The Third Circuit rejected J&J’s attempt to dump off its mounting talcum powder liability into bankruptcy. In an opinion issued today, the Court dismissed the chapter 11 bankruptcy filed by a subsidiary J&J created to offload its growing talc liabilities. J&J’s stock dropped 3% on the news, the most significant single-day drop in over two years. J&J has already vowed to appeal the ruling to the U.S. Supreme Court.
This page talks about this case and what it practically means if you have a talcum powder lawsuit or are considering bringing a claim.
Facts and Procedural Background
Johnson & Johnson Consumer Inc. (“Old Consumer”) was a subsidiary of Johnson & Johnson (J&J) that made and sold various personal care products, including Tylenol, Band-Aid, and more. Old Consumer also sold Johnson’s Baby Powder made from talc, a mineral mined out of the earth and ground into a fine powder called talcum powder.
Talcum powder in these products may contain asbestos and cause cancer. This led to a wave of talcum powder lawsuits against Old Consumer and J&J, alleging that their baby powder products caused ovarian cancer and mesothelioma. While some of these lawsuits failed, many others went to trial, resulting in massive verdicts. All the while, thousands of additional talcum powder lawsuits continued to get filed.
In 2022, with talc liabilities growing by the day, J&J’s legal team devised a controversial legal strategy to offload the talc liabilities into bankruptcy. J&J executed a series of corporate transactions under Texas law to implement this strategy. The transactions split Old Consumer into two new entities: (1) LTL Management and (2) Johnson & Johnson Consumer, Inc. (“New Consumer”).
LTL Management received all of the old company’s talcum powder liabilities and a “funding agreement” in which J&J agreed to provide LTL with some money to pay claims. The other entity, New Consumer, received all the other profitable business assets from the old company and continued operation.
Two days after this corporate division, known as a “Texas Two Step,” LTL Management filed for Chapter 11 bankruptcy. The purpose of all this is to isolate the talc liabilities into the LTL entity so that it could file for bankruptcy without pulling Old Consumer’s entire business into bankruptcy.
The bankruptcy immediately stayed all proceedings in the ongoing talcum powder mass tort litigation. The talc plaintiffs immediately filed a motion asking the Bankruptcy Court to dismiss the LTL Management bankruptcy because it was filed in bad faith. The Bankruptcy Court denied those motions, and that decision was appealed to the Third Circuit.
Third Circuit Ruling Rejects Texas Two-Step Bankruptcy
The primary question for the Third Circuit on appeal was whether J&J’s Texas Two Step strategy and the LTL Management bankruptcy was filed in “good faith.” The talc plaintiffs argued that the LTL Management bankruptcy was not filed in good faith because the Old Consumer business was not insolvent, and the only purpose of the bankruptcy was to force the litigation claims to be resolved in bankruptcy. In response, J&J argued that the bankruptcy was simply a good-faith attempt to resolve the ongoing talc claims equitably.
The Third Circuit held that if a debtor is not in actual “financial distress,” it cannot demonstrate that a Chapter 11 bankruptcy petition serves a valid bankruptcy purpose. Without a proper bankruptcy purpose, the debtor cannot establish that the bankruptcy was filed in good faith. The Court cited several prior cases establishing that “good faith necessarily requires some degree of financial distress on the debtor.” In re: SGL Carbon, 200 F.3d 154, 162 (3rd Cir. 1999).
Next, the Court explained the degree of “financial distress” necessary to show a good faith bankruptcy filing. The Court clarified that a company does not need to be insolvent to show financial distress, but the Bankruptcy Code does not provide any rigorous test or definition.
According to the Court, the test for “financial distress” is whether the debtor is in the type of trouble that would normally justify Chapter 11 relief. This test is very situation-specific and must be applied on a case-by-case basis.
Can Mass Tort Liabilities Ever Justify a Good Faith Bankruptcy?
In its opinion, the Court made it clear that overwhelming liabilities related to mass tort litigation can, in some cases, create the type of financial distress that would justify a Chapter 11 bankruptcy. The Court noted the example of Johns Mansville in the 1980s. The company was flooded with asbestos liabilities that threatened to overwhelm it and probably would have resulted in a forced liquidation. That circumstance was where Chapter 11 was justified by financial distress and filed in good faith. See In re: Johns-Mansville Corp. 36 B.R. 727 (Bankr. S.D.N.Y. 1984).
LTL Management Was Not in Financial Distress
Ultimately, the Third Circuit rejected J&J’s Texas Two-Step strategy because it found that LTL Management was not in real financial distress. The Court noted that LTL’s funding agreement with J&J included a right to demand cash payment from J&J of $61.5 billion to cover any talc-related liabilities.
This gave LTL direct access to J&J’s assets and cash. J&J is one of the world’s biggest and most solvent companies, with over $400 billion in equity value. J&J’s balance sheet included another $31 billion in cash, paying shareholders $13 billion in annual dividends. This is where the Third Circuit disagreed with the ruling of the Bankruptcy Court, which failed to properly consider LTL’s access to J&J’s assets when assessing its financial solvency.
What Does this Ruling Mean for the Talcum Powder Lawsuits?
The end result of the Third Circuit ruling was the dismissal of the Chapter 11 bankruptcy filed by LTL Management. This effectively blocks J&J’s effort to move the thousands of talc claims out of the trial courts and resolve them within the leveraged parameters of a bankruptcy proceeding.
The dismissal of the LTL bankruptcy will significantly and immediately impact the status of the thousands of talc lawsuits currently pending. Since the LTL bankruptcy was filed, an automatic stay has been in place, which means all proceedings in the pending lawsuits were frozen, and no new talc lawsuits could be filed in civil court. This brought everything in the ongoing talc litigation to a sudden halt.
The dismissal of the LTL bankruptcy means that the automatic stay will be immediately lifted. This will allow all proceedings in the pending talc lawsuits to resume, and new talc lawsuits can be filed again.
J&J has already vowed to appeal the Third Circuit decision. That appeal would be to the Supreme Court of the United States. J&J can and probably will request that the automatic stay be continued, pending that appeal’s outcome. However, based on the Court’s decision, it seems very unlikely that the request will be granted since the appeal could take several years to resolve.
What Does This Ruling Mean for Other Mass Torts?
The Third Circuit’s decision will significantly affect current and future mass torts. 3M is currently attempting a similar strategy to force over 200,000 defective earplug claims to be resolved in bankruptcy. Unlike in the J&J case, the Bankruptcy Court rejected 3M’s attempt. That case is now on appeal to the Fifth Circuit, which will undoubtedly consider the Third Circuit decision.
Aside from the 3M situation, the Third Circuit ruling will undoubtedly impact other companies dealing with mass tort liabilities. The ruling makes it clear that offloading mass tort liabilities into bankruptcy is only viable if the company is facing real and immediate financial trouble. In other words, the bankruptcy spin-off is only a last resort and not a tool for managing tort exposure.