to settle now versus later, versus

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Speaker 1: something else. So in bankruptcy there is a mandatory table.

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Speaker 1: And so if you, as a claimant, don't come through

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Speaker 1: bankruptcy court and try and be part of the negotiation process,

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Speaker 1: a settlement may go forward without you. And so that's

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Speaker 1: a very powerful tool. On that I imagine is why

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Speaker 1: bankruptcy so appealing now the Texas to set itself that mechanism.

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Speaker 1: There are many other ways to kind of get at

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Speaker 1: the same thing. All sorts of pre bankruptcy planning, what

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Speaker 1: companies decide where they you know, shift their assets around.

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Speaker 1: The biggest challenge they face is whether it Once they

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Speaker 1: fall for bankruptcy, people will challenge what they've done and

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Speaker 1: say that they were fraudulent transfers. And so the beauty,

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Speaker 1: at least in theory of the Texas two steps, is

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Speaker 1: that you can create these new structures and stay law

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Speaker 1: said it's not a transfer, and so in theories they

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Speaker 1: won't have to worry about it being a fraudulent transfer.

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Speaker 1: And that's why the Texas Statute. There's a couple of

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Speaker 1: other states, but we've named it after Texas. That's why

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Speaker 1: it's still appealing. Now again, we really haven't had a

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Speaker 1: court testas and say well, all the way through and

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Speaker 1: through the bankruptcy code has a fraudulent transfer provision. And

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Speaker 1: so you know, we either agree that the state law governs,

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Speaker 1: or we say the state law doesn't matter in that

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Speaker 1: transfrender bankrupt laws and transcender bankrupty law. So we don't

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Speaker 1: know for sure whether a Texas two step will quote

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Speaker 1: work all the way through a bankruptcy process. We don't

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Speaker 1: have any cases where it's gone all the way through,

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Speaker 1: but at least in theory, that's the argument, and that's

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Speaker 1: the appeal. The Third Circuit ruled against Jay and Ja

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Speaker 1: over its Texas to step. Explain the reasoning. The Third

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Speaker 1: Circuit opinion dismissed Johnson and Johnson's bankruptcy case of the

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Speaker 1: entity it actually filed, which is called lt L. So

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Speaker 1: that's one of the entity that was created through the

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Speaker 1: Texas two sets. The reason they discussed it was that

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Speaker 1: basically the company that filed for bankruptcy didn't show that

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Speaker 1: they had filed it in good faith. And so the

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Speaker 1: the opinion kind of grappled with what's the question of

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Speaker 1: what is good faith when you file for bankruptcy? And

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Speaker 1: they determined under Third Circuit law that a valid bankruptcy

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Speaker 1: purpose which would satisfy good faith requires that there be

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Speaker 1: some form of financial distress. And in this case, they

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Speaker 1: looked very closely at the fact they ignored really the

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Speaker 1: Texas two sets, they didn't touch on any events. They

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Speaker 1: looked at a company the better lt L and said,

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Speaker 1: is this company in financial distress? Is there some sort

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Speaker 1: of immediacy to their need knows? There's this question about

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Speaker 1: whether you know they have real trouble, and because in

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Speaker 1: creating lt L Johnson, Johnson facilitated this funding agreement whereby

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Speaker 1: everything basically up to the level of you know, sixty

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Speaker 1: one some billion dollars would be paid for. And so

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Speaker 1: the third Circuit looking at this said, you know this

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Speaker 1: better is facing liability clearly, right, And there's nothing that

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Speaker 1: says you have to be completely insolvent, but there has

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Speaker 1: to be some sort of financial distrust. And given all

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Speaker 1: the products of funding, we really don't see anything on

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Speaker 1: the fact that says today LPL had any risk anytime

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Speaker 1: soon of not being able to pay everything as it

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Speaker 1: comes to and that's not good enough to justify filing

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Speaker 1: for bankruptcy. Yeah, if the court compared the funding back

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Speaker 1: stop to an a t M disguised as a contract,

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Speaker 1: did it leave anything open or you know, as far

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Speaker 1: as the third circuit is concerned, is this J and

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Speaker 1: J attempt dead in the water. So just generally, I

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Speaker 1: think the court was very clear that it's not saying

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Speaker 1: mass sort cases can't use bankruptcy in any circuit. It's

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Speaker 1: also not saying that it's possible where even defendant with

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Speaker 1: plenty of money might satisfy that financial distress test, But

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Speaker 1: they did say effectively, for a debtor like this like

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Speaker 1: LTL that is going to have really every bit of

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Speaker 1: a finance that's taken care of for the foreseeable future,

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Speaker 1: that's not going to be enough. So I don't think

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Speaker 1: it is going to shut the door on any mass

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Speaker 1: Swart Tase. I do think it will have an impact

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Speaker 1: on very well resourced, big name companies using the two

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Speaker 1: sets to create a company and then putting it into

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Speaker 1: bankruptcy while also paying for everything. I just think that

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Speaker 1: model is going to be a lot less appealing to

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Speaker 1: companies weighing their options because again, you know Johnson Johnson

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Speaker 1: has gone through this whole process and now they're to

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Speaker 1: some degree back where they started not that long ago,

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Speaker 1: and now the president is harder. So well, future cases

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Speaker 1: testing the third circuit exactly where the line of financial

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Speaker 1: distresses imagine at some point yet. But I think if

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Speaker 1: you're weighing your strategic actions, bankruptcy is not off the table.

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Speaker 1: I'm not sure bankruptcy and the third circuit exactly like

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Speaker 1: this is something I would chance, But there are three Texas.

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Speaker 1: Two step bankruptcy is similar to Jay and Jay's winding

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Speaker 1: their way through the US Bankruptcy Court for the Western

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Speaker 1: District of North Carolina, which is in the Fourth Circuit.

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Speaker 1: Absolutely so there's a number of mass stort cases, in

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Speaker 1: particular dealing with the SPECIs liability where the large you know,

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Speaker 1: solid parent has put a smaller entity, sometimes created for

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Speaker 1: the purpose of filing bankruptcy into bankruptcy. And so far,

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Speaker 1: at least at the lower course levels, that tactic has

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Speaker 1: not been thwarted on emotion to the Smith. So parties

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Speaker 1: have tried to get the case of Smith, and at

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Speaker 1: least in current decisions, the court has said, no, you know,

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Speaker 1: this is not a bad bath filing this decision can stand.

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Speaker 1: But the Third Circuit is the first circuit to deal

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Speaker 1: with this issue. None of the cases pending in the

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Speaker 1: Fourth Circuit have gone up to a pilot level uh.

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Speaker 1: And again this issues also expliculating in the Seventh Circuit

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Speaker 1: where the three um arrowcases something uh and that recently

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Speaker 1: whether or not that case was filed in good faith

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Speaker 1: is also an issue before the court at the lower level.

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Speaker 1: So the first cercut is really the first to directly

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Speaker 1: address this flavor of case. I imagine it won't be

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Speaker 1: the last. Are these cases very fact specific? Because on

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Speaker 1: the surface, it seems like, you know, it's a big

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Speaker 1: company separating off another unit to go into bankruptcy, and

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Speaker 1: it seems like they would have a lot of the

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Speaker 1: same legal problems. Well, interestingly, the reason that it didn't

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Speaker 1: work in LPL is that there was this funding agreement,

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Speaker 1: So the debtor's put a lot of money behind the

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Speaker 1: company in an effort to say, hey, we're going to

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Speaker 1: pay everybody. So this is not us trying to use

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Speaker 1: bankruptcy to get out of our debt. This is us

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Speaker 1: saying bankruptcy is the right strategic option, and we're going

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Speaker 1: to resource this company so people will get paid and

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Speaker 1: so in an effort to I think make the bankruptcy

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Speaker 1: process to some degree more fair. It also meant that

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Speaker 1: the company didn't satisfy the requirements of financial distrust. So again,

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Speaker 1: could a company with less money available do basically the

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Speaker 1: same thing and still stay in bankruptcy? I think the

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Speaker 1: answer is Yet, the funding agreement that LTL had with

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Speaker 1: J and J allowed payment rights to the tune of

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Speaker 1: sixty one point five billion dollars, so those funds could

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Speaker 1: be tapped to satisfy TALC liabilities, and analysts aren't predicting

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Speaker 1: that the company will pay out anything near that figure

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Speaker 1: to settle the cases. Why isn't that a good situation

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Speaker 1: for the TALC plaintiffs to have it all in one

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Speaker 1: place and to be assured that the money is there

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Speaker 1: to pay them. It's a perfectly good question. And that's

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Speaker 1: the people who support the idea that bankruptcy are saying, Hey,

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Speaker 1: by dismissing this, you're losing so much value because all

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Speaker 1: the money is here. This is not in your best interest.

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Speaker 1: And I think it kind of comes down to what

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Speaker 1: I said earlier, which is to some degree, claimants one

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Speaker 1: different things. And so first I'll say, you know, people

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Speaker 1: are suspicious at a bankruptcy court will be the same

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Speaker 1: as a jury in deciding their claims, and people are

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Speaker 1: very hesitant to give up this idea of their day

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Speaker 1: in court, whatever that means for a mass wort climate.

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Speaker 1: So that's saying number one, they don't like that they're

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Speaker 1: being forced to take what would go to a jury

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Speaker 1: and give it to a bankruptcy judge. There's this perception

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Speaker 1: that maybe the claims wouldn't be paid as much, or

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Speaker 1: perhaps in going through the payment process, I imagine and

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Speaker 1: again we didn't get to this point because we never

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Speaker 1: saw the plan in LPL. Everything got dismissed early on.

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Speaker 1: But at some point usually these cases create a trust

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Speaker 1: and there are procedures that the parties have to go through.

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Speaker 1: It looks very different than siling your own lawsuit and

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Speaker 1: putting on your evidence and going to a jury. So

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Speaker 1: you know, maybe even if at the ends of money

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Speaker 1: is the same, the process isn't quite right, and the

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Speaker 1: parties are very worried that Johnson Johnson says they'll pay

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Speaker 1: all of it, but they'll end up paying less. And

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Speaker 1: really this idea of holding Johnson Johnson accountable won't be

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Speaker 1: the same in bankruptcy, and I think that's a lot

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Speaker 1: of the concern. So Johnson and Johnson says it's going

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Speaker 1: to challenge the ruling, so it can ask for and

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Speaker 1: on bank hearing before the whole Third Circuit, or try

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Speaker 1: to go to the Supreme Court, where it hasn't had

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Speaker 1: much luck in the past on bank hearing, or the

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Speaker 1: Supreme Court judge am Brown, who wrote the decision is

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Speaker 1: a very well respective jurist in the field of bankruptcy.

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Speaker 1: So if anyone on the Third Circuit is going to

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Speaker 1: write is very weighty bankrupty opinion that will be thinking,

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Speaker 1: you know, perspective. For the most part, it would be

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Speaker 1: Judge Ambro. And so there's this perception among bankruptcy types

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Speaker 1: that the Courts of Appeals in the Supreme Court aren't

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Speaker 1: really in touch with how bankruptcy works on the ground

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Speaker 1: and don't understand and the implications of their decisions. I

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Speaker 1: think those criticisms are pretty much silenced in the context

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Speaker 1: of Judge Ambro because you know, for a very long

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Speaker 1: time he's been writing bankruptcy opinions in a way that

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Speaker 1: really reflects an awareness of how the system works, on

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Speaker 1: how it should work. And so you know, again, I

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Speaker 1: don't really have a ton of criticism of this idea

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Speaker 1: that the judges didn't know what they were doing. I

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Speaker 1: think if anyone, Judge Ambro is the right hand to

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Speaker 1: do this, and we'll get a lot of respects from

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Speaker 1: the MBOX Third Circuit I imagine. So they may not

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Speaker 1: even take it on banks then yeah, I'm not sure

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Speaker 1: about that. I don't know enough about the practices and

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Speaker 1: the Third Circuit about how likely they are to take

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Speaker 1: it or not on the whole. Would you say that

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Speaker 1: this decision will have a chilling effect on big companies

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Speaker 1: who think about doing the texas to steps in the

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Speaker 1: third circuits, definitely in other circuits potentially, just because again,

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Speaker 1: any time you're sitting down with a potential better to

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Speaker 1: think about actions, if the risk is higher that you'll

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Speaker 1: get down the road and your case will get dismissed,

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Speaker 1: then all of a sudden, you know, the cost benefit

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Speaker 1: weighs a little bit against it. So if I represented

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Speaker 1: a big company right now, I would be concerned about

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Speaker 1: how likely it is to get my case across the

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Speaker 1: thresholds that the third stort gets created. Because here's the

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Speaker 1: other problem. If, for example, they were to just plug

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Speaker 1: it a little bit less in order to show that

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Speaker 1: the companies in finding to distrust, then all of a sudden,

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Speaker 1: the question becomes, well, was the process of creating this company?

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Speaker 1: Was it a fraudulent transfer? Should they get the benefit

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Speaker 1: of bankruptcy that way? And then even further down the line,

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Speaker 1: what most of these companies ultimately want. There's a nonbetter release.

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Speaker 1: So in bankruptcy, the better often get the claims against

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Speaker 1: them discharge for one reason or another, and that's a

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Speaker 1: normal part of bankruptcy. Another nuance and mass work cases

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Speaker 1: is that non betters, like for example, the sacklers in

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Speaker 1: the Produce form A case or here Johnson Johnson in

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Speaker 1: the LCO case, they also want release it. And because

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Speaker 1: they're not better, there's a lot of scrutiny on whether

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Speaker 1: or not the litigation claims against the parties that never

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Speaker 1: falls the bankruptcy should be released. And so one of

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Speaker 1: the things courts will look at is whether they contributed

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Speaker 1: substantial enough amounts to the case to justify that release.

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Speaker 1: And so if those risks don't fund the company they're

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Speaker 1: gonna put in the bankruptcy, they don't put their money

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Speaker 1: behind it, there's also a risk that they won't get

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Speaker 1: the ultimate thing that they want out of the case,

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Speaker 1: which is to get released. What do you think the

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Speaker 1: real world ramifications of this decision will be, Just to

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Speaker 1: follow up on the last point I mentioned on non

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Speaker 1: data releases, I think to some degree that the incentive

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Speaker 1: of this opinion will actually go against what most people want.

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Speaker 1: So most people that see this issue that earned in

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Speaker 1: the bankruptcy world arearn in the mass turant world, will say,

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Speaker 1: how can they force people into bankruptcy? We shouldn't let

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Speaker 1: companies do this? Well, Johnson Johnson put about as much

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Speaker 1: money as any other company I've seen behind these claims.

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Speaker 1: They were saying, I will stay here, I will pay

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Speaker 1: these claims, we will go through this process. But it

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Speaker 1: will end up things better for claimate. That's not acceptable.

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Speaker 1: And so now it's actually pushing companies to put less

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Speaker 1: money behind the clients. Is gonna I suspect it's gonna

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Speaker 1: push more of them to say, well, we're not gonna

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Speaker 1: do this two steps and file. We'll just attach ourselves

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Speaker 1: to another bankruptcy and try to buy the releases. And

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Speaker 1: I don't know if that ends up being better or

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Speaker 1: worse for claimants. Part of me suggests that, you know,

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Speaker 1: unless we fix all of how bankruptcy deals with mass

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Speaker 1: toward cases, we're just gonna be pushing companies from one

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Speaker 1: bucket to the other. And I'm not sure that the

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Speaker 1: wind is really a win that people thinking it. Well,

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Speaker 1: you just explain to me, how would company attach themselves

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Speaker 1: just an ongoing bankruptcy somewhere. So again I'll use the

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Speaker 1: Sacklers and Produce Farma as an example. Now I'll say,

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Speaker 1: is this case Produce Farma is pending before the second circuit,

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Speaker 1: So we're waiting on an opinion really any day now

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Speaker 1: about whether this is acceptable. But the Sacular family never

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Speaker 1: filed for bankruptcy at all, but in part of the

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Speaker 1: produced form of bankruptcy, they are getting non debt or releases.

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Speaker 1: So no one will be able to do the tacklers

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Speaker 1: for their openoid claims forever because the software has put

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Speaker 1: many billions of dollars into the produced form of bankruptcy

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Speaker 1: and so basically they paid their way to get the

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Speaker 1: benefits of bankruptcy without actually filing themselves. And so that

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Speaker 1: model exists. There's plenty of companies that have done it,

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Speaker 1: and so there's no reason to say that if the

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Speaker 1: sackware produce Cinema is allowed to stand, that will just

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Speaker 1: become a more appealing option for a company like Johnson Johnson.

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Speaker 1: So they go to a bankruptcy that somehow related that

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Speaker 1: impacts them. So you know, again, I'm not going to

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Speaker 1: time specifically in Johnson Johnson, but usually there are codefendents

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Speaker 1: in these cases, and it's a codefendant files to bankruptcy

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Speaker 1: and there are similar claims where there's causes of action

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Speaker 1: that are tied together, there's some other links. They can

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Speaker 1: become a nondubtor that resolves their issues in not bankruptry.

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Speaker 1: Let's at least a possibility. Thanks so much, Lindsay. That's

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Speaker 1: Lindsay Simon, a professor at the University of Georgia Law School.

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Speaker 1: And that's it for this edition of The Bloomberg Law Show.

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Speaker 1: Remember you can always get the latest legal news on

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Speaker 1: our Bloomberg Law Podcast. You can find them on Apple Podcasts, Spotify,

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Speaker 1: and at www dot Bloomberg dot com slash podcast Slash Law,

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Speaker 1: and remember to tune into The Bloomberg Law Show every

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Speaker 1: week night at ten pm Wall Street Time. I'm June

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Speaker 1: Grosso and you're listening to Bloomberg m