Texas two-step bankruptcy
Based on Wikipedia: Texas two-step bankruptcy
In October 2021, a solvent corporation with AAA credit ratings declared bankruptcy. This was not a company on the brink of collapse, hemorrhaging cash, or unable to meet its payroll. It was LTL Management LLC, a newly created entity spun off by Johnson & Johnson to hold the legal liabilities associated with its talc powder products. The parent company, J&J, remained financially robust, continuing its operations unencumbered while its new subsidiary filed for Chapter 11 protection in North Carolina. This maneuver, known as the Texas two-step, represents one of the most aggressive and controversial evolutions in American corporate law: a strategy that allows wealthy, healthy companies to shield their assets from tort claimants by artificially engineering a financial crisis for a shell company they still control.
To understand how a company can be both solvent and bankrupt simultaneously, one must first dismantle the traditional understanding of corporate mergers. In standard commercial practice, a merger is an act of unification. Two distinct entities join forces, pooling their assets and liabilities into a single, stronger whole. The Texas two-step inverts this logic entirely through a legal mechanism known as a divisive merger. Under specific statutes in Texas, a company can legally split itself into two separate entities without the need for a traditional sale or transfer of assets. One entity retains the valuable assets—the cash, the intellectual property, the operating factories—while the other is carved out to absorb all the toxic liabilities: lawsuits, future claims, and debts.
The brilliance, from a corporate defense perspective, lies in the mechanics of this split. Because Texas law defines this division as occurring without "any transfer or assignment" of assets, it bypasses many traditional hurdles associated with fraudulent conveyance. In a normal asset sale, moving liabilities to a hollow shell while keeping the cash could be easily challenged as an attempt to defraud creditors. The divisive merger statute creates a legal fiction where the two companies simply cease to exist in their original form and are reborn as two new ones, one good, one bad.
Once this division is complete, the second step of the process begins. The newly created liability-laden entity, now saddled with millions in potential claims but possessing little to no assets, files for Chapter 11 bankruptcy. This filing typically occurs not in Texas, where the merger took place, but in North Carolina, specifically in the Western District of North Carolina. Legal scholars and critics note that this venue is chosen deliberately; the bankruptcy courts there have historically demonstrated a willingness to approve complex restructuring plans involving third-party releases that other jurisdictions might reject.
The immediate effect of filing for Chapter 11 is an automatic stay. This legal order halts all litigation against the debtor company instantly. For thousands of individuals who had filed lawsuits against the parent company for injuries related to asbestos, talc, or other products, this single motion acts as a wall. But the strategy goes further. The bankrupt spin-off can petition the court to extend that stay to cover the solvent parent company as well. Courts have permitted this expansion when the debtor demonstrates that litigation against the third party (the parent) would substantially harm its ability to complete a bankruptcy plan and distribute funds to creditors.
The result is a paradoxical state of affairs. The spin-off is in bankruptcy, yet it remains a "debtor in possession," meaning the same executives appointed by the parent company continue to run it. They are protected from lawsuits, but they also have no real money to pay victims. Meanwhile, the parent company continues to operate normally, earning profits and maintaining its credit rating, effectively immune from the very claims it just dumped into a bankrupt shell.
The ultimate goal of this intricate dance is the third-party release. In a traditional bankruptcy plan, creditors can be forced to accept a settlement in exchange for releasing the debtor from future liability. The controversial innovation of the Texas two-step is seeking a release not just against the bankrupt spin-off, but against the solvent parent company that orchestrated the whole scheme. If approved, this release prevents litigants from ever suing the parent company again, even though the parent never declared bankruptcy and possessed the funds to pay those claims outside of court.
History shows that this is not a theoretical possibility but a practiced reality, albeit one with a small footprint. While Texas divisive mergers have existed since 1989, only four major corporations have successfully utilized them to shield themselves from mass tort liabilities. All four were represented by the same prestigious law firm, Jones Day, suggesting a highly specialized playbook. The first instance occurred in 2017, when Georgia-Pacific, owned by Koch Industries, spun off its asbestos-related liabilities into an entity called Bestwall. Three months later, Bestwall filed for bankruptcy in North Carolina.
The pattern repeated with increasing frequency. In 2019, Saint-Gobain, a French multinational, executed the same maneuver through its North American subsidiary, CertainTeed. Liabilities related to asbestos-containing building products were transferred to DBMP, a shell company with no operations of its own. DBMP filed for bankruptcy in North Carolina three months later. In 2020, Trane Technologies followed suit, spinning off asbestos liabilities into Aldrich Pump and Murray Boiler, which declared bankruptcy just seven weeks after their creation.
However, it was the 2021 case involving Johnson & Johnson that brought the Texas two-step into the global spotlight and exposed its most contentious flaws. J&J created LTL Management LLC to hold billions of dollars in potential claims related to its talc products, which plaintiffs alleged caused cancer. The filing was massive, involving a trust intended to compensate tens of thousands of victims. Yet, from the beginning, critics pointed out that LTL had no financial distress whatsoever. It was funded with $2 billion by J&J and carried no debt other than the assigned tort claims.
The legal system eventually pushed back against this lack of financial distress. On January 30, 2023, the U.S. Court of Appeals for the Third Circuit ruled that LTL's bankruptcy should be dismissed. The court found that a company must demonstrate genuine financial trouble to qualify for Chapter 11 protection; a solvent entity cannot simply choose bankruptcy as a litigation strategy. This was a significant blow to the J&J strategy, forcing them to withdraw their first attempt.
Undeterred, LTL filed for a second time on April 4, 2023. But the courts remained skeptical. On July 28, 2023, Chief Judge Michael Kaplan of the U.S. Bankruptcy Court in New Jersey dismissed the second filing. The judicial system was beginning to recognize that the mechanism was being used not to restructure a failing business, but to manipulate the legal process. Even when LTL attempted a third bankruptcy filing later, it was dismissed by Judge Christopher Lopez on April 1, 2025. By late April of that same year, Judge Lopez denied requests from plaintiffs' lawyers to revive the bankruptcy, signaling a potential turning point in how courts view these aggressive restructuring tactics.
The human cost of this legal maneuvering is often obscured by corporate filings and financial jargon. For the victims—many of whom are suffering from cancer, lung disease, or other severe injuries caused by asbestos or talc—the Texas two-step represents a denial of justice. Instead of facing their day in court where they could present evidence to a jury, these individuals find themselves trapped in a bankruptcy process designed to resolve claims quickly and cheaply. They are often offered settlement amounts that are significantly discounted compared to what they might have won in traditional litigation.
Critics argue that the Texas two-step is, by definition, a fraudulent transfer. The core argument is straightforward: when a parent company strips its assets from a division and leaves it with only liabilities, knowing that this will force an insolvency, it is effectively defrauding creditors of their ability to collect on those claims. Under US bankruptcy law, fraudulent transfers are illegal attempts to avoid paying debts by moving money or assets to another entity.
However, the legal architecture of the Texas two-step has created formidable obstacles for creditors trying to prove fraud. The first hurdle is semantic. Because the Texas divisive merger statute explicitly states that no "transfer" or "assignment" occurs during the split, corporate lawyers argue that there is nothing to be fraudulent about. Without a transfer, the definition of a fraudulent conveyance cannot technically be met. While scholars note that courts could interpret this differently, the ambiguity provides a shield for the parent company.
The second obstacle is economic. Litigating a fraudulent transfer claim is expensive and time-consuming. Creditors must hire their own legal teams to challenge the merger, often while waiting years for a resolution in bankruptcy court. The third, and perhaps most insidious hurdle, is structural. In a bankruptcy proceeding, the right to sue for fraudulent transfers belongs to the bankrupt entity itself—the very shell company created by the parent. This means the executives appointed by J&J or Koch Industries would have to agree to sue their own boss to recover assets. It is a conflict of interest built into the system; the people running the debtor are financially and professionally dependent on the parent company they are supposed to be suing.
These structural barriers create a powerful incentive for plaintiffs to accept whatever settlement offer is put on the table. Faced with years of legal uncertainty, high costs, and a legal framework stacked against them, many victims feel compelled to take a discounted payment rather than fight a battle that seems unwinnable. The Texas two-step effectively leverages this desperation to force settlements that might never happen in open court.
Proponents of the strategy, including Johnson & Johnson and its legal counsel, defend the Texas two-step as a necessary tool for handling mass tort litigation. They argue that when thousands of people are injured by a single product, traditional courts are ill-equipped to handle the volume efficiently. Bankruptcy, they contend, ensures that all claimants are treated equally, preventing a "race to the courthouse" where only the fastest or richest plaintiffs get paid before the company runs out of money.
In this view, the bankruptcy trust is portrayed as a more equitable mechanism than the tort system. It promises a guaranteed payout for all victims, rather than leaving future claimants with nothing if the company goes insolvent naturally. They argue that using bankruptcy to address complex, multi-district litigation is a legitimate and fair use of the legal system's resources.
Yet, this argument falters when applied to solvent companies. The fundamental purpose of Chapter 11 is to provide relief for businesses in financial distress, giving them breathing room to reorganize and pay creditors over time. When a company like Johnson & Johnson, with billions in cash and a AAA credit rating, voluntarily files for bankruptcy, it undermines the very premise of the law. It uses a safety net designed for the struggling as a weapon against the injured.
The concept of "bad faith" is central to this debate. While US bankruptcy law does not explicitly define bad faith filing, courts have established standards that reject bankruptcies filed for improper purposes. These include cases where a company creates a new entity solely to file for bankruptcy or uses the process to reduce debts it could easily pay outside of court. When a court dismisses a case for bad faith, the company loses all bankruptcy protections and can be sued directly.
The dismissal of LTL Management's filings by federal judges suggests that the judiciary is increasingly recognizing the Texas two-step as an abuse of the system. The Third Circuit's ruling that a solvent company cannot file for bankruptcy is a landmark decision that challenges the viability of this strategy. It forces companies to confront the reality that they cannot simply buy their way out of liability by creating a shell company and declaring financial ruin.
Despite these judicial setbacks, the allure of the Texas two-step remains powerful for corporations facing existential litigation threats. The potential savings are astronomical. By avoiding jury trials where juries might award punitive damages or massive compensatory awards, companies can cap their losses at a fraction of the total liability. The strategy transforms the legal landscape from one of accountability to one of managed risk.
The controversy surrounding these filings also highlights a broader issue in American corporate law: the imbalance between the power of well-resourced corporations and the rights of individual plaintiffs. In traditional litigation, the system is designed to give each party a fair hearing. The Texas two-step disrupts this balance by shifting the entire dispute into a forum where the rules are different, the timeline is compressed, and the outcome is often predetermined by the financial engineering of the defendant.
As the legal battles over LTL Management continue, with judges dismissing filings and plaintiffs' lawyers fighting to revive claims, the future of the Texas two-step remains uncertain. It stands as a testament to the ingenuity of corporate legal teams in navigating complex statutes, but also as a stark reminder of how those same mechanisms can be used to evade responsibility.
The story of the Texas two-step is not just about accounting tricks or procedural loopholes. It is about what happens when a company decides that its financial health is more important than the rights of the people it has injured. It asks whether the bankruptcy code, designed to help failing businesses survive, should be allowed to serve as a shield for successful ones. As courts grapple with these questions, the human cost remains the most pressing metric. For every dismissed filing and every legal precedent set, there are thousands of individuals waiting for justice that may never come.
The narrative of corporate bankruptcy is evolving. What began as a tool for reorganization has been repurposed into a sophisticated defense mechanism against tort liability. The Texas two-step represents the apex of this evolution, where the line between financial distress and strategic maneuvering becomes indistinguishable. Whether courts will ultimately close this door or allow it to remain open depends on how they balance the letter of the law with the spirit of justice.
For now, the strategy remains a potent, if controversial, option in the corporate arsenal. It has forced millions of dollars into trusts and halted thousands of lawsuits. But it has also drawn intense scrutiny from judges who see through the financial engineering to the underlying lack of good faith. The dismissal of LTL's bankruptcy filings marks a potential turning point, suggesting that the era of using bankruptcy as a shield for solvent companies may be drawing to a close. Yet, until the law is unequivocally changed or definitively interpreted against this practice, the shadow of the Texas two-step will loom over mass tort litigation.
The implications extend far beyond asbestos and talc. If successful, this model could be applied to any product liability crisis, from pharmaceuticals to consumer electronics. The stakes are high, not just for corporations looking to manage risk, but for the integrity of the legal system itself. Can a bankruptcy court truly remain neutral when one party has manipulated its own financial status to fit into the court's jurisdiction? The answer to this question will shape the future of corporate accountability in America.
As we look back at the cases of Georgia-Pacific, Saint-Gobain, Trane Technologies, and Johnson & Johnson, a clear pattern emerges. These are not desperate companies scrambling for survival; they are giants using the law to protect their bottom lines. The Texas two-step is a strategy born of legal ingenuity, but its moral legitimacy remains deeply contested. In the end, the measure of any legal system should be whether it serves justice or merely efficiency. For the victims of mass torts, the answer has been painfully clear: efficiency often comes at the expense of justice.