‘Good Faith’ Bankruptcy Filings Get Fresh Look Ahead of J&J Move

As Johnson & Johnson readies its third attempt to resolve talc-related cancer litigation through bankruptcy, courts remain divided on how to determine whether a corporation’s Chapter 11 filing is made in “good faith.”

There is no standardized method of evaluating good faith filings in the US Bankruptcy Code, leaving courts to determine for themselves how to address the issue.

When the US Court of Appeals for the Third Circuit last month affirmed a bankruptcy court’s dismissal of a J&J unit’s second Chapter 11, it said the case wasn’t filed in good faith because the company wasn’t in financial distress. The National Rifle Association and a unit of 3M Co. met similar fates in recent years.

The lack of any clear-cut definition of “good faith” in bankruptcy law provides leeway for litigants to challenge the legitimacy of a case. Opponents often allege the company is financially healthy and is improperly seeking bankruptcy protection to fend off legal troubles.

But establishing a fully defined good faith requirement, such as insolvency, under Chapter 11 would present additional complications for struggling companies and could have lasting effects, bankruptcy professionals say.

“A good faith filing requirement would have to allow for a lot of flexibility, but would generally be based upon debtor’s demonstration of need rather than financial distress,” said bankruptcy lawyer Hannah Waldman of Greenberg Glusker Fields Claman & Machtinger LLP.

A hypothetical good faith rule “must be so narrowly defined that it does not become a basis for litigation at the beginning of every Chapter 11 filing, potentially thwarting legitimate filings,” said Daniel Cohn, a partner at Murtha Cullina LLP who advises financially distressed businesses. “In these litigious times, if there’s any opportunity to fight, people are going to take it.”

To avoid excess litigation, “courts should be crystal clear about what is meant by lack of a legitimate Chapter 11 purpose, and should entertain a motion to dismiss only if lack of such purpose is clear based on indisputable facts,” Cohn said.

J&J’s Journey

People who say J&J’s baby powder caused their cancer have largely voted in favor of a settlement that would be administered through a third talc bankruptcy.

J&J is expected to conduct its third filing in Texas, after being booted from New Jersey and North Carolina bankruptcy courts. Since Texas is part of the Fifth Circuit, that means J&J won’t be confined by the Third Circuit’s interpretation of good faith.

Individual bankruptcy courts use their “gut feeling” when evaluating good faith filings in such cases, said Matthew Gensburg of Gensburg Calandriello & Kanter PC, who leads the firm’s bankruptcy, commercial litigation, and restructuring practice group.

“While there are factors that go into what is evidence of good faith and what is evidence of bad faith, no one factor will be determinative,” Gensburg said. “It’s going to be cumulative.”

J&J, which has long maintained that its products are safe, faces more than 61,000 suits blaming talc in its powders for causing ovarian and asbestos-related cancers.

The Third Circuit’s July decision upholding a New Jersey bankruptcy court’s dismissal of the J&J unit’s second case focused on the financial status of the J&J unit, LTL Management LLC. That was a “bit of a new horizon,” said Douglas Mintz, a partner at Schulte Roth & Zabel who represents creditors in financial restructuring.

“The rubber has really met the road” in Chapter 11 filings such as LTL’s that were made specifically to benefit a third party such as the parent company, not the debtor itself, Mintz said.

J&J plans to ask the US Supreme Court to review the Third Circuit decision, Erik Haas, the company’s worldwide vice president of litigation, said in July. The ruling doesn’t impact the company’s plan to attempt to resolve the talc claims through a third bankruptcy, Haas said.

When a “bankruptcy is being used as a sword rather than as a shield,” it’s typically dismissed for bad faith, Waldman said. “This is mostly true when there is no value to be created through the bankruptcy.”

Insolvency is generally defined under the bankruptcy code as a debtor’s inability to pay its debts as they come due, but it isn’t a requirement to file for bankruptcy. The argument could be made that a seemingly healthy entity is filing for Chapter 11 because they have “contingent liabilities that aren’t obvious to an observer as support for a good faith filing,” Mintz said.

However, there’s a “never-ending metronomic back and forth where bankruptcy lawyers push the boundaries,” Mintz said.

‘Objective Futility’

How courts view good faith can arguably be a “reflection of what’s going on in the economy,” Gensburg said.

When the real estate market in the 1980s was “experiencing distress, there were a number of court decisions dealing with the issue of good faith in the context of single asset real estate, largely because of the sheer number of filings,” he said.

Debtors in some of those cases seemed “to be abusing the automatic stay,” Waldman said.

In the US Court of Appeals for the Fourth Circuit, a debtor battling challenges to its bankruptcy must defeat allegations of “objective futility,” after a 1989 decision included that factor when addressing good faith, she noted.

Under that standard, a Chapter 11 filer can be rejected if there’s a “showing that reorganization is not realistically possible within a reasonable amount of time,” Waldman said.

The US Court of Appeals for the Eleventh Circuit in 1988, on the other hand, found that even when reorganization is possible, a case filed in bad faith may be dismissed, Waldman said.

“It’s not always about reorganization,” Gensburg said. Sometimes, “it’s about maximizing value.”

Most federal appeals courts look at other factors including whether a company filed false or misleading information, if there was a failure to comply with court orders or rules, and successive filings without any changes to financial conditions, bankruptcy professionals say.

A Dozen Exceptions

3M subsidiary Aearo Technologies is among the companies that were tossed out of bankruptcy amid efforts to resolve tens of thousands of lawsuits over faulty earplugs.

The US Bankruptcy Court for the Southern District of Indiana found that Aearo’s bankruptcy didn’t serve a legitimate reorganization. 3M eventually reached a $6 billion settlement in March outside of bankruptcy, prompting the company in July to drop its appeal of the bankruptcy decision.

“If a Chapter 11 debtor cannot demonstrate a need for use of the protections afforded by the code, aside from harassing or delaying creditors, that is a bad faith filing,” Waldman said.

The NRA’s Chapter 11 was dismissed in 2021 after the US Bankruptcy Court for the Northern District of Texas agreed with New York government officials that the case was filed in bad faith to dodge oversight.

Some of the factors courts use aren’t always translatable among different types of commercial debtors, Gensburg said. Measuring whether a company filed for bankruptcy with good faith has to be done on a case-by-case basis, bankruptcy professionals say.

“In the practice of law, you have the general rule and then you have a dozen exceptions to the general rule,” Gensburg said. “That’s true with respect to good faith.”