By: Jacqueline Brant*

The Texas Two Step: Double Standards of Bankruptcy Code Abuse

 

For decades, there has been a stigma attached to individuals seeking to discharge their debt through filing bankruptcy. The purpose of bankruptcy is to “give a ‘fresh start’ to honest but unfortunate debtors by providing them with an opportunity to reorganize their affairs, make amends with their creditors, and ‘enjoy a new opportunity in life with a clear field for future effort, unhampered by the pressure and discouragement of preexisting debts.”^[1] Debtors can discharge credit card debt, medical debt, personal loans, past due rent, past due utilities, and more.^[2] Chapter 7 allows individuals and businesses with an overwhelming amount of debt to compile their assets, liquidate their assets, pay off creditors with the liquidated assets, and discharge the remaining debt they are not able to pay.^[3]

The explicit purpose of Chapter 7 bankruptcy is to give individuals and businesses a fresh start – a chance to wipe the financial slate clean and try again.^[4] Despite this, there is a stigma – almost a moral judgment – that individuals who file Chapter 7 must be running up large credit card debt, spending irresponsibly and recklessly, and are enjoying pleasures that they cannot afford.^[5] Thus, many people believe that individuals who file Chapter 7 are undeserving of financial assistance because they have purposely spent outside their means.^[6] In fact, this stigma against individual debtors filing Chapter 7 was so strong that the bankruptcy code was reformed in 2005.^[7]

Named the “Bankruptcy Abuse Prevention and Consumer Protection Act of 2005,” the reformed bankruptcy code added a harsh presumption of abuse against individuals filing Chapter 7 bankruptcy, and made it increasingly more difficult to obtain a Chapter 7 discharge by creating a “means test.”^[8] The means test is a benchmark of whether an individual is abusing the bankruptcy system – only debtors who make under the median income in their state may obtain a Chapter 7 discharge of debts.^[9] Debtors who fail the means test must declare bankruptcy under Chapter 13, which requires the individual to pay back most or all of their original debt over an extended period of time.^[10] Arguably, Chapter 13 is not a discharge of debt at all – rather, it is a reorganization of the debtor’s repayment plan.^[11]

Bankruptcy procedures for individual debtors have become increasingly harsh, leading to an all-time low in Chapter 7 bankruptcy filings in the United States.^[12] The new rules presume that individual debtors are abusing the bankruptcy system, and thus are undeserving of a full discharge. This tightening of the bankruptcy code is undoubtedly tied to popular misconceptions of low-income individuals. That is, there is a popular misconception that low-income individuals should not be allowed to discharge their debt, because these people must have spent irresponsibly or purposely not repaid their debts, and they are therefore undeserving of financial assistance.^[13] It is rooted in a societal judgment of poverty as a moral failing.^[14]

Despite the public’s hyper fixation on low-income individuals using the bankruptcy code, condemnation of corporations who use the bankruptcy code to avoid accountability for serious mass torts has been nonexistent.^[15] In fact, the public seems altogether unaware of this abuse of the bankruptcy code. Dubbed the “Texas two-step,” this strategy allows companies to evade liability by creating a legal entity before filing bankruptcy, transferring mass tort liability to the new entity, while transferring relatively little of the original company’s assets to the newly formed company.^[16]  After the new company is created, it files bankruptcy in connection with the mass tort claims – often worth billions of dollars –  and the original company’s assets are shielded because they are separate entities.^[17]

While some bankruptcy courts in the United States do not allow companies to utilize the Texas two-step, some states – Texas most famously – continue to allow this maneuver in bankruptcy courts. There have been four companies to use the Texas two-step. Three companies – Koch Industries, Saint-Gobain, and Trane Technologies – used the Texas two-step to transfer liability for claims related to their asbestos-containing products to a subsidiary and successfully shielded the parent company’s assets from asbestos liability.^[18]  More recently, Jonson & Johnson attempted to use the Texas two-step maneuver to shield their assets from claims related to their asbestos-containing talc powder.^[19] The Third Circuit Court of Appeals dismissed Johnson & Johnson’s initial bankruptcy filing, which prevented Johnson & Johnson from protecting their assets from around 40,000 lawsuits related to their talc powder.^[20] It has been estimated that the Texas two-step would save the parent company billions of dollars if successful.^[21]

Even though the Court of Appeals in the Third Circuit dismissed the bankruptcy ploy, Johnson & Johnson intends to challenge the decision.^[22] Thus, while the future of the Texas two-step is uncertain, it has not been eliminated as a strategy all together. In fact, the only way to eliminate the strategy completely in all states would be a decision from the U.S. Supreme Court.^[23] Johnson & Johnson has taken the appeal to the Supreme Court, but it is not clear whether the Court will rule on the case yet.^[24]

While corporations like Johnson & Johnson argue that the Texas two-step is the most efficient way to resolve massive amounts of tort claims and is the only way to guarantee plaintiffs a payout in a timely fashion.^[25] However, critics of the Texas two-step argue that resolving mass torts in this manner drastically decreases the available assets with which the company is required to compensate victims.^[26] For example, in the Johnson & Johnson case, their proposed plan would allow plaintiffs to recover for harm they suffered through the subsidiary’s $8.9 billion trust.^[27]

However, $8.9 billion is a mere drop in the bucket of Johnson & Johnson’s worth – over $375 billion.^[28] The fewer assets available in the pool, the less each claimant will get when split between the other tens of thousands of claimants. Thus, the Texas two-step drastically minimizes the assets that the parent company stands to lose, as well as the amount that claimants stand to gain.

Furthermore, resolving these claims through bankruptcy prevents plaintiffs from having their day in court and denies plaintiffs the protections they would receive in an ordinary court proceeding or trial.^[29] The bankruptcy proceedings essentially evaluate the financial health of the corporation – determining wrong-doing is, at best, an ancillary goal.^[30] Rather than having their claims assessed by the traditional court and jury system, claimants in many jurisdictions are forced to have their claims adjudicated by the bankruptcy court, or risk losing their claims against the corporation forever.^[31]

As noted above, there is a presumption of abuse in individual Chapter 7 bankruptcies. However, corporations are not subject to the same skepticism when they file bankruptcy. Rather, when a corporation files bankruptcy, their case may be dismissed “for cause,” which courts may interpret to be a good faith requirement but are not required to interpret it as such.^[32] In fact, only one attempt at the Texas two-step has ever been dismissed as a bad faith filing.^[33]

Regardless of whether or not the Supreme Court certifies the Texas two-step as an acceptable bankruptcy maneuver for handling mass tort claims, the presence of public stigma against individuals filing Chapter 7 bankruptcy and the absence of a similar stigma against corporation exploiting the bankruptcy code through methods such as the Texas two-step lays bare a troubling truth. American society is quicker to condemn low-income individuals than corporations who have committed mass torts against tens of thousands of people. Thus, the legal mechanisms of bankruptcy reflect the public perception of poverty as a moral failing, while protecting corporations who have perpetrated billions of dollars’ worth of injuries against the public.

 

* JACQUELINE  BRANT is a JLI Managing Editor. 

^[1] Charlie Hu, Court Rejects Johnson & Johnson’s Use of the “Texas Two-Step” to Tackle Baby Powder Liability, The University of Chicago Business Review Online Article,  https://businesslawreview.uchicago.edu/online-archive/court-rejects-johnson-johnsons-use-texas-two-step-tackle-baby-powder-liability.

^[2] Timothy Czekaj, How Bankruptcy Can Wipe Your Slate Clean, Czekaj Law LLC, https://www.keystoneattorney.com/how-bankruptcy-can-wipe-your-slate-clean/.

^[3] Alternatives to Chapter 7, United States Courts, https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-7-bankruptcy-basics.

^[4] Czekaj, supra note 2.

^[5] Bankruptcy Stigma is Not What You Think, CC Advising: Credit Counseling Session, https://ccadvising.com/articles/bankruptcy-stigma-is-not-what-you-think#:~:text=It%20is%20not%20uncommon%20that,shame%2C%20you%20are%20not%20alone; Why Does Bankruptcy Have Negative Stigma Attached to It?, Atlas Law Firm (Jan. 13, 2023), https://www.atlasbankruptcy.com/blog/why-does-bankruptcy-have-negative-stigma-attached-to-it/.

^[6] Id.

^[7] The Evolution of U.S. Bankruptcy Law: A Time Line, Federal Judicial Center, https://www.rib.uscourts.gov/newhome/docs/the_evelution_of_bankruptcy_law.pdf.

^[8] Id.

^[9] Jim Akin, What is a Bankruptcy Means Test?, Experian (Apr. 21, 2023), https://www.experian.com/blogs/ask-experian/what-is-bankruptcy-means-test/#:~:text=A%20means%20test%20is%20required,can%20afford%20to%20do%20so.

^[10] Chapter 13 – Bankruptcy Basics, United States Courts, https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-13-bankruptcy-basics.

^[11] Id.

^[12] Jack Caporal, Chapter 7 Bankruptcy and Chapter 13 Bankruptcy Statistics, The Ascent (Jan. 5, 2023), https://www.fool.com/the-ascent/research/personal-bankruptcy-statistics/.

^[13] Bankruptcy Stigma is Not What You Think, supra note 5.

^[14] Matthew Maniaci, The Dichotomy of Poverty: Humble Living or Moral Failing?, Medium (Dec. 18, 2023), https://medium.com/thing-a-day/the-dichotomy-of-poverty-humble-living-or-moral-failing-afd46a3ccff4.

^[15] What’s Stigma Got to Do with It?, American Bankruptcy Institute (July 1, 2003), https://www.abi.org/abi-journal/whats-stigma-got-to-do-with-it; George Medici, Bankruptcy’s Impact on Brand Perception, Pondel Wilkinson (July 13, 2012), https://www.pondel.com/2012/07/bankruptcys_impact_on_brand_perception/https://www.csun.edu/sites/default/files/Evolution%20of%20Bankruptcy%20Stigma%20Article.pdf.

^[16] Jason Fernando, Thomas J. Catalano, Melody Kazel, Texas Two-Step Bankruptcy: Meaning, Criticism, Example, Investopedia (Jan. 4, 2023), https://www.investopedia.com/texas-two-step-bankruptcy-definition-5225888.

^[17] Id.

^[18] Texas Two-Step Allows Georgia-Pacific to Pay Out Billions to Koch Industries, Worthington & Caron, PC (Feb. 2023), https://www.worthingtoncaron.com/News/2023/February/Texas-Two-Step-allows-Georgia-Pacific-to-pay-out.aspx; Daniel Gill, Saint-Gobain Unit’s Bid to Dodge ‘Texas Two-Step’ Challenge Nixed, Bloomberg Law (July 8, 2022), https://news.bloomberglaw.com/bankruptcy-law/saint-gobain-units-bid-to-dodge-texas-two-step-challenge-nixed; Akiko Matsuda, Trane Technologies Subsidiaries to Remain in Texas Two-Step Bankruptcies, Wall Street Journal Pro Bankruptcy (Dec. 29, 2023), https://www.wsj.com/articles/trane-technologies-subsidiaries-to-remain-in-texas-two-step-bankruptcies-617b6dd9.

^[19] Chu, supra note 1.

^[20] Kevin Dunleavy, Court Rejects Johnson & Jonson’s Texas Two-Step Bankruptcy Ploy for Talc Claims, Fierce Pharma (Jan. 30, 2023), https://www.fiercepharma.com/pharma/court-says-no-johnson-johnsons-bankruptcy-ploy-talc-claims.

^[21] Id.

^[22] Id.

^[23] Nicholas J. Schuler, Jr., A Major Roadblock for Johnson & Johnson’s Texas Two-Step, National Law Review (Aug. 22, 2023), https://www.natlawreview.com/article/update-major-roadblock-johnson-johnson-s-texas-two-step.

^[24] Kevin Dunleavy, After Appeals Loss, Johnson & Johnson Will Take Texas Two-Step Case to the US Supreme Court, Fierce Pharma (Mar. 22, 2023), https://www.fiercepharma.com/pharma/johnson-johnson-will-take-its-talc-bankruptcy-case-us-supreme-court#:~:text=After%20appeals%20loss%2C%20Johnson%20%26%20Johnson,to%20the%20US%20Supreme%20Court.

^[25] Ellen Bardash, ‘Texas Two-step’ is Only Path to Talc Claim Payouts, J&J Litigation VP Tells Senate Panel, The National Law Journal (Sept. 19, 2023), https://www.law.com/nationallawjournal/2023/09/19/texas-two-step-is-only-path-to-talc-claim-payouts-jj-litigation-vp-tells-senate-panel/.

^[26] Laura S. Rossi, The Texas Two-Step: How Corporate Debtors Manipulate Chapter 11 Reorganizations to Dance Around Mass Tort Liability, 39 Emory Bankr. Dev. J. 585 (2023), https://scholarlycommons.law.emory.edu/cgi/viewcontent.cgi?article=1239&context=ebdj.

^[27] Ronald V. Miller, Jr., Talc Powder Ovarian Cancer Lawsuit, Lawsuit Information Center: Latest News & Updates on Class Action Lawsuits & Personal Injury Settlements (Apr. 2, 2024), https://www.lawsuit-information-center.com/2-billion-verdict-in-missouri-motivates-jj-to-settle-talcum-powder-lawsuits.html#:~:text=The%20hearing%20focused%20on%20J%26J’s,trust%20provides%20more%20compensation%20quickly.

^[28] Market Capitalization of Johnson & Johnson (JNJ), Largest Companies By Market Cap, https://companiesmarketcap.com/johnson-and-johnson/marketcap/.

^[29] What is Texas Two-Step and How Does it Impact Plaintiffs in Mass Tort?, Demand Lane, https://demandlane.com/what-is-texas-two-step-and-how-does-it-impact-plaintiffs-in-mass-torts/

^[30] Maureen Carroll, The Mismatched Goals of Bankruptcy and Mass Tort Litigation, Courts of Law JOTWELL: The Journal of Things We Like (Mar. 18, 2024), https://courtslaw.jotwell.com/the-mismatched-goals-of-bankruptcy-and-mass-tort-litigation/.

^[31] Brigid Lynn, Personal Tort Claims as Core Proceedings in Bankruptcy Courts – Broad, Narrow, and Intermediate Approaches, 15 St. John’s Bankr. Research Libr. No. 19 (2023),  https://scholarship.law.stjohns.edu/bankruptcy_research_library/331/.

^[32] Katharine H. O’Neill, Dirty Dancing: Is the Texas Two-Step a Bad Faith Filing?, 91 Fordham L. Rev. 2471 (May 1, 2023), https://fordhamlawreview.org/issues/dirty-dancing-is-the-texas-two-step-a-bad-faith-filing/.

^[33] Id.