Prison Health-Care Bankruptcy Tests ‘Texas Two-Step’ Strategy

A troubled prison health-care provider’s bankruptcy trial will test a controversial corporate legal maneuver to settle mass tort liabilities, which has garnered outrage from federal officials and civil rights groups.

Tehum Care Services Inc. is a shell company created to absorb the medical malpractice suits and other legal liabilities of what used to be the nation’s largest prison healthcare provider: Corizon Health Inc. Tehum is pushing for court approval of a settlement that would remove the rights of prisoners and others to sue parties that took over Corizon and engineered its bankruptcy filing.

Conversely, a committee representing personal injury plaintiffs has moved to dismiss Tehum’s Chapter 11 case, calling Tehum “a legal fiction created to perpetrate an obvious fraud” for the benefit of the company’s owners.

The outcome of the trial, set to begin Friday in the US Bankruptcy Court for the Southern District of Texas, promises to be a noteworthy addition to developing case law over the treatment of mass tort claimants in bankruptcy and a polarizing legal technique, commonly referred to as the Texas Two-Step. The maneuver has been employed by corporate behemoths like Johnson & Johnson and Georgia Pacific LLC to halt and attempt to forcibly settle thousands of personal injury lawsuits. The Tehum case is now one of its toughest tests.

“We may get an important opinion on how bankruptcy courts interpret the transfers behind ‘Texas Two-Steps’ in bankruptcy,” said Emory University law professor Lindsey Simon. “You’ve got a lot of claimants that can’t access the system, and that’s a problem.”

Tort claimants argue the deal is designed to shield company insiders and settle some $775 million worth of alleged personal injury claims for pennies on the dollar. But Tehum maintains its $55 million settlement offer is the product of good faith negotiations and will provide “fair and equitable distributions.”

The Justice Department’s bankruptcy monitoring arm, the US Trustee, backs calls to have the settlement rejected and the case thrown out. The case is also causing a stir beyond typical bankruptcy overseers. Senate Democrats led by Elizabeth Warren (Mass.) and groups like the American Civil Liberties Union have publicly weighed in, voicing outrage over alleged manipulation of the bankruptcy code and mistreatment of incarcerated creditors.

Tehum has told the court that its plan is designed to equitably address liabilities and avoid disparate treatment of creditors in the tort system.

Divide and Settle

Judges across bankruptcy and appellate courts have split over the two-step debate.

“You’re starting to see varying opinions on the two-step cases,” said Seward & Kissel LLP corporate restructuring attorney Bob Gayda. A ruling in the Tehum case would be another datapoint regarding the viability of these types of proceedings, he said.

The corporate maneuver, used for the first time in 2017 by paper and pulp manufacturer Georgia Pacific, derives its name from the use of a Texas state law that allows companies to split their assets and liabilities into new units, then subsequently place the liability-laden unit into bankruptcy to drive a global settlement. The two-step has yet to yield a successful Chapter 11 resolution of claims. But corporations have been able to take advantage of a subsidiary’s bankruptcy to secure a pause on litigation against the whole enterprise.

Bankruptcy judges in North Carolina, who have attracted most of the two-step cases to date, have ruled that the proceedings are permitted under federal law.

But the US Court of Appeals for the Third Circuit set a notable precedent last year, saying a company must demonstrate actual financial distress to justify a bankruptcy filing. The watershed ruling led the New Jersey bankruptcy court to dismiss a J&J subsidiary’s Chapter 11, and restarted more than 50,000 lawsuits alleging the health-care giant’s talc products led to cancer in users.

Read More: J&J Is Left Weighing Options After Second Talc Bankruptcy Tossed

The Jones Effect

Tehum filed for bankruptcy in February 2023, just months after it was created through a transaction that also shifted Corizon’s operating business into newly-formed YesCare Corp.

The move thwarted prosecution of hundreds of cases alleging substandard medical care in prisons, including ones that led to wrongful deaths. Driven by Corizon’s record of purportedly shoddy care of inmates, several local and state governments in New York, California, Indiana and elsewhere have canceled contracts with the provider.

The company and an official committee of unsecured creditors struck a deal in September to bring the case to a close, premised on a $37 million settlement. The plan included liability releases for YesCare and other third parties connected to the debtor.

But that proposal fell apart after revelations in October that Houston bankruptcy judge David R. Jones, who mediated the settlement talks, was romantically involved with YesCare’s hired attorney, Elizabeth Freeman. Discovery of the relationship led to Jones’ resignation, and snowballed into myriad legal actions affecting corporate bankruptcy cases involving Freeman and her former law firm.

“All of the Jones stuff played into the case trajectory” and the appointment of a new committee that has been more critical of Tehum, Gayda said. “They’re the fly in the ointment.”

For Tehum, the fallout led to a public rebuke by nine Democratic senators, renewed settlement negotiations, and the appointment of an official committee tasked with representing the interests of only the tort claimants.

‘Gratuitous’ $10 Releases

Tehum and the unsecured creditors’ committee advanced a revised settlement in January. The new deal increased the settlement pool to about $55 million, while keeping intact provisions that would release claims against Tehum’s affiliates, including director Isaac Lefkowitz.

The settlement quickly drew backlash from the newly-appointed tort claimants’ committee, which moved in January to have the case dismissed so plaintiffs could sue YesCare and others “who orchestrated this fraud” to cheaply settle $775 million worth of injury claims.

In a Jan. 31 letter, Warren lamented the lack of accountability for Corizon committing “serious harms,” and urged the US Trustee to back the committee’s motion to toss the case.

The US Trustee ended up assailing the proposal for its lack of details about the value of assets intentionally kept out of Tehum’s estate, and its inclusion of “gratuitous” litigation releases for third parties. The government cited excerpts from a recent deposition of Lefkowitz, in which he stated that he would be contributing just $10 in exchange for a release.

The case serves as a demonstration that “valid challenges can disappear” if everybody settles, Emory University’s Simon said.

‘Everybody Here Is Mad’

In spite of the vociferous pushback, factions of creditors, including some tort claimants, still support Tehum’s proposed settlement.

“Sometimes a bird in hand is better than nothing at all,” said Betsy Lynch of Chinnery Evans & Nail PC, an attorney representing the estate of an inmate who died while in custody. “Everybody here is mad and everybody here is going to lose — but how much you lose is all going to depend on a variety of factors and every individual claim.”

Lynch’s client, the estate of Robert Miller, can continue to press claims against the city of St. Louis and others over Miller’s death once the bankruptcy is over, she said.

There are also personal injury plaintiffs who oppose the pending offer but still believe bankruptcy offers their best shot at recourse.

Alabama Department of Corrections inmate Tracey Grissom has a pending lawsuit alleging Corizon staff’s inattention to her medical need for an ostomy bag led to intestinal protrusion out of her body. For her, bankruptcy may be the only way to pursue claims against the state of Alabama, her lawyer said.

“Tracey’s medical provider is doing business with the state of Alabama and you can’t go sue the state” without running up against sovereign immunity defenses, said Grissom’s attorney, Frank Ozment. Bankruptcy has some tools to get around those defenses, he said.

But with the current deal, Tehum and YesCare are “manipulating the bankruptcy process,” he said. “There’s a brazenness to it that makes you wonder, ‘What is going on here?’”

Tehum is represented by Gray Reed LLP. The unsecured creditors’ committee is represented by Stinson LLP. The tort committee is represented by Brown Rudnick LLP.

The case is In re Tehum Care Services Inc., Bankr. S.D. Tex., No. 23-90086, trial 3/1/24.