‘Two-Step’ Spat Returns as Claimants, Senators Appeal to Justices

People suing bankrupt companies over asbestos-tainted products have long tried to convince the Fourth Circuit to decide whether those Chapter 11 cases are legally valid. Now, for the first time, one group is hoping the US Supreme Court will hear the matter.

The question goes to the heart of the controversial legal maneuver known as the Texas Two-Step, which allows a solvent company to shift its liabilities into a subsidiary and then place the unit into Chapter 11, aiming to settle those liabilities in one legal proceeding. Georgia-Pacific LLC became the first to employ the strategy in 2017 when it placed Bestwall LLC into bankruptcy, where it has remained—with no resolution in sight—for eight and a half years.

An asbestos claimants’ committee, backed by some high-profile lawmakers, insists the US Court of Appeals for the Fourth Circuit erred by repeatedly declining to consider whether a company must be insolvent to qualify for Chapter 11, which provides benefits such as a litigation stay. The claimants say the paper materials manufacturer’s products contained cancer-causing asbestos.

The significance of a high court decision in Bestwall could be “potentially bigger than Purdue Pharma,” said Christopher Hampson, a law professor at the University of Florida, referring to the Supreme Court’s 2024 decision barring popular, third-party litigation releases without creditor consent.

Sens. Dick Durbin (D-Ill.), Sheldon Whitehouse (D-R.I.), and Josh Hawley (R-Mo.) backed the Bestwall claimants in a brief March 25, saying the Fourth Circuit decision creates a “well-defined playbook” to help corporations fend off mass tort liabilities.

They, along with several other lawmakers, backed the Bestwall claimants’ prior, unsuccessful bid for Supreme Court review of a decision allowing Georgia-Pacific to enjoy legal protections through its affiliate’s bankruptcy.

Financial Distress

The claimants, who want to sue outside of bankruptcy court, petitioned the high court in February after the Fourth Circuit rejected their effort to dismiss Bestwall’s Chapter 11 case.

They say the bankruptcy was filed in bad faith because Georgia-Pacific is financially healthy, so it can cover the asbestos liabilities.

If the justices accept the appeal, they could weigh in on the Texas Two-Step, which gained visibility in recent years as Johnson & Johnson made several failed attempts to resolve its own asbestos liabilities via a subsidiary bankruptcy. But J&J never brought the fight to the Supreme Court.

Bankruptcy law “is organized around features that presuppose an economic justification for bankruptcy where its protections are legitimate only when grounded in genuine financial distress,” a group of bankruptcy professors said in a March 23 brief.

Bestwall must respond to the petition by April 27.

Constitutional Versus Statutory

The claimants’ constitutional right to due process versus the statutory argument surrounding bad faith filings has been a sticking point for creditors in cases in the US Bankruptcy Court for the Western District of North Carolina.

A Supreme Court ruling on the issue of financial distress as a requirement for bankruptcy would resolve a split between the Third and Fourth circuits, the professor group said.

The Supreme Court’s 1999 decision in Ortiz v. Fibreboard Corp. justifies dismissal for the same “serious constitutional concerns” as Bestwall’s case, requiring companies to show they have insufficient funds to pay claims in order to affirm a mass tort class action settlement, the professors said.

Without financial distress, there are grounds to dismiss Bestwall’s case for bad faith, they added.

Since it placed Bestwall into bankruptcy, Georgia-Pacific’s value has grown more than $7 billion and its parent company Koch Inc. has received billions in dividends, according to court filings.

Bestwall has been unwilling to enforce an open funding agreement with Georgia-Pacific, instead “demanding” a capped trust that would limit assets available to pay creditors, the claimants said.

Creditors of Bestwall, CertainTeed unit DBMP, and Trane Technologies Plc. unit Aldrich Pump have asked the Fourth Circuit to dismiss those companies’ bankruptcies on bad faith grounds. But until now, none appealed their losses to the Supreme Court.

“For years now, the bankruptcy courts have asked the Fourth Circuit to take these cases and give them direction about whether the Two-Step is proper,” said Clay Thompson of Maune Raichle Hartley French & Mudd, who represents asbestos claimants.

King’s Dissents

Judge Robert King provided some hope for the claimants by dissenting in the Fourth Circuit’s August decision that allowed Bestwall to remain in bankruptcy, saying the company has access to billions in funding, so it shouldn’t be in Chapter 11.

The majority, in keeping the bankruptcy alive, cited federal courts’ subject-matter jurisdiction over a bankruptcy filed by a solvent debtor.

King “has his finger on something important, but it may not be a failure of jurisdiction,” Hampson said.

King added more fuel to the fire in February when he disagreed with a separate decision rejecting two DBMP claimants’ efforts to pursue their actions outside of bankruptcy court, saying the majority “ignores” a bankruptcy code provision that states a bad faith filing is “cause” for lifting the litigation stay.

A solvent debtor that files for bankruptcy and doesn’t need the litigation pause could be cause for a judge to let creditors pursue non-bankruptcy court actions, Brigham Young University law professor Brook Gotberg said.

“There’s not really a process of cracking back down on the automatic stay, so it makes sense that a court would be really cautious in doing that,” Gotberg said. “But I do see the automatic stay as a statutory check on abuse of the filings by debtors.”

A committee representing asbestos claimants in DBMP’s bankruptcy filed a March 4 brief supporting an en banc rehearing of the Fourth Circuit’s February decision.

“King is identifying in these Texas Two-Step cases that because you don’t have a debtor with a melting ice cube or distressed business, and rather a case about liability management,” said David Castleman, a partner at Otterbourg PC. “King is really focusing on the creditors.”