A corporate strategy that gained attention in a Johnson & Johnson spinoff’s bankruptcy continues to face uncertainty despite a refusal to dismiss the Chapter 11 case.
The maneuver, known as the Texas Two-Step because of its reliance on Texas corporate law, involves a company spinning off a unit and transferring its tort liability to that unit. The spinoff is then put into bankruptcy to manage that liability without putting the assets of the original company into play.
New Jersey bankruptcy Judge Michael Kaplan refused to dismiss J&J talc liability spinoff LTL Management LLC’s Chapter 11 case, finding it wasn’t filed in bad faith. That decision is on appeal to the U.S. Court of Appeals for the Third Circuit.
But a North Carolina bankruptcy judge last week called the Texas Two-Step into question, allowing a group of asbestos victims to continue a lawsuit seeking to undermine a reverse merger in a separate bankruptcy case.
The victims are seeking “substantive consolidation,” which would merge the assets of debtors Aldrich Pump LLC and Murray Boiler LLC with those related to industrial manufacturer Trane Technologies Plc, which isn’t in bankruptcy. Doing so effectively would nullify the Texas Two-Step maneuver that Trane used when it created Aldrich Pump and Murray Boiler and placed them in bankruptcy.
The North Carolina decision and others like it suggest that the Texas Two-Step strategy may not hold up in all courts, said Charles Tatelbaum, an attorney with Tripp Scott PA who specializes in business-restructuring cases.
“It reinforces the lack of confidence that a lot of us have in the propriety and it’s just one more chink in the armor,” Tatelbaum said. “I don’t think the one decision alone does it. But it’s verbalizing what a lot of people think: that it isn’t right.”
Judge J. Craig Whitley of the U.S. Bankruptcy Court for the Western District of North Carolina didn’t rule on the merits of consolidation in denying Aldrich Pump and Murray Boiler’s motion to dismiss on April 1. But Whitley also said he’s not bound by Kaplan’s decision in the J&J case.
“Bankruptcy judge opinions vary across the land on a variety of fronts and no one here is going to be relying on a bankruptcy judge’s opinion,” Whitley said during a hearing. “The challenges to the merger are going to get resolved higher up, either by an appellate court, maybe the Supreme Court, maybe they get resolved in Congress,” he said.
Last month, Whitley also gave the green light for an asbestos victim group to proceed with a lawsuit to consolidate the assets of building material maker CertainTeed LLC with those of its bankrupt spinoff unit, DBMP LLC.
Whitley was “dead-on” in not being bound by Kaplan’s decision, said Mark Lanier of the Lanier Law Firm, a plaintiffs’ lawyer who represents asbestos victims.
“Bankruptcy can be a black hole for claims, and it is a good thing that judges don’t automatically let one or two dictate results all around the country,” he said.
The decisions allow asbestos victims to “peek behind the curtain” to find the “true motivations” behind the divisive mergers, said Jon Ruckdeschel of Ruckdeschel Law Firm LLC, an attorney with experience litigating asbestos cases.
Those victims eventually could pursue claims to undo the Texas Two-Step and bring the parent companies’ assets into the bankruptcy case, creating a larger pool for recovery, he said. Meanwhile, asbestos victims can probe the details of the spinoffs’ creation during discovery, he said.
“If successful, these claims could force the profitable parents to put their entire company into bankruptcy if they want the benefits of bankruptcy,” Ruckdeschel said.
‘Rare Equitable Remedy’
But Whitley’s decision isn’t a complete victory for the asbestos victims, said Anthony Casey, a business law, finance, and corporate bankruptcy professor at the University of Chicago Law School. The judge is only letting the case proceed and hasn’t made a decision on the merits, he said.
The ruling also could just be a strategy to put pressure on both sides to reach an agreement, Casey said.
“Substantive consolidation is supposed to be a rare equitable remedy and these are odd cases for substantive consolidation,” he said. “Courts often stress the rarity point saying it is an extreme remedy.”
Analysts have said the J&J ruling raises the odds that other companies facing costly product-liability claims could pursue the same reverse-merger bankruptcy strategy.
But even the J&J case continues to raise doubts.
Kaplan didn’t rule on all matters regarding the Texas-Two Step, just that its use wasn’t sufficient grounds to dismiss the case for lack of good faith, said Melissa Jacoby, a bankruptcy law professor at the University of North Carolina at Chapel Hill.
The judge also allowed the appeal to go straight to the Third Circuit because of the question’s importance.
“The opinion had a rosy outlook about bankruptcy being a good place to resolve the talc liability issues, but that doesn’t preclude other types of challenges,” Jacoby said.
With Kaplan’s decision heading to the Third Circuit and Whitley saying an appeals court or Congress must weigh in, the propriety of the Texas Two-Step may be in doubt for some time.
“The main take away is that we have a long way to go before these issues are finally resolved,” Casey said.