Johnson& Johnson’s Scheme to Avoid Cancer Lawsuits Just Fell Apart in Court
A cynical Big Law shell game got torched at the 3rd Circuit.
BY MAX KENNERLY
JAN 31, 20231:55 PM
Informant: Nicole Hausmann
Periscope News Group
Over the past few years,corporations facing thousands of lawsuits have increasingly turned to a legaltactic that was literally a joke in The Office: declaring bankruptcy under a differentname. As the legal theory goes, it doesn’t matter if the company isactually insolvent or in need of debt restructuring, because a quirk in Texaslaw allows companies to perform a “divisional merger” in which two newcompanies are created: one to keep all the productive business assets and oneto absorb the litigation liabilities. The latter company then declaresbankruptcy and uses the bankruptcy process to delay, reduce, or whollyeliminate the claims against it. This so-called “Texas two-step”looked to be the future for mostmass torts (particularly those involving carcinogens) untilMonday, when the 3rd U.S. Circuit Court of Appeals pumped thebrakes in the LTL Management case.
LTL Management markedJohnson & Johnson’s effort to avoid liability for its talc-based babypowder products. (Disclosure: I’ve litigated against J&J subsidiaries buthave no financial interest in the talc litigation.) Tens of thousands of peoplehave sued the company, claiming it knew these products contained asbestos that caused womento develop ovarian cancer and mesothelioma. In response to aslew of lawsuits from patients and their survivors across the country, J&Jcreated two new companies. It offloaded all its liabilities into one, calledLTL Management, and shifted all its assets into another, called J&JConsumer Inc. The first company, LTL Management, then swiftly declaredbankruptcy and obtained an injunction against lawsuits involving J&J’s talcproducts, preventing alleged talc victims from moving forward at all in theircases, much less recovering damages. Meanwhile, the second company, J&JConsumer Inc., just kept on making money.
If this looks like an obvious shellgame, that’s because it is. And it gets worse. J&J is headquartered andincorporated in New Jersey. Yet it created these new companies under the lawsof Texas, then filed bankruptcy in North Carolina. Why? Forum shopping. NorthCarolina is in the 4th U.S. Circuit Court of Appeals, which hasa low standard for determining if a bankruptcy was filed “in good faith.”That gives the Texas two-step a better chance of passing muster. As the 3rd Circuitnoted yesterday, it is “perhaps not by coincidence then, debtors formed bydivisional mergers and bearing substantial asbestos liability seem to preferfiling in the Fourth Circuit, with four such cases being filed in the WesternDistrict of North Carolina in the years before LTL’s filing.”
But that’s where everything startedgoing off the rails for J&J. The bankruptcy court for the Western Districtof North Carolina noticed some rather obvious problems with thefiling. For example, “the employees of the Debtor are all employeesof Johnson & Johnson Services, Inc., a New Jersey corporation,” and “theDebtor’s assets involve no operation of a business in North Carolina.” Thecourt concluded that “in this case, the Debtor is not just forum shopping; theDebtor is manufacturing forum and creating a venue to file bankruptcy.” In ourera of rising judicial sophistry and arrogance, Judge J. CraigWhitley’s candor and humility is refreshing: Pointing out thatJ&J’s claims mirrored four previous bankruptcy cases filed in his district,he wrote: “There is no reason this court should be the only bankruptcy court tohave the opportunity to weigh in on these novel legal issues, especiallyconsidering that the ‘Texas Two Step’ tactic is being employed by nationalcorporations and impacts tens of thousands of present and future claimantsacross the country.”
Judge Whitley thus transferred thecase to New Jersey, where it should have been filed in the first place.
New Jersey was a more receptivevenue for J&J, which is one of the state’s largestbusinesses. The plaintiffs filed a motion to dismiss the bankruptcy,but the New Jersey bankruptcy court let J&J have its cake and eat it too,allowing LTL Management to rely on a $61 billion “funding agreement” withJ&J to show that it wasn’t just pulling off an enormous fraudulent transferwhile also allowing LTL Management to pretend it only had$373.1 million in assets for purposes of deciding if the company was in“financial distress.” The bankruptcy was allowed to proceed—including,crucially, the “automatic stay” that prevented lawsuits against J&J fromgoing forward in other venues.
Plaintiffs appealed to the 3rd Circuit,and J&J did what a lot of shady companies do when they want an appellatecourt to adopt a cockamamie legal theory that lets them avoid ever facing ajury trial: hire Neal Katyal.(Plaintiffs hired David Frederick. If you’re so inclined, the two-and-a-half-houroral argument is available here.)And on Monday, the court sided firmly with the plaintiffs.
The 3rd Circuit’sprecedential opinion doesn’t wholly neutralize the “Texas two-step,” but itdoes make it harder for corporations to knock over more structural componentsin our already shaky civil justice system. Bankruptcy is, by design, one of themore potent tools in the law, a legal black hole with a gravitational pull thatautomatically halts every lawsuit in the country against a debtor, grantscourts the discretionary power to halt other lawsuits that might affectthe debtor, and pulls in every debt, contract, and claim ever made against thecompany, enabling debtors to set their claimants against one another as theyfight for timing and priority. In LTL Management, the 3rd Circuitmade clear that bankruptcy is not merely an alternative proceeding thatcorporations can elect if they dislike the results produced by the civiljustice system: “absent financial distress, there is no reason for Chapter 11and no valid bankruptcy purpose. … Financial distress must not only
J&J is, of course, not infinancial distress. The 3rd Circuit noted: “At the time ofLTL’s filing, J&J had well over $400 billion in equity value with a AAAcredit rating and $31 billion just in cash and marketable securities. Itdistributed over $13 billion to shareholders in each of 2020 and 2021.”Moreover, the 3rd Circuit recognized that J&J’s estimate ofthe potential defense costs and liability from its talc products—well over $300billion—was wildly inflated: J&J had already settled about 6,800talc-related claims for under $1 billion and obtained dismissals of about 1,300ovarian cancer and over 250 mesothelioma claims without paying a dime tothe plaintiffs. The essence of the 3rd Circuit’s opinion isthat courts need to look seriously at the company’s actual situation, ratherthan eagerly accepting every bit of contradictory hype pushed by the company’slawyers.
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Presumably, J&J’s next step is to file for certiorariwith the U.S. Supreme Court. (It could file for en banc reviewwith the full 3rd Circuit, but that is likely a lost cause.Because it was a precedential decision, the draft was already circulatedamong the entire 3rd Circuit and the three-judge panel wasnonetheless comfortable with their unanimous opinion.) Certiorari seems alongshot: The Supreme Court already declined an opportunity to review a $2.24billion talc judgment against J&J in favor of 20 ovarian cancer plaintiffs,there’s no split among the circuits yet on the “Texas two-step,” and the 3rd Circuit’sopinion is well reasoned and limited to the issue at hand.
One final point: this case alsoprovides us with a concrete answer to the question “how much does it cost toget the supposed liberal hero Neal Katyal to help a SeditionCaucus–funding corporation like Johnson &Johnson try to slam the courthouse doors on thousands of cancervictims?” The answer is $2,465 an hour.