Texas Two-Step Spat Revival Deserves Supreme Court’s Attention

Must a debtor be in financial distress to be in bankruptcy? This is essentially the question presented by the petition for a writ of certiorari to the US Supreme Court filed by the Official Committee of Asbestos Claimants in Bestwall LLC’s Chapter 11 bankruptcy case. We recently filed an amicus brief in support of this petition, joined by several prominent bankruptcy and legal historian professors, focusing on why the answer to this question goes to core constitutional judicial powers—and should be “yes.”

The answer will fundamentally shape how companies can leverage bankruptcy as a litigation management system, bypassing ordinary courts, drastically curtailing due process protections, and forcing people into structurally biased settlements. The Supreme Court should step in to resolve a circuit split about the need for financial distress to maintain a Chapter 11 case.

Bestwall is a subsidiary of Georgia-Pacific LLC that Georgia-Pacific strategically placed in bankruptcy in 2017 as part of a legal maneuver called the “Texas Two-Step.” This allowed Georgia-Pacific to place its healthy assets and business operations in one business entity while saddling Bestwall with virtually all of its asbestos-related liabilities. At the time, Georgia-Pacific was facing tens of thousands of personal injury claims stemming from asbestos exposure.

Bestwall then filed Chapter 11 in a bankruptcy court in the Western District of North Carolina. It entered Chapter 11 supported by a “funding agreement” from Georgia-Pacific that guaranteed to fully pay the asbestos-related financial obligations. While Bestwall’s case was pending, the US Court of Appeals for the Third Circuit booted Johnson & Johnson’s subsidiary from Chapter 11 after it filed under similar circumstances, holding that its petition lacked good faith, as required by bankruptcy law, because the subsidiary didn’t evidence some degree of financial distress based in large part on its funding agreement from J&J.

The Third Circuit’s holding paved the way for the asbestos claimants’ committee in Bestwall to appeal to the US Court of Appeals for the Fourth Circuit on the basis that, like the debtor in the J&J matter, Bestwall entered Chapter 11 solvent and not in financial distress because of the funding agreement and thus its filing wasn’t in good faith. Contrary to the Third Circuit in J&J’s case, the Fourth Circuit held that financial distress isn’t required for a Chapter 11 filing to be deemed to be in good faith. The court held that even though Bestwall was solvent, its filing still was for a valid purpose—resolving the asbestos claims—and thus met the good faith requirement.

Under the Fourth Circuit’s holding, financially solvent companies may freely turn bankruptcy courts into a litigation management system. However, we think the framers of the Constitution likely would have said that bankruptcy isn’t an all-purpose litigation management vehicle. Our brief focuses on the historical foundations and constitutional scope of the bankruptcy system to resolve the circuit split about the need for a debtor to be in financial distress to use bankruptcy.

As we show in the brief, Congress’ power to enact laws on the “subject of bankruptcies” under Article I, Section 8, Clause 4, presumes a debtor in some form of financial distress in the form of insolvency, a refusal to pay, or acts in fraud of creditors. Because Bestwall concedes that none of these conditions are met, its use of bankruptcy couldn’t be constitutionally permissible under the Bankruptcy Clause and its case can’t continue to proceed in bankruptcy court.

Although the scope of bankruptcy isn’t frozen in its founding-era form, it always has presumed some degree of financial distress on the part of the debtor. This was true in 18th-century England, where bankruptcy was limited to balance-sheet insolvents, refusal to pay, and people who defrauded their creditors. The same was true of the US’s earliest-enacted bankruptcy regimes.

When Congress enacted the current Bankruptcy Code in 1978, the legislative history emphasized that Chapter 11 should promote speed to minimize value destruction caused by delay. Filing didn’t require a showing of insolvency. But that didn’t mean Congress believed financial distress was irrelevant. Instead, doctrines such as good faith would cabin access to bankruptcy, precluding companies from using bankruptcy to escape other parts of the legal system.

This history is even more important when bankruptcy threatens other structural protections of the legal system, particularly the rights to an adjudication of private-rights disputes by an Article III or competent state court, and a jury trial. The Bestwall bankruptcy, now in its ninth year, enables Georgia-Pacific to bypass these central protections. Although Chapter 11 can do that in appropriate cases, the constitutional justification for such displacement always required a debtor in genuine financial distress.

Under the Fourth Circuit’s interpretation, however, the bankruptcy power is indifferent to financial distress: Any debtor sued or facing the threat of lawsuits can pick an entirely different forum, displacing the civil justice system.

This result seems deeply problematic. Rather than plaintiffs deciding when and where to initiate lawsuits, and then how to pursue those lawsuits, defendants can flip the legal system on its head by filing bankruptcy and putting themselves in the litigation driver’s seat. The history of bankruptcy shows that the bankruptcy system was never meant to be used to circumvent other portions of the overall justice system—true financial distress is, and always was, key to prevent such circumvention.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Pamela Foohey is the Allen Post Professor of Law at University of Georgia School of Law.

Jonathan C. Lipson holds the Harold E. Kohn Chair and is a professor of law at Temple University Beasley School of Law.

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