The Texas Three-Step

Johnson & Johnson is preparing to take a third crack at addressing its toxic talc liabilities through bankruptcy in what we might call a "Texas Three-Step". And as with J&J's previous attempts, this one has some pretty glaring issues.Yet because of J&J's ability to forum shop and even picks its judge, it will likely be able to sidestep adjudication of many of the issues and avoid appellate review entirely. Instead, J&J's strategy is going to be to ram a seriously deficient plan through with the assistance of its hand-picked judge and then avoid appellate review through the equitable mootness doctrine. It's a strategy that might work. And if it does, it is a sign that the bankruptcy system is seriously broken.

To recap how we got here, J&J's first attempt (LTL 1.0) was the most prominent example of the infamous Texas Two-Step technique:  J&J redomesticated a lower-tier subsidiary with talc liability to Texas and then used a unique Texas law feature to undertake a "divisional merger" that split the subsidiary into two successor entities, a BadCo with talc liabilities ("LTL), and a GoodCo with most of the assets and other liabilities. GoodCo redomesticated to NJ and continued to operate normally, while LTL redomesticated to NC and filed for bankruptcy. The bankruptcy case was transferred to New Jersey, and it was ultimately dismissed by the Third Circuit Court of appeals based on LTL lacking good faith in filing its bankruptcy because of it did not face any immediacy of financial distress. 

Within hours of the dismissal order being entered, J&J was at it again, with another LTL bankruptcy filing (LTL 2.0), this time in NJ. This time around LTL filed with a plan support agreement signed by attorneys claiming to represent tens of thousands of talc claimants, many of whom had never asserted a claim in LTL 1.0, in the bankruptcies of J&J's talc suppliers (Imerys and Cyprus Mines), or in the talc MDL. Despite the support from these putative claimants, LTL 2.0 didn't get very far. The bankruptcy court, constrained by the Third Circuit, reluctantly dismissed the case for lack of good faith filing. 

That brings us to the current attempt. Last winter LTL redomesticated back to Texas and changed its name to LLT. Now J&J is proposing a new prepackaged bankruptcy plan (LTL 3.0). Here's the basics of it.

First, J&J is trying to make LTL 3.0 only about ovarian and other gynecological cancer claims. To that end, it has been trying to settle as many of the non-ovarian/gynecological cancer claims as it can—governmental claims, insurers, mesothelioma victims. 

Additionally, to further ensure that the third bankruptcy only deals with ovarian and gynecological cancer claims, J&J plans a series of complex series progression of corporate transactions that will result in LLT disappearing but having as its successor two new Texas entities:  Red River Talc LLC and Pecos River Talc LLC.  Red River Talc LLC will be the entity allocated all of the domestic ovarian and other gynecological cancer claims. (I'll avoid comment on the incredibly bad judgment in the choice of company name...). Pecos River Talc LLC will be allocated all of the mesothelioma and lung cancer claims, as well as the Canadian personal injury tort claims. (Why not a separate Canadian River entity, eh?) In other words, there will be a slimmed down BadCo that will have only ovarian and gynecological cancer liabilities, and that will be the debtor entity, so the remaining mesothelioma claims, etc. will not be directly affected by the bankruptcy. 

You'd think J&J would have hived off the ovarian/gynecological cancer claims with just a simple divisional merger of LLT into two entities, but no. J&J has come up with a much more complex string of transactions to achieve the same result. We might call it the "I'm my own grandpa" transaction. To summarize: a J&J subsidiary, Old Holdco, currently owns LLT.  Let's call Old Holdco "Dad" and LLT "sonny boy." A new entity, New HoldCo (let's call it "Grandpa"), will be incorporated and funded with the equity interest in the Old Holdco (Dad) of LLT. Old Holdco (Dad)  will redomesticate to Texas. LLT (sonny boy) will merge into Old Holdco (Dad).  Afterward, Old HoldCo (again Dad, now combined with sonny boy) will undertake a divisional merger into three entities—Red River, Pecos River, and a third entity. The third entity will merge back into New Holdco (Grandpa). If this isn't some version of "I'm my own grandpa," then it's surely a revival schismatic heresy about the nature of the Trinity. 

So why is J&J doing all of this corporate strum und drang? As far as I can tell it's just a giant fraudulent transfer mechanism. LLT's major asset is a 2023 Funding Agreement with Old HoldCo. By merging LLT into Old Holdco, the funding agreement "effectively terminates":  the funder and the fundee become the same entity. I've got to say that it's clever. But it also seems vulnerable to a fraudulent transfer challenge, just like the termination of the original 2021 Funding Agreement before the LTL 2.0 bankruptcy.

Second, having hived off the ovarian/gynecological cancer claims with settlements and corporate transactions, Red River is going to solicit votes on a prepackaged plan that will set up a personal injury trust to funded with $8 billion over 25 years ($6.5 billion present value). All ovarian/gynecological cancer claims will be channeled to the trust under a 524(g) injunction, meaning that reorganized Red River will have no liability for future talc claims.

Third, the channeling injunction and a release is also supposed to cover all of the other J&J affiliates and be supplemented with a section 105(a) injunction that will cover additional parties, such as retailers that sold J&J talc products. Q.E.D. 

Now there are some substantial issues with this plan. Let me adumbrate a few of them: 

(1) Good faith. J&J has foundered on the shoals of good faith twice so far because of a lack of immediacy of financial distress. Nothing has changed about the nature of the financial distress; if anything Red River's distress is less because it has fewer claims against it and it's entered into settlements for many of them. Presumably the J&J strategy is to hope that it will get different results in a different circuit. (There's still the separate good faith issue of bankruptcy being used as a litigation strategy.) In particular, J&J is likely planning to shop for a friendly bankruptcy judge who will confirm a plan notwithstanding the glaring good faith problem, at which point it becomes a question of whether an appeal will be heard before the plan is substantially consummated and equitable mootness kicks in. The lack of a timely appellate check on bankruptcy courts is an invitation for bankruptcy judges to disregard circuit law they disagree with. That's a fundamental problem in the bankruptcy system.

(2) Fraudulent transfer. The whole scheme is frankly a fraudulent transfer—the bankruptcy process is being used to hinder, delay, and defraud creditors by forcing a low-ball settlement on them without an opt-out—but the termination of the 2023 Funding Agreement is more specifically a problem as noted above. Yet delay will kick in again to help J&J. Red River will have first crack at a fraudulent transfer action and by the time it gets pried away from Red River, well, the action will have been settled as part of the plan, so we're right back to the lack of timely appeal problem. The rights of tens of thousands of women should not be determined by an Article I judge (or frankly any judge) who is effectively immune from appellate review. 

(3) Scope of Releases. The releases in the contemplated plan have a Purdue Pharma risk.  Red River can get a channeling injunction and discharge without question if it meets the necessary requirements. J&J affiliates can get a channeling injunction and release under 524(g) for their derivative liability of Red River. But they cannot get a release or channeling injunction under section 524(g) for their direct liability, and the top level J&J parent company has direct liability. And retailers cannot get any release or channeling injunction under section 524(g). J&J surely knows this and the disclosure statement suggests that they are going to run these releases and channeling injunction under section 105(a), the last refugee for  scoundrels and bankrupts. As things currently stand, that doesn't work in the Fifth Circuit, and it might not work anywhere if the Supreme Court overturns the 2nd Circuit's decision in Purdue Pharma. There's a risk that the plan leaves J&J on the hook for its own liability and for indemnity obligations to retailers.  

(4) Nature of the Prepackaged Plan. The prepackaged plan here is just weird. It is a solicitation of votes on a prepackaged plan for a debtor entity that does not yet exist, with no commitment to file the plan, no commitment about where the plan would be filed if it even is filed, and no commitment to fund the plan. So women are being asked to vote on a whole bunch of hypotheticals.  Furthermore, the disclosure statement was prepared and signed by LLT's officers, but the plan is supposedly for Red River. How is a disclosure statement prepared by a third party for a non-existent entity supposed to be binding on that non-existent entity? 

Additionally, I've never seen a prepackaged plan be used in this sort of highly contested mass tort context. There have been prepackaged asbestos plans, but those have been used to deal with future claims when there's already a deal with buy in for almost all present claims. That's not this situation. The super-fast prepack mechanism, with fewer procedural protections, seems inappropriate for a highly contested mass tort situation. 

(5) Classification and Voting. I've previously noted the problem of J&J trying to stuff the bankruptcy ballot box with "junk" claims. Many of these "junk" claims are apparently settled, subject to a master settlement agreement. It's not clear if the settlements are really finalized or not, but that matters because it means that it isn't clear who will receive what un her the plan. I cannot figure out who goes in what class:  are settled claims subject to a master settlement agreement in Class 3 (general unsecured claims, as they are now just contract claims)? Or are they in Class 4 (talc personal injury claims)? If they're in Class 3, they don't vote, so the ballot box stuffing goes away, but J&J then faces a real risk that it won't get the votes needed to get the channeling injunction (75%).  And if they're in Class 4, then there's an 1123(a)(4) problem because there's payment of the settled claims through a different mechanism with different funding risk. 

(6) Feasibility. The funding of the trust will take 25 years, as it is cash payments (I think), rather than an immediate slug of J&J stock. Can any of us say with any confidence that there will be a J&J entity capable of making the payments in a quarter century? My own rule of thumb is that once payments go beyond 10 years in any bankruptcy that it starts to raise real feasibility concerns. Sure, folks will still likely be buying Band-Aids, but there are liabilities that can arise too--consider the Tylenol-autism litigation that J&J defeated this year. It's entirely reasonable to think that other such litigation might arise over the next quarter century and impair J&J's future repayment capacity. 

These are just some top level issues—there's a lot of problems in the weeds and a whole bunch more that I cannot figure out if actually exist or not because of lack of clarity in the disclosure statement—but as noted regarding (1) and (2), the J&J strategy here is the steamroller. J&J is going to come into court claiming to have the votes to confirm the plan with the channeling injunction and it will try to ram confirmation through before objecting talc victims can ever get a real hearing on their objections. If the judge is friendly, the judge will use control of the docket and scheduling sequencing to ensure that a plan confirmation comes up before various challenges can be heard, leaving objectors to have to fight against a plan confirmation order.

The scary thing is that because of J&J's ability not just to forum shop the case, but to pick the judge, J&J's got a good chance of succeeding because it's not going to file unless it has a judge lined up whom it feels confident won't blow the whistle and stop its hurry-up play. The plan has committed to filing in any particular venue, but it's pretty clear J&J won't go back to the Third Circuit and given the Texas domestication (and lack of other obvious venue hooks via location of assets or principal place of business), it's not hard to guess where they will file. 

* I am a consultant for counsel for certain parties with talc claims against J&J. These opinions are solely my own.