Many companies involved in mass tort claims that incur excessive amounts of debt opt for Chapter 11 bankruptcy. It is a form of bankruptcy that allows the company to still operate while it reorganizes in an attempt to pay the debt. However, some high-profile companies have recently employed strategies designed to centralize claims, obtain finality, and avoid trials. These strategies are called:
- The Texas Two-Step
- Extending the Automatic Stay to Third Parties
- Nonconsensual Non-debtor Releases
Tort victims do not agree with these strategies, as they believe they provide more benefits to the companies in debt than the victims looking for fair compensation. They argue that these strategies are designed to circumvent trials, impose settlements without consent from victims, and give companies the advantages of bankruptcy without the burdens. Attempts at using these strategies have led to federal court appeals that will determine how mass tort cases are litigated in the future.
What is Chapter 11 Bankruptcy?
Some personal injury claims involve many plaintiffs (mass torts) that require a company to go bankrupt to reorganize the company’s debts, assets, business affairs, etc. This is where Chapter 11 bankruptcy, known as reorganization bankruptcy, comes into effect. A company will file for Chapter 11 bankruptcy to restructure its debts under the supervision of a U.S. court.
Chapter 11 bankruptcy can buy a company time to operate while they handle the massive debt incurred, possibly during a mass tort case. The company will remain open under the leadership of the owner of the company currently in debt (the debtor in possession) unless they are involved in a case of fraud, dishonesty, or gross incompetence. In that case, the court will appoint a trustee to run the company through bankruptcy proceedings.
While under Chapter 11, the company cannot make important decisions without the approval of the court. These include selling assets, starting or ending a rental agreement, stopping or increasing business operations, or negotiating a loan to commence after the end of the bankruptcy. The debtor in possession must propose a plan to reorganize the company to escape the debt, which can include downsizing, renegotiating debts, or liquidating assets.
The Texas Two-Step Allows a Company to Divide Itself
The first controversial bankruptcy strategy is called the Texas Two-Step and involves an existing company dividing itself into two or more entities. One entity keeps the assets and businesses, while the other absorbs all of the liability and debt and files for bankruptcy. The entity with the assets funds the other entity’s bankruptcy.
This strategy is designed to hide liability in bankruptcy, which can affect the level of compensation mass tort victims can receive and undermine creditor-debitor relationships. This strategy was employed by Johnson & Johnson in the LTL Management case meant to address the dangerous qualities of Johnson & Johnson’s talc products. It allowed Johnson & Johnson to benefit from the advantages of bankruptcy for their new subsidiary without incurring the negative effects of bankruptcy, including damage to the company’s reputation, financial situation, or credit rating.
The case is currently pending in the Bankruptcy Court for the District of New Jersey. The Third Court is reviewing the bankruptcy court’s denial of motions meant to dismiss the case for being filed in bad faith. The talc claimants’ representative argued that Johnson & Johnson used this strategy to receive bankruptcy benefits without the disadvantages, while Johnson & Johnson argued this strategy provided the claimants a better chase to receive a settlement for their damages. The panel overseeing the oral arguments was more in favor of Johnson & Johnson’s argument, which could make way for this strategy to be more widely used.
Extending the Automatic Stay to Third Parties Relieves Them From Litigation
The automatic stay provision protects an entity in debt from receiving harassment and the threat of lawsuits from debt collectors. This provision normally protects the debtors themselves, but recent cases have extended the protection to third parties. Extending the automatic stay to third parties relieves them from litigation attempts until the debtor can obtain a global settlement with third-party coverage in reorganization plans.
This strategy was used in the Aearo case, which seeks to hold subsidiaries of 3M liable for damages caused by earplugs used by the military that result in hearing loss. Aearo is one of the subsidiaries of 3M that plaintiffs are attempting to hold liable through product liability. The company and its affiliates filed for Chapter 11 in the Bankruptcy Court for the Southern District of Indiana and attempted to extend the automatic stay to 3M.
Judge Jeffrey Graham refused to extend the automatic stay, stating that the court’s legal standard was not the same as the Fourth Circuit’s that the debtor wanted them to follow. He also noted that 3M’s obligation to fund Aearo’s bankruptcy had nothing to do with extending the automatic stay. Aearo and 3M filed a direct appeal in the Seventh Circuit, with a decision in their favor possibly setting a precedent for the Seventh Court being a more attractive venue for mass tort cases.
Nonconsensual Non-debtor Releases Removes Third Parties From Liability
Chapter 11 bankruptcy sometimes releases nonconsensual non-debtor third parties from liabilities associated with the debtor. The majority of circuits allow nonconsensual non-debtor releases for third parties, but there are other federal courts unsure of whether they should be approved.
This issue has come up in the Purdue Pharma case, with the legality of the issue on appeal at the Second Court. Purdue Pharma is the largest opioid case in U.S. history and recently involved a $6 billion global settlement. The Second Circuit is currently reviewing the ruling by the U.S. District Court for the Southern District of New York that the bankruptcy court did not have the authority to approve nonconsensual non-debtor releases for third parties in the Purdue Pharma Case.
Judges seemed to be moved by the debtor’s oral arguments, which included the support for their reorganization plan and the point that the undoing of the plan would not lead to better settlements for the victims. This could set a precedent for nonconsensual non-debtor releases for third parties, but it’s unlikely for it to take hold across the country unless the U.S. Supreme Court makes a ruling.
Will Congress Allow for These Chapter 11 Bankruptcy Strategies?
There have been previous attempts in Congress to curb these strategies, but those movements did not gain enough momentum to stop companies from using them. Due to a divided government, it’s highly unlikely anything will be done by Congress to stop these strategies from being used.
As more mass tort cases are litigated, laws will develop based on what happens in each case. There may come a day when one of these mass tort cases gets litigated in front of the Supreme Court due to constitutional issues or circuit splits. In that case, a decision may be made to prevent companies from using these strategies.