Bankruptcy being used (or, in the view of some, misused) to resolve mass tort litigation

Back to All Thought Leadership

The Third Circuit opinion in In re LTL Management LLC adds to the growing number of decisions looking at the extent to which bankruptcy can be used (or, in the view of some, misused) to resolve mass tort litigation .

Johnson & Johnson Consumer Inc. (“Old Consumer”), a wholly-owned subsidiary of Johnson & Johnson (“J&J”), sold many commonly known personal healthcare products, including Johnson’s Baby Powder, which ultimately was reported to have caused lung disease, mesothelioma, and ovarian cancer. By the time of LTL’s Chapter 11 filing, Old Consumer and J&J faced over 38,000 ovarian cancer actions and over 400 mesothelioma actions, with payouts for talc-related verdicts and settlements totaling over $3.5 billion and generating over $1 billion in costs.

To manage its ever-increasing talc liabilities, a new company called LTL Management LLC (“LTL”) was formed as the product of a divisional merger process under Texas state law, colloquially labeled the “Texas Two-Step,” for the primary purpose of taking on the talc liabilities of Old Consumer. As a result of the merger, LTL and Johnson & Johnson Consumer Inc. (“New Consumer”) were formed; the former holding Old Consumer’s liabilities and a funding support agreement from its corporate parents, and the latter holding virtually all of the productive businesses previously held by Old Consumer. Crucially, under the funding agreement New Consumer and J&J were obligated to pay “any and all costs and expenses” arising out of LTL’s talc-related liabilities, up to the value of New Consumer.

Bankruptcy Filing and Motions to Dismiss

On October 14, 2021, two days after completion of the divisional merger, LTL filed a petition for chapter 11 relief in the United States Bankruptcy Court for the Western District of North Carolina. Following motions from talc claimants and other parties, the North Carolina bankruptcy court transferred LTL’s chapter 11 case to the Bankruptcy Court for the District of New Jersey (the “Bankruptcy Court”). Various groups of talc claimants then filed motions to dismiss, arguing that LTL’s chapter 11 case was filed without a proper bankruptcy purpose and therefore lacked good faith under section 1112(b) of the Bankruptcy Code.

After a five-day trial on the motions to dismiss, the Bankruptcy Court denied the motions to dismiss, finding that LTL filed its petition in good faith.1 First, Judge Kaplan emphasized that there is no insolvency requirement under the Bankruptcy Code. Although it was not currently insolvent, Judge Kaplan found that the weight of the talc litigation could eventually crush LTL financially. The Bankruptcy Court acknowledged that while the funding agreement gave it access to a substantial funding source to pay talc claimants, LTL’s potential liability was also massive. That was sufficient for the court to find that LTL suffered from financial distress.

Second, the Bankruptcy Court found that LTL had not filed its bankruptcy petition to gain an unfair tactical advantage in the talc litigation. It concluded that the bankruptcy forum offers better protections for talc claimants than that of the American tort system, because it is the only forum that can account for the entire pool of tort claimants, as opposed to a case in front of a jury that can only consider the claims of the individual plaintiff before it. Judge Kaplan held that chapter 11 is a more equitable

1 In re LTL Mgmt., LLC, 637 B.R. 396, 406 (Bankr. D.N.J. 2022).

proceeding in which to resolve tort claims because bankruptcy courts are in a position to look at the entire class of claimants, ensuring that everyone receives equitable distributions instead of the vastly varying awards granted by juries and the race to the courthouse that civil litigation encourages.

The talc claimants appealed the Bankruptcy Court’s denial of the motions to dismiss, by direct appeal, to the Third Circuit Court of Appeals.

Third Circuit Reversal

On January 30, 2023, in an opinion authored by Justice Thomas Ambro (a noted jurist on many bankruptcy issues),2 the Third Circuit panel reversed the Bankruptcy Court’s decision, holding that LTL had not filed its petition in good faith. Specifically, it found that the company was not in financial distress and therefore could not show that its chapter 11 filing served a valid purpose under Bankruptcy Code § 1112(b).

Relying on SGL Carbon and Integrated Telecom,3 the Third Circuit held that a chapter 11 debtor must show that it is financially troubled, and that such financial troubles are immediate, as a requirement for a good faith filing. LTL’s claimed financial troubles, based on potential future talc liability, compared to the size of the parents’ guarantee payment under the funding agreement, were too tenuous to justify the need for the Bankruptcy Court’s protection and did not rise to the level of financial distress necessary to demonstrate good faith.
In making its decision, the Third Circuit found that the Bankruptcy Court had failed to fully consider the value to LTL of its parents’ funding agreement when judging its financial condition. The Third Circuit found that LTL’s backstop provided ample financial support to LTL, and that LTL had improperly sought shelter in the bankruptcy system – a system designed to protect those without such support.

Interestingly, however, the Third Circuit’s decision does not denounce the use of the Texas Two-Step, and the Third Circuit did not invalidate the use of the divisional merger by companies planning to file a chapter 11 case. Rather, the Third Circuit left open the possibility that LTL could potentially refile if it did ultimately suffer financial distress, and that other companies might be able to use the Texas Two-Step in filing chapter 11 cases in good faith.

LTL moved the Third Circuit to stay dismissal of its chapter 11 case while its petition for certiorari was pending before the Supreme Court. The Third Circuit panel, in a brief order, denied the request and upheld its January ruling.

Ongoing Developments

The story of LTL does not stop at the Third Circuit dismissal. Recently, LTL announced that it had proposed an $8.9 billion settlement that it believed was supported by at least 75% of LTL’s talc claimants. LTL used that proposal as the basis for filing a second chapter 11 case on April 4, 2023, just two hours after Judge Kaplan’s order came down dismissing the first in accordance with the Third Circuit’s ruling. The new chapter 11 case is also before Judge Kaplan in the United States Bankruptcy Court for the District of New Jersey.

2 In re LTL Mgmt., LLC, 58 F.4th 738, 745 (3d Cir. 2023).
3 See In re SGL Carbon Corp., 200 F.3d 154, 159-62 (3d Cir. 1999); see also In re Integrated Telecom Express, Inc., 384 F.3d 108, 118 (3d Cir. 2004).

On April 20, 2023, Judge Kaplan ruled that jury trials in the roughly 40,000 pending talc-related lawsuits against J&J would be stayed until mid-June to allow the parties time to negotiate a global settlement. However, he allowed pre-trial discovery to continue. Judge Kaplan reportedly expressed skepticism that LTL could file a confirmable plan or that the case was filed in good faith, but he ultimately found that it was too early to make those decisions.

Post-LTL and Implications

Given the number of mass tort bankruptcies filed in recent years, LTL could have significant implications for companies seeking strategies for managing and resolving such liabilities. While the Purdue Pharma decision by Judge McMahon in the Southern District of New York (which invalidated a chapter 11 plan that granted non-consensual third party releases in favor of the Sackler family and which is pending appeal before the Second Circuit Court of Appeals) arguably got more press attention than the LTL decision, the LTL decision could have a more significant impact because it dictates which companies are allowed to seek the protection of the bankruptcy court – a potential gatekeeping issue – whereas Purdue Pharma merely rules on the validity of one type of provision in a plan of reorganization.

The developing case law around mass tort bankruptcies may create interesting venue decisions by such companies. For example, unless the Second Circuit Court of Appeals reverses Judge McMahon’s decision in Purdue Pharma, the ability to get non-debtor third party releases is now doubtful in the Second Circuit, while in the Third Circuit, per LTL, there is a financial distress component to the good faith test (a requirement that does not exist in most other Circuits). To the extent that a company may have multiple venues in which it can file a chapter 11 case, they will need to consider carefully the differences among those venues, and the potential implications on its plans to reorganize, with their bankruptcy advisors
Future debtors filing in the Third Circuit who face mass tort liabilities may find themselves in a better position than LTL with the benefit of hindsight. Judge Ambro’s decision suggests that, with appropriate and strategic corporate structuring, they could use the Texas Two-Step to file a bankruptcy petition that survives the LTL good faith standard. It is worth noting that creating an undercapitalized company saddled with legacy liabilities through a divisive merger would expose the company and its parent and affiliates to fraudulent conveyance litigation. The challenge, then, is ensuring that a company with sufficient financial distress to pass the LTL good faith test is sufficiently funded to survive a fraudulent conveyance challenge.

The potential benefits of a bankruptcy filing in managing and resolving mass tort liabilities, to both debtors and claimants, are numerous: claimants are treated equally, chapter 11 cases generally are resolved more quickly than civil litigation, and overall legal costs are therefore reduced. Mass tort bankruptcy cases are usually resolved with the formation and funding of a claimant trust (such as the $8.9 billion settlement proposed by LTL), through which all tort claims are channeled pursuant to a confirmed chapter 11 plan. The company receives the benefit of a channeling injunction that cuts off further recourse against the company. These benefits, and others, are so significant that it may be worth the risk of losing a motion to dismiss to try filing a chapter 11 petition. Evidently, J&J thinks it is worth that risk to do it twice.

Keller Benvenutti Kim LLP is a corporate restructuring firm in San Francisco, CA

Jane Kim is the Managing Partner at KBK. Her full bio can be found here.

Gabrielle Albert is an Associate at KBK. Her full bio can be found here.

Jullian Sekona is an Associate at KBK. Her full bio can be found here.

Sign In

[login_form] Lost Password