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Johnson & Johnson’s controversial use of Chapter 11 to handle widespread asbestos-related litigation is under review by the Third Circuit, which will weigh whether a financially healthy company can use bankruptcy to resolve mass tort cases.
The dispute stems from J&J’s decision last year to shift billions of dollars in mass tort liabilities to a newly-created entity, LTL Management LLC. The health care giant then immediately placed LTL into bankruptcy to consolidate all its asbestos litigation in one place.
The US Court of Appeals for the Third Circuit on Monday is hearing oral arguments on whether a solvent company can spin off an entity to handle mass tort claims. The court will also review the extent of bankruptcy courts’ powers to shield non-bankrupt companies—including Johnson & Johnson—from being sued for those injuries.
The Third Circuit ruling will likely be watched closely as more companies resort to similar ways to cabin mass tort liability in a spun-off company with few assets.
Victims who allegedly suffered asbestos-related injuries from using J&J’s baby powder appealed to the Third Circuit a ruling by the US Bankruptcy Court for the District of New Jersey in February that declined to dismiss LTL’s bankruptcy. The court also barred any further litigation against J&J and other co-defendants.
In siding with LTL and J&J, the bankruptcy court said handling complex mass tort litigation is a valid purpose for bankruptcy, even if a debtor’s assets are greater than its liabilities.
But the tort claimants will argue that J&J, with a market capitalization of about $450 billion, is an enormous financial success, and its bankruptcy filing for LTL was done in bad faith. The US Trustee, the Department of Justice’s bankruptcy watchdog, has agreed with the claimants.
The claimants also argue that the bankruptcy court’s ruling violates their constitutional rights to due process and to a jury trial.
The bankruptcy code exists to give the “honest but unfortunate debtor” a fresh start, said Monique Hayes, a partner of DGIM Law and adjunct professor at the University of Miami School of Law.
“When there’s a catastrophe, you need redress that’s fair and equitable, but you also have the idea that people and businesses should be able to get a fresh start,” she said.
At the heart of the case is J&J’s use of a Texas state law that allows companies to split into two, with one of those new entities exclusively housing tort liability. The maneuver is commonly called the “Texas Two-Step.”
Facing tens of thousands of claims alleging J&J’s product caused mesothelioma or ovarian cancer, J&J’s affiliate that sold the baby powder split into two new entities. One of those entities, LTL, assumed the liabilities but none of the operations or assets.
J&J funded LTL with $2 billion to pay tort claimants. Shortly after its creation, LTL filed Chapter 11.
“J&J is using this bankruptcy as a tactic to force an agreement—an attempt to remove the jury trial,” said attorney Jonathan Ruckdeschel of Ruckdeschel Law Firm, LLC, who represents a mesothelioma claimant.
It’s not per se bad faith to use the Texas Two-Step, said Bruce Markell, a bankruptcy professor at Northwestern Pritzker School of Law and former bankruptcy judge.
But the combination of several factors—including J&J’s quest for legal protections, the LTL spin off, and attempt to avoid jury awards—that make it problematic for many critics of J&J’s moves, Markell said.
If the Third Circuit doesn’t reverse, “the public’s confidence in a just bankruptcy system will be further eroded as the rich get to write their own rules,” Markell said.
LTL argues that bankruptcy is a more efficient way to manage mass tort debt even for the claimants, as it would likely result in quicker payouts. Many victims are dealing with serious, terminal illnesses.
“There’s no way the tort system could conceivably keep up with” all of victims’ claims, LTL said in a court filing. The bankruptcy court would proceed “at a far more expeditious pace,” it said.
Damage awards can also vary widely among state courts. “Talc litigation has already proven inequitable,” LTL said in court filings.
The New Jersey bankruptcy court said in its ruling that tort claimants would have to engage in “an uneven, slow-paced race to the courthouse” if their claims weren’t handled through LTL’s bankruptcy.
LTL has also argued that a bankruptcy court is the least expensive and most expedient forum for handling mass tort litigation.
The bankruptcy court agreed, finding that without Chapter 11, the company would spend between $100 and $200 million a year litigating the claims. Such litigation could take decades, the New Jersey bankruptcy court said.
Counsel for LTL didn’t respond to a request for comment.