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The Texas Two-Step and How Corporations May Use it to Avoid Bankruptcy

It's a dance of sorts, and reportedly one that Johnson & Johnson considered to avoid punishment for its ovarian cancer lawsuits.

Healthcare and pharmaceutical giant Johnson & Johnson has been dealing with accusations about its baby powder for decades, and investigations have revealed that the company knew that its signature product contained asbestos. They were sued in 1997, and J&J denied the allegations, even though internal documents from the 1970s revealed the presence of asbestos in its baby powder. 

Now, more than 34,000 lawsuits are alleging that the asbestos in the talc in baby powder has contributed to cancer in patients all over the country, including women connecting the use of the powder to ovarian cancer. The product is no longer sold in the US and Canada. 

But J&J explored a plan to use a Texas law to deflect the blame and financial punishment to another company, Reuters reports. The move is called the “Texas Two-Step.” It works like this: A company with liabilities, like J&J and the asbestos suits, transforms into a Texas entity, and then the new company undertakes a “divisive merger” that splits that company into two companies, which is allowed under Texas’ divisive merger statute. Then, liabilities and assets can be split, protecting the money and letting the other company take on the liabilities. Though this would typically be a fraudulent transfer, Texas law makes it legal.

The company taking on the liabilities next files for bankruptcy, and the other company is released from all claims against it. During settlement discussions, J&J lawyers mentioned that the company was considering the move. There wouldn’t have been anything plaintiffs could have done to stop it. The potential payment could be $24 billion, and the move would limit compensation to pennies on the dollar and could end all trials in state courts across the nation. “The parent company would not have any of the stigma attached to filing bankruptcy,” says Andy Birchfield, Mass Tort Section Head of the Beasley Allen law firm, which represents thousands of ovarian cancer victims. “It would just be the new company that is formed, and there would be a limited pool of assets in that new company that would be available to the victims that are now creditors.”

In September, the plaintiffs sought a temporary restraining order and preliminary injunction to prevent J&J or any corporate affiliates from transferring its assets to a subsidiary. “Plaintiffs deserve to have their day in court before a judge and jury, not arbitrarily placed in bankruptcy court with little hope of adequate compensation,” Birchfield said via release. “Bankruptcy should not be used as a ploy to delay or deny justice for the victims of a dangerous product produced by a company with hundreds of billions of dollars in assets.”

 The financial implications could be massive as well. One suit with only 22 claimants resulted in an award of $2.12 billion already, which was reduced from an initial jury award of $4.69 billion. With tens of thousands of claimants on the latest suits, the results could be astronomical. It is unlikely to be successful, and J&J hasn’t made any moves yet, but Birchfield says plaintiffs won’t know in advance, tying up the plaintiffs in bankruptcy filings rather than giving them their day in court. “It would be atrocious for our clients and cancer victims,” Birchfield says. “They would be further victimized by Johnson & Johnson by taking this bankruptcy process and using it to their advantage, and extreme disadvantage for their former customers and our clients.”