Companies Accused of Undermining Law with Texas Bankruptcy ‘Loophole’

Business, Featured

Photo of Johnson and Johnson baby talc powder. | Image by Wachiwit

When Kimberly Naranjo was diagnosed with terminal cancer, she was given 12 to 16 months to live. The single mother of seven children is expected to pass away in March 2023.

“After spending hours going over every place I’ve ever lived or worked, it was determined that the only way I was exposed to asbestos was from Johnson & Johnson’s Baby Powder,” she alleged.

The 49-year-old thought she had found a way to care for her family financially, even in death, by filing a lawsuit against Johnson & Johnson, having her claim decided by a jury. But then Johnson & Johnson declared bankruptcy, and the substance abuse counselor learned that she would not be given her day in court.

“Johnson & Johnson took advantage of a ‘loophole’ where they made a new company and put all their responsibilities related to Johnson & Johnson’s Baby Powder into that company, then filed bankruptcy, and now everything has stopped, except for the progression of my cancer,” Naranjo added.

That ‘loophole’ is known as the ‘Texas Two Step,’ and the strategy is based on Section 10.901 of the Texas Business Organizations Code, according to bankruptcy attorney Kevin C. Maclay.

“Since 2017, five different companies have filed for bankruptcy after undergoing what is referred to as a divisional merger under a somewhat obscure and previously-little-utilized provision of Texas law,” Maclay said. “They have done so to put their assets out of the reach of creditors and the courts, an unprecedented legal maneuver that undermines the entire civil justice system.”

After a corporation is split into two separate entities under Section 10.901 of the Texas Business Organizations Code, Company One is saddled with the claims while Company Two takes the corporate assets. The company that is saddled with the claims then files for bankruptcy, and victims allegedly harmed by the corporation are left in bankruptcy proceedings that can take years to resolve.

“While the Texas Two-Step so far has been used to disadvantage tort victims, the very same mechanism can, and will, inevitably be used to permit corporations to rid themselves of any unwanted creditors,” Maclay alleged. “The Texas Two-Step is a free pass for a corporation to disregard its obligations under the law at will. Unless this ‘loophole’ is closed, more corporations will engage in the Texas Two-Step scheme, and twist the bankruptcy system into something unrecognizable.”

Companies that have employed the ‘Texas Two Step’ include Johnson & Johnson, Georgia Pacific, CertainTeed, Ingersoll-Rand, and Trane.

Johnson & Johnson, for example, created LTL Management LLC in October 2021 as a separate subsidiary to manage Baby Powder talc claims under Chapter 11 bankruptcy protection.

“We are taking these actions to bring certainty to all parties involved in the cosmetic talc cases,” said Michael Ullmann, Executive Vice President, General Counsel of Johnson & Johnson, said in a press release. “While we continue to stand firmly behind the safety of our cosmetic talc products, we believe resolving this matter as quickly and efficiently as possible is in the best interests of the Company and all stakeholders.”

The subsidiary was provided $2 billion for use as a settlement fund and an additional revenue stream of over $350 million to further contribute to any potential costs or claims, according to the release.

“There are major consequences to the abuse of the Texas Two-Step loophole,” Maclay added. “As of the dates of their bankruptcy filings, there were hundreds of thousands of claims collectively pending against Georgia Pacific, CertainTeed, Ingersoll-Rand, Trane, Johnson & Johnson, and their affiliates. Those injured victims have now been trapped in illegitimate bankruptcies manufactured by undeniably wealthy companies.”

However, Paul H. Zumbro, a bankruptcy practitioner, said the strategy is an appropriate use of bankruptcy.

“While the transaction involves two steps, which is the separation of entities and a bankruptcy filing, it does not involve the side-stepping of accountability or financial responsibility,” he said. “The law should not and would not allow that.”

In its press release, Johnson & Johnson stated that its business posturing was “a means to achieve an equitable and efficient resolution of the claims raised in the cosmetic talc litigation.” The company also asserted that it “continues to believe that none of the talc-related claims against the company have merit…More than 40 years of studies by medical experts around the world continue to support the safety of cosmetic talc.”

Johnson & Johnson did not respond to requests from The Dallas Express for comment.

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