- Will Harty
The Texas Two Step: Avoiding Liability for Defective Products by Manipulating the Bankruptcy Code
Updated: Jun 2, 2022
More and more companies are pursuing a legal tactic to avoid liability for their defective products in courts. Known as the "Texas Two-step," this tactic uses something called a divisive merger under Texas law to split a company up into two or more separate entities, one of which receives all of the product defect liabilities of the company, while the other receive all of the original company's assets. In this way the new, liability-absorbing company is immediately bankrupt because its assets have been separated from the problematic liabilities, and it is able to immediately file for bankruptcy protection. To do this, the liability company "shops" for a favorable bankruptcy forum and declares bankruptcy there. Until recently, the most favorable forum was the Western District of North Carolina. Once it files for bankruptcy protection, it cannot be sued in court for product defects that have injured consumers.
So, how does this actually work in the real world? Take Johnson & Johnson, the baby powder company, as an example. Faced with thousands of lawsuits for mesothelioma and ovarian cancer as a result of its asbestos-contaminated talc products, J&J decided to do the Texas Two-step. First, it went to Texas and performed a divisive merger to spin off "LTL Management Corp" which absorbed all of J&J's product defect liabilities, and "New JJCI" which absorbed all of old J&J's assets. New JJCI then incorporated in New Jersey, J&J's longstanding home, while LTL moved to the North Carolina, a state J&J was never incorporated in before, and filed for bankruptcy. All of this happened within the span of a couple days.
With LTL's bankruptcy filing, an automatic stay was imposed on all J&J baby powder litigation nationwide. The lawsuits of thousands of terminally ill consumers of J&J's talc products were put on hold indefinitely. And, if successful, J&J, which was by no means "bankrupt", will be able to discard all of its talc liabilities.
Imagine if you, as an individual, were able to clone yourself, assign all of your debts to that clone and then have that clone file for bankruptcy to get rid of all of those debts. Poof! your mortgage, car loans, and any other debts to assign to your clone are discharged in bankruptcy and your creditors don't get a dime, but you continue to have all of your assets and savings. That is what is happening and it is a travesty in our opinion.