Relevant Documents:OpinionJudgment
The U.S. Court of Appeals for the Third Circuit has dismissed LTL Management’s chapter 11 case as a bad-faith filing, a landmark decision in the case law on the “Texas two-step” strategy for companies managing mass tort liabilities. At the heart of the opinion is the court’s finding that LTL was not in “financial distress” when it entered chapter 11. Although LTL faced billions in asserted talc claims on the petition date, the court spotlights LTL’s $61.5 billion funding agreement with parent Johnson & Johnson as “not unlike an ATM disguised as a contract.”
As a result, the opinion concludes, LTL’s
“funding backstop plainly mitigates any financial distress foreseen on its petition date,” disqualifying it from chapter 11 protection (emphasis added). Nor do any “unusual circumstances” - such as the benefits that the chapter 11 process could offer to litigants as an alternative to the jury system - erase that requirement, the ruling states.
The Third Circuit’s rebuke of the LTL filing focuses on key questions that have dogged companies using the Texas two-step maneuver: When it comes to chapter 11 eligibility, how should courts “draw the line” between the debtor and the larger enterprise from which it was separated through a divisional merger? When assessing the debtor’s “financial distress,” how should courts weigh the assets and liabilities of the larger corporate family? Judge Thomas L. Ambro, writing for a three-judge panel, says,
“Only LTL’s financial condition is determinative” but stresses that the debtor’s funding agreement is “
a roughly $61.5 billion payment right against J&J and New Consumer.” He adds,
“To ignore a parent (and grandparent) safety net shielding all liability then foreseen would allow tunnel vision to create a legal blind spot. We will not do so” (emphasis added).
However, the court stops short of a total critique of the Texas two-step strategy, maintaining a laser focus on the financial distress requirement.
“Some may argue any divisional merger to excise the liability and stigma of a product gone bad contradicts the principles and purposes of the Bankruptcy Code,” Judge Ambro writes,
“But even that is a call that awaits another day and another case” (emphasis added).
Today’s opinion is a litigation victory for talc claimants who
appealed key
rulings from Bankruptcy Judge Michael Kaplan in February 2022. Judge Kaplan denied claimants’
motions to dismiss the case as a bad-faith filing and imposed a preliminary injunction shielding nondebtor affiliates, including J&J, from talc litigation. The Third Circuit notes that dismissal of the case “annuls the litigation stay” on the debtor’s affiliates and “makes moot the need to decide that issue.”
In his opinions, Judge Kaplan had lauded the ability of the bankruptcy system to resolve thorny mass tort issues that could stall in the jury trial system for years or decades. Judge Ambro today acknowledges that the panel’s decision “restricts J&J’s ability to move thousands of claims out of trial courts and into bankruptcy court so they may be resolved, in J&J’s words, ‘equitably’ and ‘efficiently.’”
The opinion also notes an “apparent irony: that J&J’s triple A-rated payment obligation for LTL’s liabilities, which it views as a generous protection it was never required to provide to claimants, weakened LTL’s case to be in bankruptcy. Put another way, the bigger a backstop a parent company provides a subsidiary, the less fit that subsidiary is to file.”
However, the panel remarks, “
we mean not to discourage lawyers from being inventive and management from experimenting with novel solutions … we need not lay down a rule that no nontraditional debtor could ever satisfy the Code’s good-faith requirement” (emphasis added). Ultimately, the court concludes that in this case, LTL does not clear the bar because of its lack of financial distress, a “safeguard [that] ensures that claimants’ pre-bankruptcy remedies - here, the chance to prove to a jury of their peers injuries claimed to be caused by a consumer product - are disrupted only when necessary.”
The Third Circuit heard
oral argument in the talc claimants’ appeal last September.
Only LTL’s Financial Condition Is Determinative
Before turning to the question of whether LTL was in financial distress, Judge Ambro critiques the bankruptcy court’s methodology for measuring debtor distress. Judge Kaplan reasoned that LTL inherited the financial distress of its pre-Texas two-step predecessor, Old Johnson & Johnson Consumer Inc., writing that “[o]ne cannot distinguish between the financial burdens facing Old JCCI and Debtor” because Old JJCI’s talc liabilities became the legal responsibility of LTL. Absent a global settlement, Judge Kaplan reasoned, neither entity would be able to defend or economically resolve the current and future talc-related claims.
Judge Kaplan also pointed to several talc-related damages awards against Old JJCI in the run-up to the LTL filing. In particular, he highlighted the verdict in the
Ingham mesothelioma case, in which a jury awarded $4.14 billion in punitive damages, reduced on appeal to $2.24 billion. “Even without a calculator or abacus,” Judge Kaplan said, “one can multiply multi-million dollar or multi-billion dollar verdicts by tens of thousands of existing claims, let alone future claims, and see that the continued viability of all J&J companies is imperiled.”
The Third Circuit rejects this approach, stating that “
the financial state of LTL - a North Carolina limited liability company formed under state law and existing separate from both its predecessor company (Old Consumer) and its newly incorporated counterpart company (New Consumer) - should be tested independent of any other entity” (emphasis added).
Judge Ambro writes, “It strains logic [] to say the condition of a defunct entity should determine the availability of Chapter 11 to the only entity subject to it. To do so would introduce uncertainty regarding how far back and to what entities a court can look when evaluating a debtor’s financial distress.” As a result, the financial condition of Old JJCI is “relevant only to the extent it informs our view of the financial condition of LTL itself.”
LTL Was Not in Financial Distress
After fixing the lens on LTL’s financial condition, the panel rejects Judge Kaplan’s conclusion that LTL was distressed when it entered bankruptcy. Judge Ambro writes that the bankruptcy court overemphasized the financial condition of Old JJCI and proposed faulty projections of LTL’s future liability based on the scope and costs of earlier talc litigation.
Discussing the funding agreement, the opinion observes, “To recap, under it LTL had the right, outside of bankruptcy, to cause J&J and New Consumer, jointly and severally, to pay it cash up to the value of New Consumer as of the petition date (estimated at $61.5 billion) to satisfy any talc-related costs and normal course expenses. Plus this value would increase as the value of New Consumer’s business and assets increased.” As for New JJCI, it “had access to Old Consumer’s cash-flowing brands and products along with the profits they produced, which underpinned the $61.5 billion enterprise value of New Consumer as of LTL’s filing.”
“Most important,” Judge Ambro continues, “the payment right gave LTL direct access to J&J’s exceptionally strong balance sheet.” He notes that at the time of LTL’s filing, J&J had well over $400 billion in equity value with a AAA credit rating and $31 billion just in cash and marketable securities, adding that it is “hard to imagine a scenario where J&J and New Consumer would be unable to satisfy their joint obligations under the Funding Agreement.”
However, according to the Third Circuit,
“the Bankruptcy Court hardly considered the value of LTL’s payment right to its financial condition” (emphasis added). The panel highlights the bankruptcy court opinion expressing doubt that LTL was “not to be regarded as being in ‘financial distress’” “merely because [LTL] contractually has the right to exhaust its funding options [under the Funding Agreement].”
In effect, according to Judge Ambro, the bankruptcy court “speculated that a draw on the payment right could force J&J to deplete its available cash or pursue a forced liquidation of New Consumer and have a ‘horrific impact’ on those companies.” The assumption here, Judge Ambro writes, is that “out of concern for its affiliates, LTL may avoid drawing on the payment right to its full amount.
But this is unsupported and disregards the duty of LTL to access its payment assets” (emphasis added). Ultimately, the opinion continues, “the Bankruptcy Court did not consider the full value of LTL’s backstop when judging its financial condition.”
At the same time, the bankruptcy court overemphasized the impact of talc litigation on Old JJCI.
“Directing its sight to Old Consumer and away from the Funding Agreement’s benefit to LTL essentially made the financial means of Old Consumer, and not LTL, the lodestar of the Court’s financial-distress analysis. This misdirection was legal error,” the opinion states (emphasis added).
In addition, Judge Ambro says that the bankruptcy court failed to account for Old JJCI’s past litigation successes. Before LTL’s bankruptcy, “in the over five years of litigation to date, the aggregate costs had reached $4.5 billion (less than 7.5% of the $61.5 billion value on the petition date), with about half of these costs attributable to one ovarian cancer verdict,
Ingham, to date an outlier victory for plaintiffs.”
Despite these facts, the opinion adds, the bankruptcy court “invoked calculations that just the legal fees to defend all existing ovarian cancer claims (each through trial) would cost up to $190 billion” and that exposure from existing mesothelioma claims alone exceeded $15 billion. The ruling also faults the bankruptcy court for
“the casualness of the calculations supporting” its projections, which “engenders doubt as to whether they were factual findings at all, but instead back-of-the-envelope forecasts of hypothetical worst-case scenarios” (emphasis added).
Judge Ambro writes, “What these projections ignore is the possibility of meaningful settlement, as well as successful defense and dismissal, of claims by assuming most, if not all, would go to and succeed at trial.” The record instead supports the conclusion that “LTL, at the time of its filing, was highly solvent with access to cash to meet comfortably its liabilities as they came due for the foreseeable future.”
The opinion also addresses a litigation what-if: the possibility that the
Ingham verdict “is not an anomaly but a harbinger of things to come” and that cash available under the funding agreement cannot adequately address LTL’s talc liability.
“Perhaps at that time LTL could show it belonged in bankruptcy,” Judge Ambro reasons. “But it could not do so in October 2021” (emphasis added).
“Unusual Circumstances” Do Not Preclude Dismissal
Finally, the Third Circuit focuses on the bankruptcy court’s holding that “the interests of current tort creditors and the absence of viable protections for future tort claimants outside of bankruptcy … constitute such ‘unusual circumstances’ as to preclude … dismissal.”
Judge Ambro responds, “[W]hat is unusual instead is that a debtor comes to bankruptcy with the insurance accorded LTL.” He continues, “Our ground for dismissal is LTL’s lack of financial distress,” and that “[n]o ‘reasonable justification’ validates that missing requirement in this case.”