As a kid, Lori Knapp watched her dad come home with his work clothes completely splattered in white.
It was the 1970s in South Florida, and Ed Chapman worked for contractors during a housing boom, applying drywall and spray texture to walls and ceilings in thousands of retirement village homes, commercial sites, and high-rises.
Chapman didn’t wear a mask and didn’t know the materials he was inhaling were toxic. A few times, his daughter tagged along and watched as he dumped the powder into a machine to mix the paste, she said.
“And the puff—the smoke—would just come up and we would kind of run through it thinking, you know, we look like ghosts,” Knapp recalled. “We thought it was all fun and games.”
Chapman was diagnosed in 2018 with mesothelioma, the disease linked to asbestos exposure, and died within two years. Before his death, he had accepted a payout to settle an asbestos exposure lawsuit against drywall material companies.
But Knapp, his sole beneficiary, is still waiting to resolve another claim, this one targeting Georgia-Pacific, the industrial giant that Chapman said manufactured the joint compound he used.
She’s among thousands of claimants impacted by a novel legal strategy that has let major corporations divert a mountain of lawsuits by carving out the offending division as a separate entity that then declares bankruptcy. Potential plaintiffs like Knapp become creditors who instead must get in line and wait, sometimes years, for the bankruptcy cases to conclude.
Now, more than five years into the bankruptcy proceedings for Bestwall, the Georgia-Pacific unit that Chapman’s estate has pursued, the legal landscape may be shifting.
A first of its kind ruling against a Johnson & Johnson subsidiary that used the same bankruptcy pivot—nicknamed the Texas Two-Step—to manage tens of thousands of cancer-victim lawsuits over its baby powders has ignited a new campaign to kick those controversial cases out of bankruptcy courts.
Lawyers in at least two other unrelated bankruptcies in North Carolina have in recent weeks cited the opinion as they ask judges to reconsider those cases.
The fight could be tricky. The J&J ruling came in late January from the Philadelphia-based Third US Circuit Court of Appeals, whose purview doesn’t reach to North Carolina. And the Georgia-Pacific subsidiary is being represented by the same lawyers as in the J&J case, who have already signaled a willingness to take their arguments to the US Supreme Court if needed.
Still, Samir Parikh, a bankruptcy law professor at Lewis & Clark Law School, said the opinion could be a “death knell” for the Texas Two-Step.
“Practically speaking, I think companies will be extremely reluctant” to use it, he said.
Friendly Carolina Court
Named for a “divisional merger” law in the Lone Star State that’s been around since the late 1980s, the Texas Two-Step is pretty straightforward: Companies use the law to divide their assets and exposure liabilities into newly created subsidiaries. That’s the first step.
The new unit that’s loaded up with liabilities but relatively few assets then files for Chapter 11 in a different venue—often the Western North Carolina bankruptcy court, which has developed a reputation as a favorable venue for asbestos cases. That’s Step Two.
The company that received most of the assets stays out of bankruptcy but promises to fund a trust created by the bankrupt unit. In the Bestwall case, Georgia-Pacific pledged $1 billion for such a trust.
Greg Gordon, a Jones Day lawyer who’s represented several companies that used the Texas Two-Step and is credited for pioneering the technique, has defended the tactic. He’s asserted that asbestos liabilities are otherwise very difficult for companies to manage because of the thousands of claims each year and their associated costs, including settlements.
At an American Bankruptcy Institute meeting last year, Gordon also argued that litigating those claims in the regular civil courts is akin to a “lottery” for victims when it comes to awards: Many get nothing and a few get large payouts, making it a poor system for both corporations and claimants. The bankruptcy system, in which corporations potentially agree to fund trusts for current and future claimants, offers a way to settle all claims at once, he said.
“I, of course, think the divisional merger is the greatest innovation in the history of bankruptcy,” Gordon said at the event.
His firm’s clients include J&J, which in 2021 became perhaps the most prominent multinational to employ the strategy when it placed LTL Management, its subsidiary facing 40,000 baby powder lawsuits, into bankruptcy. It also committed $2 billion to LTL claimants.
Jones Day also represents Aldrich Pump and Murray Boiler, two firms formed as part of a corporate restructuring to absorb the legal liabilities held by Irish heating and air conditioning company Trane Technologies and industrial product maker Ingersoll-Rand Co. Before their Texas Two-Step, those companies had been spending about $100 million a year on asbestos-related settlements and legal defense costs, they said in court papers.
The strategy isn’t just confined to asbestos-related companies. 3M has used a similar tactic in a bid to manage 230,000 claims by soldiers who blame their alleged hearing loss on earplugs sold by one of its subsidiaries.
Gordon also represents Bestwall, the Georgia-Pacific subsidiary. In 2017, it became the first entity to try the Texas Two-Step.
Since then, Georgia-Pacific has been able to keep operating normally outside of bankruptcy without having to defend itself in more than 60,000 asbestos lawsuits, including the one from Chapman’s estate. And a bankruptcy-induced freeze on litigation has forestalled annual payments by Georgia-Pacific of more than $160 million on asbestos-related defense and indemnity costs.
At the same time, the global pulp and paper and manufacturer continues to thrive. In a January court filing, Georgia-Pacific disclosed that it’s paid roughly $5.39 billion to its own parent, Koch Industries Inc., since Bestwall filed for bankruptcy.
That bankruptcy, along with LTL and an equally large one by DBMP LLC, a spinoff of cement pipe maker CertainTeed LLC, were filed in the same courthouse in Charlotte.
But the court’s bankruptcy administrator, in a move supported by LTL creditors, persuaded the court to transfer that case to New Jersey, where J&J is based. At first the move didn’t pay off: A trial judge rejected the claim that LTL’s bankruptcy petition was flawed and just a strategy to limit their liability costs.
In its Jan. 30 ruling, the Third Circuit panel disagreed. It ruled that a company must be in financial distress to justify using bankruptcy. LTL’s funding agreement from J&J, worth potentially $61.5 billion, undercut that it was in immediate danger, the court said.
“Good intentions—such as to protect the J&J brand or comprehensively resolve litigation—do not suffice alone,” Judge Thomas Ambro wrote for the panel.
Jones Day attorneys did not respond to requests for comment.
Battles over the harm caused by asbestos have raged for a half-century. The personal injury litigation largely took off in the US in the 1970s, as exposure became more closely tied to diseases like asbestosis and mesothelioma, a form of cancer that often affects the lungs.
The health issues often don’t manifest in people until years after exposure, so the number of lawsuits filed against manufacturers and sellers of asbestos-laced products such as insulation grew exponentially over time, eventually driving companies into bankruptcy.
In 1982, Johns Manville Corp., then the largest manufacturer of asbestos-containing products, filed for Chapter 11 relief and ultimately created a path for other companies also overwhelmed with asbestos liability.
Johns Manville used its bankruptcy proceedings to establish a $2.5 billion settlement trust to pay victims and serve as a channel to address all future claims against the company. In 1994, Congress enshrined this option into the bankruptcy code, giving companies a statutory mechanism to keep claims out of the civil court system. Scores of asbestos bankruptcy trusts have since been created, spawning a multibillion-dollar industry in and of itself. At least 60 are still active.
Georgia-Pacific was the first to use the Texas Two-Step, with the Bestwall spinoff in 2017. But other companies have since followed, prompting controversy and scrutiny of the tactic. In 2021, Democrats in Congress introduced measures to stop the maneuver, but their proposals failed to advance.
Meanwhile, more relatives of asbestos-related victims became aware of the Texas Two-Step.
One was Amy DeMaio, whose father, Peter Bergrud, died in 2019 at 77 after being diagnosed with mesothelioma following two decades of work laying CertainTeed and Johns Mansville asbestos-cement pipe throughout Seattle and Tacoma, Washington.
DeMaio said she feels like she’s been forced to relive her father’s death without closure as a DBMP creditor while CertainTeed continues to turn a profit.
“The most frustrating part is them trying to get out of their accountability,” she said.
‘A Lot More Aggressive’
Lawyers for the J&J subsidiary have asked for the full Third Circuit bench to rehear its case, calling it part of an appeal they think is “well taken.”
Meanwhile, Gordon has already sought to diminish the opinion’s significance. During a February DBMP bankruptcy court hearing in Charlotte, he highlighted to Judge J. Craig Whitley that LTL had the financial commitment of J&J as a co-obligor on its claims. DBMP has no such agreement from its parent company, he said. He also noted that the appellate judges’ opinion expressed no concerns about divisional mergers generally, and didn’t find that the restructuring which led to LTL had harmed claimants.
“In fact, it found the opposite, that the restructuring put the claimants in a more favorable position than they had been in before,” Gordon said.
Still, the LTL opinion has become a new arrow in the quiver of attorneys in the Charlotte bankruptcies.
“We are going to be a lot more aggressive in those North Carolina cases—whether it’s through the committees or my law firm—for our clients,” said Clay Thompson, an attorney representing cancer-stricken plaintiffs against each of the bankrupt companies.
At the same February hearing where Gordon dismissed the LTL ruling as immaterial to the other cases, a lawyer representing creditors against DMPB called it “a repudiation” of the Texas Two-Step strategy.
“It calls out the emptiness of conjuring up a subsidiary into existence, loading it with liability, putting it into bankruptcy, and then promising to pay all of its liabilities through a so-called funding agreement,” the lawyer, James P. Wehner of the firm Caplan & Drysdale, told the judge. “The decision insists that bankruptcy is a matter of substance, not just a form.”
Jonathan Ruckdeschel of Ruckdeschel Law Firm LLC, who represents Knapp and other claimants, said the opinion emphasized the need for financial distress from bankrupt businesses and pointed to the billions of dollars Georgia-Pacific has generated for Koch Industries. Georgia-Pacific has also rejected a bankruptcy plan proposed by claimants that would have allowed them to choose to fight their claims in the tort system, Ruckdeschel said.
Last month, some claimants renewed a bankruptcy court request to dismiss the Bestwall case, a motion the court first denied in 2019. A claimants’ committee also revived a long-dormant request to the district court to finally consider its appeal to the dismissal rejection, which Bestwall quickly opposed.
Judge Robert J. Conrad, Jr. of the US District Court for the Western District of North Carolina has yet to rule even on the group’s request to appeal.
Knapp, 59, meanwhile waits from her home in Tennessee for an end to the legal saga— one she said her father didn’t want to leave to her.
“It burns me up,” Knapp said. “He wanted closure. He didn’t want me to deal with all of this.”
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