What is the Texas Two Step?

Corporate Legal Escape Hatch In Doubt?

A legal maneuver that companies use to avoid legal responsibility for injuries they caused, the Texas Two Step’s viability may be in doubt.

It may sound like a snappy dance, but the Texas two-step is anything but pleasant. Companies facing lawsuits are burdened with high legal costs and negative customer responses. If a company chooses, it can sidestep (a legal dance maneuver) such a lawsuit by filing bankruptcy and shifting the burden onto someone else. That “someone else” is usually a subsidiary corporate entity that is registered in a corporate-friendly state such as Texas – hence the name.

By transferring the consequences of a lawsuit to a new company, the original company, and its assets, remain safe. After forming the new entity (two steps, remember), this business can then file for Chapter 11 bankruptcy while shielding the parent company from the legal and financial consequences of a tort trial.

The Two-Step in Action

Koch Industry’s subsidiary Georgia-Pacific was the first company to use the Texas two-step in 2017 as it faced a mass of lawsuits claiming it was concealing the dangers of asbestos. Georgia-Pacific achieved its legal two-step dance by transferring its assets to a new corporate entity it named (perhaps not so creatively) New Georgia-Pacific. The new corporation has continued to pay dividends totaling more than $481 billion to the parent company, Koch Industries.

3M has also used this legal step in the past, moving legal claims regarding its earplugs (worth billions) to a subsidiary and following up with a Chapter 11 bankruptcy.

Johnson & Johnson Talc Claims

Following an attempt by Johnson & Johnson (J&J) to protect itself using the Texas two-step method against mass litigation of more than 400,000 cancer suits involving its baby powder (talc) and asbestos, the Third U.S. Circuit Court of Appeals declared that J&J was too large and rich to use this legal maneuver. The court’s ruling came after the company had already spent more than $100 million in legal fees trying to “beat the system.”

After losing its appeal, Johnson & Johnson now needs to defend itself against the claim that its talc-containing baby powder causes cancer. The company has already lost several baby powder cases to the tune of $2 billion. Now it may well require $10 billion to resolve all claims, which would amount to approximately $250,000 per claim.

Potential Consequences of the J&J Case

Many companies have successfully attempted the Texas two-step method to resolve lawsuits against them. The difference here is that Johnson & Johnson is far too large to claim the need for bankruptcy, and courts may rely on this decision in future cases.

Texas Two Step bankruptcy protection may not be as effective after a new ruling in the Johnson & Johnson case.

Smaller companies fighting cancer-causing asbestos suits have been especially successful in filing for Chapter 11 bankruptcy, which has permitted them to continue operating while making deals with the hundreds of thousands of asbestos litigants. Again, this could change given the Johnson & Johnson decision.

According to University of Illinois Professor Ralph Brubaker, “The J&J decision makes the Texas two-step bankruptcy a much less reliable strategy. Solvent entities using the bankruptcy process to resolve their mass tort exposure is clearly up for grabs and raises profound issues that judges are, and will continue to, seriously struggle with.”

The recent J&J ruling indicates that courts will be inclined to accept the use of the two-step procedure only if a company is being legitimately financially threatened, i.e., as tends to be the case with smaller, more vulnerable companies. In the meantime, J&J is appealing the court’s decision.

Criticism of the Texas Two-Step: Bankruptcy maneuver allow companies to escape responsibility for their bad acts

Steven Wolens, a Texas lawmaker, and an initial supporter of the Texas two-step has now become a very vocal opponent, saying, “Had we known in 1989 that provisions could be dubiously interpreted for entities to avoid known liabilities such as those causing severe and permanent injuries and deaths, it would never have passed with the ‘Texas two-step’ provision. Never, never, never.” The bill’s original intention was to provide businesses with greater flexibility instead of allowing them to avoid legal and ethical responsibilities to their customers.

Curtis Huff, a former member of the Corporation Law Committee of the Texas State Bar that initially drafted the divisive merger amendments, agreed that the ruling had been intended to create a more flexible business environment in Texas, not to enable companies to avoid liability.

Johnson & Johnson has argued that its baby powder does not contain cancer-causing asbestos, and it has set up a $2 billion fund for tort claims as it restructures its corporation. Company execs have stated that continued defenses against said tort claims could reach a $190 billion liability, and thus, the company will appeal. Depending on the outcome, the Texas two-step will gain in popularity or will cease to be used as a legal defense in tort claims.

The Decades-Long Asbestos Conspiracy

The dangers of asbestos have been known since the early 1940s. In 1943, Charles Roemer, the attorney for UNARCO, an asbestos company, had a meeting with the attorney for the asbestos company Johns-Manville. As they discussed what to do about employees suffering from asbestos-related problems, Roemer was surprised that the company had not revealed the risks of asbestos to its employees. His question was, “Do you mean to tell me that you would let them work until they dropped dead?” The attorney, Mr. Brown, answered, “Yes. We save a lot of money that way.”

The funds that the company considered “saved” were placed, instead, into an account for those employees who suffered from asbestos-related illnesses.

Johnson & Johnson’s Next Steps

Should Johnson & Johnson succeed in its appeal to avoid the responsibility of its talcum powder liabilities, tens of thousands of asbestos sufferers may be denied the opportunity to file a tort claim and go after the company’s assets. Thus far, Johnson & Johnson has avoided being held accountable for years – since it first tested for asbestos in its product in 2003. Thousands of people have been exposed to the talc, although J&J claims its new talc powder is asbestos-free.

J&J officials were well-aware of the risks posed by asbestos yet failed to warn its customers. A loss of the company’s appeal would bring assurance to consumers that other companies with products containing asbestos will reveal this fact, rather than cover it up, and will warn the public of any potential risks involved.

References:

120 Mich. L. Rev. Online 38 (2022): Texas Two-Stepping out of Bankruptcy https://heinonline.org/HOL/LandingPage?handle=hein.journals/mlro120&div=4&id=&page=