Chapter 11 Bankruptcy & Mass Torts: A Review of the Third Circuit’s LTL Opinion

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Sam Fendler:  Hello, and welcome to this Federalist Society virtual event. My name is Sam Fendler, and I'm an Assistant Director of Practice Groups with The Federalist Society. Today, we're excited to host “Chapter 11 Bankruptcy & Mass Torts: A Review of the Third Circuit’s LTL Opinion,” featuring Professors Tony Casey and Lindsey Simon.

 

Professor Tony Casey is the Donald M. Ephraim Professor of Law and Economics at the University of Chicago Law School. He is an expert on business law, finance, and corporate bankruptcy, and his research examines the intersection of finance and law. Before entering the academy, Professor Casey was a corporate attorney focused on corporate bankruptcy and related matters.

 

Professor Lindsey Simon is the Robert Cotton Austin Associate Chair in Corporate Law at the University of Georgia School of Law. Professor Simon's research currently focuses on the intersection between mass torts and bankruptcy, and she has provided commentary on major bankruptcies, such as Purdue Pharma and USA Gymnastics. Before entering the academy, Professor Simon was a practicing attorney with a focus on commercial litigation and corporate restructuring.

 

If you'd like to learn more about today's speakers, their full bios can be viewed at fedsoc.org. After our speakers give their opening remarks, we will turn to you, the audience, for questions. If you have a question, please place it into the Q&A function at the bottom of your Zoom window, and we'll do our best to answer as many questions as we can.

 

Finally, I'll note that, as always, all expressions of opinion today are those of our guest speakers, not The Federalist Society. And with that, Professor Casey, thank you very much for joining us, and the floor is yours.

 

Anthony Casey:  Great. Thanks, Sam. I appreciate being here. I find this topic fascinating and interesting. The case is definitely worth thinking about. And I'm especially excited to be here with Professor Simon talking about it. This question of how bankruptcy deals with mass torts has become super important in the last few years.

 

And Professor Simon, though I think you'll see we disagree about some major issues in it, I think she was the first person to really dig into this and give a thorough analysis. And so, her work is the starting point for thinking about it in the Academy. And I think one thing she will agree with me on is that, once you get past the lawyers in the cases, a lot of people don't understand what's going on in these cases. That includes academics. That includes the media.

 

And a lot of people talking about the Johnson & Johnson case, which we'll talk about today, about Purdue, say things that have very little connection to the reality of the case. And so, I'm glad to have someone here who knows the reality of these cases, and so when we disagree, it's going to be about things that are happening in the real cases, which is we should be thinking about when we talk about these topics.

 

So here's the update, and I'll give you the background of the case before getting into the Third Circuit opinion. As I said, mass tort in bankruptcy has become a hot topic. It's been a topic for 30, 40 years where one way to resolve mass torts, or one attempted way, is to put a debtor into bankruptcy and then try to settle claims in that forum.

 

Lately, there's been high-profile attempts at doing this, and the Johnson & Johnson LTL case is one of the very high-profile ones. So the mass tort we're talking about is baby powder, talcum powder-related mass tort. And I'm not going to get into the science of the allegations and whether or not they're valid, but the basic idea is two things: that talcum powder itself might contribute to ovarian cancer and might also contain asbestos, which might contribute to ovarian cancer and mesothelioma.

 

And so, there's been -- The last decade has seen an increase in lawsuits against Johnson & Johnson and other parties in the talc industry, alleging that their either mesothelioma or ovarian cancer was contributed to by the talc that they produced. At the time of filing, Johnson & Johnson was facing estimated about 38,000 to 40,000 cases. I think now it's over 40,000.

 

Predicted, depending on who you ask, there's at least as many future claims coming, or at least tens of thousands of future claims coming. Part of that is that the effects take a while to become known. So you don't use it and get sick; you use it and years later, perhaps decades later, you get sick.

 

And so, they're facing 40,000, but maybe up to 80,000 to 90,000 cases related to baby powder and talcum powder. Now, most of those are the ovarian cancer cases. A smaller group are the mesothelioma cases. And in the litigation, there's slightly different characteristics of the claims that make those play out differently and have different strategies, perhaps, that the lawyers might take.

 

Anyway, so there was a few trials that went forward a while ago, before the bankruptcy we're talking about, and they were verdicts all over the place. Johnson & Johnson was successful in a few at trial. They were successful in a few on appeal. They were unsuccessful on others, and there was one large one where it was around $4 billion to, I think, 22 claimants. And so, you can think of the damages in these claims that have been tried, not that many trials, but in the ones that happened, ranging from zero to about 200 million per plaintiff. And that's a pretty big range and kind of hard to predict what'll happen.

 

So then Johnson & Johnson sees this and tries to settle. They negotiated settlements one off with some of the parties, and then there was actually an attempt to settle in a different bankruptcy before they did any of the Texas two-step. The Emerus bankruptcy was a supplier of theirs, and they tried to use that -- They tried to offer a settlement in that proceeding to wrap this all up. When that failed, the next thing they did was what's pejoratively and infamously become known as the Texas two-step.

 

So they're faced with these tens of thousands of claims, and they want to either make them go away and pay nothing is one story of it, or if they're valid claims, they want to settle them for some amount and make them go away and move on. And so, the Texas two-step, the strategy they used was to create an entity and then put it in bankruptcy with the intent of getting to a settlement number and the settlement number to cover all the claimants.

 

And so, the Texas two-step, I've always said, is kind of the red herring in all this. It's not the important part of it. It's not the parties' -- The media is like, "Oh, this is this really nefarious move to avoid liability." It's not. It doesn't avoid any liability. It is a move to simplify the bankruptcy that's coming.

 

So the first step is to, under Texas law, separate an entity into two parts, into two new entities, give one the assets, and give the other the liabilities. Now, Johnson & Johnson is a large company, we think of as this $400 billion market capitalization. The baby powder was in a subsidiary, which is a large company in itself, reportedly around $61 billion, and that's Johnson & Johnson Consumer Industries, Inc. JJCI was what they called it before the split.

 

So that's where the most obvious target of these litigation lawsuits was, was at JJCI. So JJCI used the Texas divisional merger, and even though it's called a merger, it's really a division, and they divided into what people have called New JJCI and LTL. New JJCI had the assets. LTL had the talc liabilities.

 

And then LTL, very shortly after, files for bankruptcy, not in Texas. That's kind of simple. "Oh, this is all going on in Texas." No, they filed for bankruptcy in North Carolina. That ultimately got transferred to New Jersey, and that's where the case is now pending and why we'll talk about the appeals court in the Third Circuit.

 

Now, as I've said this a few times before, if what I just described was all that had happened, that would be a really nefarious, bad fraudulent transfer, and it would survive no court's review, but that's not all that happens. So when they created that asset entity and that liability entity, they said, "We're going to create an agreement to make sure that the liability entity has exactly the same asset support that existed before the split."

 

So old JJCI, the pre-division company, had $61 billion in assets. New JJCI has those assets and says, "We agree to pay Liability Company, LTL, whatever amount of liability they end up paying up to the amount of those assets at the time of the division." That's the $61 billion. "If those assets go up in value, we agree to give them that increase in value if the liability number requires that to be paid out."

 

And then they added to that that Johnson & Johnson, the parent company, backed that guarantee. Now, that's useful in case the asset value goes down. So let's say JJCI -- And they make the Band-Aids. They make Tylenol. If that value goes down over time, they don't have the $61 billion. Johnson & Johnson, which includes its pharmaceutical company and other prescriptions and vaccines, they've backed that $61 billion payment if those assets go down. So it's called the funding agreement.

 

The idea was that the funding agreement would be available if the company ended up paying money out of bankruptcy or if the company ended up paying money in bankruptcy, but the plan was always to immediately put LTL into bankruptcy, and that's what they did. So LTL goes into bankruptcy, as I said, filed in North Carolina. The North Carolina court said, "Wrong venue," shipped it up to New Jersey.

 

Then the claimants -- And the claimants again are -- There's a committee of talc claimants, and ultimately, they were divided into the mesothelioma claimants and the ovarian claimants. But there's also going to be -- There also is a future claims representative, future tort claims representative, because we know that people in the future might get these claims. And Johnson & Johnson and LTL in the bankruptcy are trying to settle all of that. They're trying to make all of this go in one global settlement.

 

So they filed that bankruptcy, and that's the step two of the Texas two-step. So step one was the division. Step two was the filing. Interestingly, if you read some reports, people are like, "Oh, these Texas two-steps are everywhere. This case is going to end this huge trend." I don't know if four is a trend. So there's really four—five, depending on how you count them—Texas two-step bankruptcies.

 

Now, it is true—well, I believe it to be true—that there are a lot of other companies thinking about doing this. And so, there may be a trend coming, depending on how all these cases play out, but that's the universe right now is four or five of these cases. So the claimants in New Jersey move to dismiss the case.

 

What was interesting to me is, if you read the briefs—there's actually briefs from different groups of claimants—one group argued that the funding agreement is totally illusory, and therefore, this is a bad faith filing because it's just a way for Johnson & Johnson to get away from paying anything and the funding agreement is never going to be enforceable, which, my reading of the funding agreement, I don't see that, and one of the other committee lawyers didn't either.

 

So the other argument in favor of the motion to dismiss was this funding agreement is so perfect and so bulletproof that there's so much money, this company can't be insolvent, and so why would you use bankruptcy if you've got a $61 billion pile of assets supported by a guarantee of the parent to pay these liabilities. And we don't know what they are. They might be zero. They might be $20 billion. They might be a lot more, but that's so speculative. This is no reason to be in bankruptcy, and those were kind of the motions filed in the bankruptcy court.

 

The bankruptcy judge—in a pretty thorough, I thought, opinion—went through and said, "This is a good faith filing." And it's a good faith filing because they're using bankruptcy for bankruptcy purpose, which is to solve the collective action problem that arises when you've got 40,000 current claims and maybe 40,000 future claims and you're trying to negotiate a settlement.

 

And that's very complicated, and you're going to otherwise be litigating in the MDL or state court system, which is expensive but also very complicated to get a settlement because the litigation costs are here, and then you're trying to say, "Okay, we want to settle all these various cases." And by the way, we can't bind anyone who's a holdout and we can't force future tort claimants to agree to the settlement because we don't know who they are.

 

Bankruptcy actually allows you to bind the minority of holdouts. So let's say 95 percent of claimants want a settlement. Bankruptcy, at least we think—and I say "We think" because there's other cases pending right now in this question—can bind that 5 percent to say, "You've got to go along."

 

And that's a very standard bankruptcy move and tool is, we've got a group -- We've got the majority of the group that wants to do something in their benefit and a small holdout. We force them along. Bankruptcy also has a procedure for allowing future tort claimants to be represented by an appointed representative and then have their claims settled as well, the idea being that you end up with a fund and all claims go to that fund. So they agree to some number of settlement, and then they go to that fund.

 

Importantly, the only way to get to that outcome is a settlement, right? So to get to that payout, you've got to negotiate with the class of claimants and get the supermajority to agree and be on board, and then you get the settlement that you use bankruptcy to achieve.

 

All right. That's the kind of lower -- And the bankruptcy court explains that, and then he explains the value of the two-step, which is just to take this part, this dispute among the debtor and all the tort claimants and separate it from all the other operations, from the Band-Aids and the Tylenol and all that. That's going to happen outside of bankruptcy, and we're not going to bring in all the claimants in the world to show up and raise their objections. We want to simplify and lower the cost of bankruptcy.

 

So he denies the motion to dismiss and says this is a very good place to resolve mass torts. This gets appealed to the Third Circuit, and at the Third Circuit, the parties make all kinds of arguments. They make arguments that this is depriving people of their right to court outside of bankruptcy. They make arguments that the two-step shows some sort of bad faith. They make arguments that we know that this is going to end up forcing some folks along and that's going to deprive them of their right to continue the litigation.

 

The thought was this would tell us something about whether two-steps were viable or not viable. In an opinion that I think surprised most people, not by outcome, but by reason, and very few people were sure how to predict the appellate court, but the Third Circuit reversed and it said this was not a good faith filing. The filing lacks good faith; therefore, it should have been dismissed.

 

But in the opinion, the court didn't say anything about whether two-steps are good or bad. It didn't say anything about whether trying to use this to get mass tort holdouts to go along is good or bad. All it said was that one argument I mentioned before. The one side said there's too much money here. The court said, "That's a problem. There's too much money available. Therefore, this is not what bankruptcy is about."

 

And so, it's not a good faith filing because there's no—and the phrase he used was—financial distress. And so, ultimately, the court says they weren't close enough to being out of money to file for bankruptcy, and the way they determined this was they said LTL—that's the debtor—had this funding agreement. The funding agreement, we'll assume, is good. And the court said it's basically an ATM that they can get money from, and it's supported by one of the largest companies in the world, the parent company. And with that much money, there's nothing to worry about as far as financial distress.

 

The court didn't tell us much more about what qualifies as financial distress. And so, before I hand it over to Professor Simon, I have some qualms and questions about the Third Circuit opinion. So the first is, when you have potentially 80,000 claims that range from zero to $200 million, that could bankrupt any company in the world.

 

And if those claims are all worth a million dollars, then LTL would be insolvent. If they're worth $10, obviously, it's not. And we don't know where they're at, but there's this question of how certain do you have to be that this distress is coming? That's one thing, and I'll come back to that a little in a minute.

 

The other thing is, we know that bankruptcy can help coordinate and solve collective action problems. We know that this is a group of 40,000 claimants with differing interests, and so bankruptcy could help resolve and lower the costs of that process, and that's what it does in other areas. I'm trying now to figure out, "Okay, that's not financial distress. This uncertain future of things is not financial distress. What is?"

 

And the biggest worry I have is, in all kinds of other cases, non-insolvent debtors file, and one of the, I think, benefits of the U.S. system is you don't have to be out of money to file for bankruptcy. You can file earlier than that. You can file before the house burns down is the way I always like to think about it. And other countries say, "No, you have to be insolvent." This court did not say you have to be, but they said something related to insolvency has to be true. That worries me for future cases because it's a pretty broad ruling that doesn't tell us anything about mass torts. It just says there needs to be something called financial distress.

 

The other criticisms I would have and questions is it's a very ironic outcome. So Johnson & Johnson put too much money up to be available to claimant, which implies if they put less money available, if the claimants were worse off and there was less money to support whatever liability results, that this would have been a good faith filing. That's an odd thing for me to hear. "Oh, they were in bad faith because they protected the claimants more."

 

And the other thing is, the claims, we don't know if they're valid. If these claims were 100 percent good, if we knew that these were 40,000 really good claims, there'd be no question that the company would be insolvent. And so, the bad faith on Johnson & Johnson arises because maybe the plaintiffs' claims are not all good.

 

And so, if Johnson & Johnson now goes to the MDL and loses a bunch of trials, and it turns out these claims are all worth $10 million, they'll be back -- LTL will be back in bankruptcy, and that'll be a good faith filing.

 

If it turns out they're all bad claims and we don't know who the plaintiffs are or we don't have a causation, if that's the outcome, then Johnson & Johnson was in bad faith because the claims against them weren't valid, and then they have to stay in the more expensive litigation arena. And that is just an odd outcome to say the bad faith of Johnson & Johnson arises because the claims against them might not be valid, which is an odd result.

 

And the last thing I'll say is it's an especially odd result for a rule that's not based on any statutory language. So the opinion in the Third Circuit is dismissing a case for lack of good faith because there isn't financial distress. There is nothing in the bankruptcy code that says you should dismiss a case for lack of good faith. That's a judge-made rule. And there's nothing in the bankruptcy code that says you should dismiss the case when it lacks financial distress. That's a judge-made rule.

 

And one thing I would just say is, when we find odd results when we're following text -- And I'm not myself a pure textualist, but sometimes you follow text and you get odd results. Okay. But when you have judge-made rules that lead to bad incentives of, "Oh, don't put too much money up. Oh, good claims against you make bad faith. Bad claims against you make good faith," it's very strange to have that rule created by a judge saying, "Here's this equitable rule we apply."

 

And the court even said that, "We see there's this apparent irony." And I usually think about ironic outcomes being bad text in a statute. Here, these are purely judge-made rules, which generally, I think, should make more sense than pushing a litigant out of a forum to resolve and settle a case because they were overprotecting the other side, which you may disagree that that's true, but that was the reason this court said they're dismissing the case.

 

I've talked to lawyers on both sides, and the lawyers for the claimants will say, "Oh, this isn't in good faith for other reasons," but that's not why it was dismissed. It was dismissed because there was too much money available, which seems very odd to me. So, sorry I went a little long, Professor Simon.

 

Lindsey Simon:  Excellent. Well, I think that's very helpful background. I'll also say thank you. I'm excited to be here to speak with you all about this because I do think, outside of a relatively narrow circle, getting this far in the weeds doesn't happen all that often, so I'm thrilled that you all are interested. And again, as Professor Casey mentioned, we share a lot of awareness about this, and I think our views align on most of it. We do have some areas of disagreement, which I think we will get to.

 

I want to take it back a little bit because, as you heard earlier, this is a trend. You know, it's not new to the last five or ten years, but it is a trend that, over the last five to ten years, we've seen a lot of these cases. This current case deals with a specific question of who should be able to access Chapter 11, but really, this grouping of cases, and the ones that are truly waiting in the wings based on these various appellate rulings, it's really this question of, in America, what system is best for resolving these problems? 

 

And some of these are very narrow. There'll be a hip replacement or some device of mass tort. Some of them are societal harms, right? So it's not just, is this product bad, but there's this behavioral problem that's permeated our system. How do we deal with it? So opioids or sexual abuse.

 

But these cases, for better or worse, they end up in bankruptcy courts because, so far, a bankruptcy court has been available. And so, more and more and more cases have ended up there, some because they truly ran out of money, and some because they've realized that it's a better system in terms of efficiency, in terms of outcome, in terms of process. It has all sorts of perks.

 

And so, again, what is our court's response? And so, I'll start by saying, for those that are not in bankruptcy, like any element of procedure, you don't get anything from the court unless you ask for it. When the debtor files for bankruptcy, they make all sorts of choices. They choose the system. They choose the location. In some instances, they choose the judge.

 

And so, when you contrast that process to generally litigating a mass tort out in civil litigation, plaintiffs make a lot of decisions in MDLs or even outside of MDLs. Plaintiffs have a lot of power. And when I say plaintiff, to be clear, I don't mean the actual individuals with claims. For the most part, I think their power in any system is relatively small, but plaintiffs' attorneys run a lot of the show. And so, bankruptcy is a very unique opportunity for defendants to flip the script, to take the power back, to pick the forum to do all these things.

 

So the allure makes complete sense, but again, these cases keep coming and we ask judges questions. The biggest question, as I said, is who should be able to use the system? Because bankruptcy is not designed for everybody. I think it's a very effective decision. I like bankruptcy, but I also understand the idea that many critics of this say, "Well, we shouldn't let everyone file for bankruptcy. There are reasons for it."

 

And so, on that specific question, that Third Circuit did say—and it does seem ironic—that if the company paid less, then you would be along here. And so, really, we are sending claimants back to a system where more of the money that would go to them is going to be spent on lawyers and court costs and fighting all over the place. And maybe they'll get a settlement if they can't stand bankruptcy. Maybe it'll take longer. Maybe it'll be better. Maybe it'll be worse.

 

But the court, before they know all of that, has to sit and make a decision: Is this a proper use of the system? And if you look inside the Third Circuit's opinion, Judge Ambro speaks about the costs and the significant impact that claimants experience when they go into bankruptcy. And so, they say that cost is built in; it's a feature of the system. It's there on purpose.

 

We will bind people who don't agree. That minority has to be bound in a bankruptcy case; otherwise, it doesn't work. We will force you to come to this court rather than the court of your choosing. That's the only way it works because, in a bankruptcy, if we can't resolve it in one place, we're going to lose value, and bankruptcy focuses on preserving value.

 

So all of these realities for claimants where their experience in litigation will be altered, that's a big cost. And the court's opinion in LTL says, "Well, we recognize that cost, and it is there. It's very real. It's necessary, but we're really only going to open the bankruptcy court and the bankruptcy system in instances where it is absolutely necessary."

 

And so, I don't really -- To take a step forward to what happens next, I'm not sure that this has such -- The financial distress test, I agree. If someone makes an argument in plain vanilla Chapter 11, saying, "Well, this debtor has too many assets. They could pay," I honestly think that this opinion, while it is designed to be broad, I think an easy pushback is to say, "Well, our focus on financial distress is particularly high when we're dealing, for example, in mass tort cases with so many claimants who have their rights so severely impacted."

 

So, for example, in cases where there's less of that impact, so all of the creditors are vendors or we have few very few litigation claims, we're just talking about people who won't get paid back in full on their item, maybe then financial distress isn't quite as strong of a lever to push people out of the system. So that's just me looking forward.

 

But again, that's the question today. And so, in the Third Circuit, at least so far, we have a financial distress threshold for accessing the court. And this is a big decision. I think it will certainly deter cases from filing in the Third Circuit on that basis. I don't know that any big companies are willing to take the gamble on pushing where the line is on financial distress just yet.

 

And so, then the question is, well, where else can we file? Because, again, one of the benefits of bankruptcy is that, for the most part, you get to pick where you file. And so, maybe soon we will see what the Seventh Circuit thinks on this issue because, in the related 3M case, relating to earplugs and liability there, they did not do a Texas two-step, but they did file a very similar bankruptcy and they used basically an identical funding agreement.

 

In some ways, it's even more rich because it's not capped at the old subsidiary; it's not capped at the $61 billion. I believe it's uncapped. So there's a current motion to dismiss pending in the bankruptcy court, so we will see, as that case progresses along, whether this viewpoint that financial distress is at the heart of a good faith bankruptcy filing, and without it, you really should not be able to push claimants out of their court, forcing them to a result that they don't agree to and all of the other elements of bankruptcy that are just part of the system.

 

So that question, we will figure out. I guess a bit about the second question that a lot of our cases are still going to be grappling with, and this is why Johnson & Johnson wanted to create LTL and put it in in the first place. It's what do you get out of the bankruptcy, right? What is the endgame? How does this really solve things for you?

 

And so, the consolidation element, we've discussed a couple points, and I don't think we can emphasize it enough. Having everyone at one negotiating table rather than eight negotiating tables while there are ten jury trials, it's very fast. And it will not always get done as quickly as everyone would like, but it is surely effective to force everyone in one place. It narrows the field of issues to address, and it at least imposes some order.

 

The automatic stay and preliminary injunction issue: Again, prior to the last six months or so it was pretty routine for, when you file for bankruptcy, not only do you get the automatic stay, which prevents any action to proceed in litigation or to recover against the debtor, but they, of course, will also grant preliminary injunctions for related parties, so non-debtors who, for example, were co-defendants.

 

And so, if you made a claim against one of these co-defendants, it might be res judicata and might decide the facts that would relate to some other liability. So if there's really others around the debtor, claims against them would also be paused. And so, this time and space to negotiate was pretty important and came pretty quickly.

 

Now, I'll tell you, in 3M, one of the issues they're dealing with is the fact that the court denied the preliminary injunction. So 3M filed an affiliate, Aero, in the bankruptcy court in Indiana, and the bankruptcy court said, "No, we're not extending this to 3M, the company that might also be impacted and signed to the funding agreement." So 3M had to go back and deal with the MDL that they were pretty overtly trying to avoid in filing for bankruptcy in Indiana.

 

So the initial case, the automatic stay and preliminary injunctions, getting that time and space, incredibly valuable. And then, really, beyond negotiating, the biggest one in all of this—and we haven't even gotten there—is how your claims get finally resolved by a plan of reorganization.

 

If you get through bankruptcy successfully -- And none of these types of two-step cases have gotten there yet, and maybe the fact that they are not there is a feature and not a bug. If you get to the end and you confirm a plan, you can put all the money in a trust. You can channel all that litigants into that trust, and then any future claims will also have to go against that trust. So it is a one-and-done chance to really resolve all of the disclosed liability.

 

That's not available anywhere else. We cannot do that in a class action. We cannot force people to do it without consent. It just doesn't exist. And whether that ultimate remedy remains to be available, that's, in part, the stuff of the Second Circuit appeal in the Purdue Pharma case.

 

So you signed up for a Johnson & Johnson webinar, but the thing is, the value in all of this, these cases are all tied together, testing different features of the same question: What role does bankruptcy play in our broader civil litigation system? What role should it play? And if you're allowed to engage in it, what sort of checks and limits and balances should be built into place? Which ones are actually in the bankruptcy code and supported by precedent? And how can courts, litigants, and frankly, legislators address this to be a system that can still save value but maybe do it a little bit better and provide a better system?

 

So I discussed a lot of things. I think I will pause for now. I'm sure the Q&A will bring up some other issues, but I just wanted to touch on a couple of those points.

 

Sam Fendler:  That's excellent. Well, thank you both to Professor Casey and Professor Simon for your opening remarks. I think there was -- I sense the agreement between the two of you—and maybe this is just a matter of objectivity—that the opinion out of the circuit court relied a lot on this discussion of financial distress. And, of course, what's key to that is LTL's access to this $61 1/2 billion.

 

There's a thought that maybe the court could have sent it back to the bankruptcy court to discuss the matter of financial distress and create some kind of objective definition of what that means instead of simply dismissing the case. I wonder—and Professor Casey, we can start with you—what you think about the lack of a clear definition of financial distress. Do we have a lack of a clear definition there? Do we need it? What do you think about that question?

 

Anthony Casey:  We definitely have a lack of a clear definition of financial distress. Going in, I thought bad faith dismissals were for extreme cases, like the NRA case where I can't find a purpose. I can't find anything in the bankruptcy code that can help this litigant. So they're clearly just trying to stop, there, it was a state regulator from doing something, or two-party disputes because bankruptcy doesn't solve two-party disputes.

 

So those are the quintessential bad faith dismissals. Now, we have something, "No, it's something to do with insolvency." And the Third Circuit opinion says that. And then, on whether they remanded it, there's a passage or paragraph where they say, "Well, whether or not financial distress exists is a mixed question." And so, this gets the standard of review.

 

And I was at a panel with a bunch of bankruptcy judges shortly after the opinion came out, and they're like, "Wait. That sounds like a factual question, right?" What are your potential liabilities? What are your assets? Where's the mixed question there? And if you're going to call it a mixed question, I need a legal standard to know what -- I get it. "Was I negligent" is sometimes viewed as a mixed question because I have this legal standard and then what happened.

 

Here, I know the factual inquiry, like assets, liabilities, contingencies. What's the legal input? We don't have that. And I'll say I mostly agree with what Professor Simon said that maybe most judges won't make a mess of this in most cases. I think that's kind of what she was saying. They'll just do this in the mass tort cases.

 

And one judge I heard say, "Well, this will be the Bush v. Gore opinion where it never gets applied again," but if you asked me was American Airlines in financial distress when they filed for bankruptcy, they decided to file early when they had money in the bank and they could refinance loans. They came out of bankruptcy with money for equity. I don't know. If I'm a clever litigant, maybe I argue they weren't.

 

I think any judge would let that filing have gone forward, but it's at least a plausible argument now that people have to deal with, and there is no standard from -- At least as I read the Third Circuit, there's no clear guidance on what it means, other than something to do with being close enough to running out of money and insolvency.

 

Lindsey Simon:  So I'll say I think that the input, the factual basis of the question, that doesn't bother me. I think that's pretty clear, and I think the fact that it was relatively -- Well, the factual question stands alone. Is there a legal standard? I think that's what you're getting at, right? Should this really be a mixed question, and if it is, what is our legal standard?

 

I'll say I think it was purposefully defined to not say all instances when it should be, and I think it is a flavor of insolvency very clearly not saying we need insolvency. And I think that maybe as a nod to the regimes that do require insolvency saying, "Look, our system really does give you some options because you don't have to be completely out of money to be here," unlike in some of these other places, but you have to not have enough at some time that's not so remote in the future. And really, that's what it is.

 

And so, the question is, well, what is remote enough in the future, right? You know, if we get a couple more jury verdicts, would that be enough? And to me, that's what this is going to lead to. This is going to lead to -- You didn't really ask this question, but I'll answer it. This is going to lead to -- I mean, if I were a creative litigator, I would say, "Well, let's take one of the no's, get a bad verdict, then put it in. And if they're all measured at that, let them come at us. Or let's file it after certain discovery issues where that makes it look bad, but then the science comes around and helps us after we're already in 11."

 

Because I don't think -- Let's say, for example, there were a bunch of bellwethers here and all of them were in the $50 million range, or if we had more evidence that the cost was closer to that $61 million amount, the case would proceed. Let's say we were halfway through and we got science -- Something came through that showed that these were actually tied to something else, and really, the value is going to be much lower.

 

I don't know that, at that point, if financial distress was there at the time of the filing, but then during the course of the case, I don't think we would kick them out. We don't kick out the meme stock cases that, all of a sudden, are fine halfway through.

 

So I think it is going to lead to a bit of gamesmanship on the timing of filing. And is that really better if you can dress it up? I'm not sure if it is. I think it will lead to a lot more lawyering. And I agree that the standard isn't -- It's not a one sentence that a first-year law -- I would never assign this for first-year law student to put in the memo, but maybe that's also by design so that the courts can figure out when it works and when it doesn't work.

 

Anthony Casey:  One thing just to add -- and I'm curious. When you started about the inputs, shouldn't then the Third Circuit have deferred to Judge Kaplan a little more? I mean, he says, "Look, they're running $20 million a month. This could run up to $190 billion in litigation fees. This seems, to me, to be a company that might end up down the road --" And maybe you're saying the down the road is the legal question.

 

Lindsey Simon:  Yeah. I think, honestly, at what point? So, I mean, even if we were to price this out, yes, I also think maybe this idea -- I think it's really easy to say, "Oh, but outside bankruptcy are legal costs that are just going to be outrageous." But these cases settle. You know, I was at a conference recently with MDL types and we were very much -- The bankruptcy is really kind of the black sheep in the room because MDLs are very proud of their ability to settle it.

 

And yes, it takes time, and yes, it takes money, and there's plenty of lawyers involved, but it's not certain that J&J would litigate every single one of these and pay a jury verdict. It's silly to think that that's the reality, too. So as to whether I think the court could have deferred more, I mean, I think Judge Kaplan was pretty careful to put in findings, but I don't know that the Third Circuit had to accept them. So that's all I'll say on that.

 

Anthony Casey:  One thing on settlement. As I understand, when they tried to use the Emerus bankruptcy to settle, they offered like $5 billion, and it didn't work.

 

Lindsey Simon:  Right.

 

Anthony Casey:  Okay. So I read the Third Circuit's opinion and I'm like, "They've already offered 10 percent of their asset value, so we know that the settlement is likely more than that." And I'm just thinking, if someone sued me for a plausible claim and I offered 10 percent of what I own and they said no, I would feel financial distress. That would make me very distressed. And I know it's a company, but 20 percent of your assets, that starts to get to -- That's going to change the way things are going.

 

Lindsey Simon:  Right. But would you say that 10 percent is -- If we had to say financial distress, you're facing exposure on 10 percent, you would say that's enough?

 

Anthony Casey:  No. I'm saying when we know that it's -- We know that it's more than 10 percent. We know that's the bottom.

 

Lindsey Simon:  Yeah, that's the discount rejected offer.

 

Anthony Casey:  Yeah. So it could be 100 percent, but that makes me -- I'm just like, what fact do you have to find? Twenty percent? Thirty percent? And I think there was procedural reasons why that failed, too, but let's assume the claimants don't want to accept the $5 billion claim, so they think the claims are worth more than that.

 

Once they hit, I think, 50 percent, that feels like most companies could go into bankruptcy if one problem was going to eat up half of their assets because it affects operations, too, right?

 

Lindsey Simon:  And this kind of leads us -- I'm sorry. We're totally commandeering the Q&A, but I'll ask one more. Would we have this opinion if there were no two-step? Because, as you point out, the two-step was really not part of this conversation. The court was very clear to say, "Look, we're not looking at old JJCI. We're not looking at what happened before the bankruptcy. In another case, we might have to look at that, so don't think that we're blessing it, but what we're really looking at here is what happened."

 

And so, I guess, if the old JJCI had actually put itself into bankruptcy, including its products, including its vendors, if they really did just file a clean Chapter 11, would we have this issue? And I think the answer is no. I don't think we would have had the motion to dismiss. I don't think they would have found it because, again, you alluded to the viewpoint that, look, we did this to help simplify it, right? We're simplifying bankruptcy for the claimants because we're not going to -- Why would we derail our vendors and our contracts and all this?

 

But my pushback to that -- You know, and I get that. That makes sense, right? So we'll put all the money in, but all we're going to do in this bankruptcy is deal with liability. That, to me, is part of the problem because one of the features of bankruptcy is you deal with the entire estate, and we basically fabricated an estate here.

 

If we have the entire estate, then maybe the leverage of, "Oh, wait, I have to deal with my Tylenol claims that are maybe floating around? Oh, I have to hurry up and settle here because my vendors are getting unhappy and it's impacting my --" All of those nuances are part of the bankruptcy process, too. And so, Johnson & Johnson got to avoid all of that by keeping segmented the pieces that they wanted to not deal with in 11 and only simplifying it. So I understand the argument, but I think it benefits them more than you let on.

 

Anthony Casey:  Yeah. Well, this is, I think, where we disagree the most. And I'll say, to your first point, I think you're probably right that it would have played out differently, but the opinion does not say that. So now, in the next case, I don't think JJCI, a version of it, can file because now we have this opinion. And you are right that, in some sense, when I was like, "Oh, 10 percent, that messes with your operations," the whole point of the two-step is it doesn't.

 

But I would push back and say bankruptcy has never been a punishment. It's never been the idea that you have to prove that you really, really mean to reorganize. And the idea of requiring the operating company to go in just to burn assets either to prove they should be there or, to your point, for leverage—because it does change leverage; I agree with that—but that's destroying value to create it.

 

What I would say is, if we don't like the leverage in bankruptcy, the negotiation power, we should change other things. And you mentioned, outside of bankruptcy, plaintiffs choose the court; inside, debtors choose the court. I don't know which one of those rules is right. They both give one party huge leverage, and you've just got to decide which system is better.

 

Now, if you're like, "Okay, it was better when the plaintiffs chose because they have other places, they lose leverage," don't kick cases out of bankruptcy and destroy value. Create different levers for the claimants. Think about exclusivity or, as you mentioned in 3M, think about whether you grant the injunctions against other parties. That changes the leverage a lot without burning money.

 

I never think a system should be, "We should destroy value in order to give party the right leverage." If you want to give them more leverage, fix tort law or change the control levers, but don't be like, "Oh, we want to put it in the most inefficient system possible because that gets the right settlement." That's where I always push back on. And the two-step just makes it less expensive, which should be value-maximizing for everybody if we get the negotiating leverage right.

 

Lindsey Simon:  It just assumes that the fact of not putting a whole entity in has no bearing on negotiated claim value because, if it's true that --

 

Anthony Casey:  I agree with you.

 

Lindsey Simon:  -- we've totally put the asset in, the claimants do worse off, then someone's going to lose either way. And so, I'm not sure that J&J should get to win because they used this, right? And so, I think we have different -- I don't think it needs to ruin value either, but I also don't think a maneuver should make claimants worse off. And, I think, to some degree, that's what the opinion is sort of getting at, right? I don't think because you were clever, even though you're promising to pay all this money and we take your interests as genuine, that doesn't mean that you should be able to do all these things that happen to claimants in bankruptcy.

 

Sam Fendler:  Well, I appreciate that back and forth very much. And Professor Simon, please don't worry about hijacking anything. This is exactly what I --

 

Lindsey Simon:  Oh, I wasn't actually concerned, but I do appreciate --

 

Sam Fendler:  Well, the disclaimer, I appreciate that, too. Some of our members -- There's a little bit of an allusion to this in many of the questions that we're receiving. Obviously, the conservative and the libertarian is concerned with judicial policymaking, and we're talking about the circuit court opinion.

 

And maybe there's an idea that, instead of dismissing, it should have been put down to the bankruptcy court, but I'm wondering what both of you think. Was the bankruptcy court on more of a policy bent to begin with, or did the bankruptcy court stay inside of its lane? There's some question about what the bankruptcy court did it in the first order. And I'm wondering, Professor Simon, it just seemed like you may have an opinion on it, so please.

 

Lindsey Simon:  So I think when you read the opinion—as you all should, if you haven't—I think you can sense a genuine frustration with how the various challenges to bankruptcy to resolve these problems miss all the beauty of it, right? And so, I think, to some degree, a lot of the statements weren't necessary to the opinion, but I think it's pretty clear the judge felt they were important to say and to be a part of the conversation.

 

I know I heard a lot of commentary about how it was inappropriate to talk about this and how, really, if we're going to compare MDL to bankruptcy, we should really do it in a broader way under a different scope. I mean, I do think we're getting pushed back. I think if you listen to some of the transcripts from Purdue Pharma, I think if you read carefully the MDL transcripts in 3M versus the bankruptcy court hearing transcripts, I think we are dealing with a -- not a power struggle.

 

I don't think courts are necessarily fighting over these cases, but I do think we have a genuine disagreement or misunderstanding about the role of each of these systems and the merits and the challenges. And I think it's really easy to go case by case when the features of one are fact specific when a lot of this, really, I think is a better conversation to have at the policy level, whether it's the legislature or whether it's -- I don't even know.

 

You know, I don't know the best way to go about forcing it to happen, but I think that opinion is a good example, yes, of judges at least pointing out the policy implications of why they're going a certain way. Did I think it was inappropriate? I'm not opining on that. I think, no doubt, there's more than needed to be there. Let's put it like that.

 

Anthony Casey:  I guess I have trouble with that thinking. The statute says you should dismiss cases and it lists the reasons, and then it says "including," so it allows other reasons, but I think the most effective means for dismissing a case is because there's provisions if you can't provide a proposal plan.

 

So if you can't get a feasible plan, the case shouldn't be in bankruptcy, and if you wanted to really stay in your lane, you say to the judge, "There's no good faith. Just read the statute. This case stays in, right?" This case has every -- I was talking to some non-bankruptcy academics and they’re like, "Well, what are the requirements to file? There must be something." And I'm like, you got to be a person as defined who can file for Chapter 11, a person or corporation. You've got to do the right things, but there isn't a part that says you can't come in to solve a collective action problem on your creditors.

 

And I do think this is a collective action problem among creditors, so to me, Judge Kaplan was very much staying in his lane. He's like, "Bankruptcy preserves value when creditors race to the courthouse." And we talked earlier about, "Oh, get a few bad verdicts in." If you get five verdicts, like the $4 billion one, not only is that going to put LTL or JJCI in distress, that is going to take money from future claimants that will never recover, and that is because you'll run out of money long before they have claims, right?

 

If you get to $20 billion, if you get to $60 billion, people who don't have claims yet -- So this so this is a classic bankruptcy problem. So then I'm like, "Who wasn't staying in their lane?" I read the Third Circuit opinion and I'm like, "They just don't like --" And Professor Simon said it. Maybe they don't like that you were doing this thing that disadvantaged and changed the leverage.

 

Now, I agree that leverage is being changed in all of this, but that sounds more policy to me than "I want to solve a collective action problem." And the only thing I'll add is the irony in all of this—and I think Professor Simon has seen this as well—people are so inconsistent, lawyers, academics. Not Professor Simon, but other people are talking about these things where they'll say in Purdue, it's not in the code that you can grant third-party releases.

 

And then I’ll -- but then I’ll say in Johnson & Johnson. It's not in the code that you can dismiss for lack of good faith. When are you playing policy? When are you not playing policy? And to me, I think it goes back to what is the purpose of bankruptcy, period? Follow the code toward that purpose, and releases advance that. This case advances it.

 

Again, as long as the funding agreement is real and enforceable, I don't see that as a policy decision to let that go forward. I see that as a bankruptcy judge saying, "That's my job. Collective action problem, I can solve it. Nothing in the code says I can't." And in fact, if you read the code very strictly, he can't dismiss it for the reason that the appellate court dismissed it if you want to be the purest of textualists.

 

Sam Fendler:  Professor Simon?

 

Lindsey Simon:  I got nothing. I'll let you go to the next one. I know we're short on time.

 

Sam Fendler:  Yeah. So we have one interesting question from the audience, which asks, what if

J&J redoes this funding agreement, but let's say they get an expert opinion to say, "Well, we're going to forecast a $10 billion ultimate settlement." If they redo the funding agreement and put it at $10 billion instead of $60 billion, what happens there? A related question: What if the original funding agreement was $10 billion? What do you think?

 

Anthony Casey:  So the first question is easy. It's fraudulent transfer, right? So the funding agreement exists, and they can't take it back now. And again, something that a lot of folks don't realize, it exists and applies outside of bankruptcy. So that funding agreement -- If this does appeal, is final, and it goes out, that funding agreement is there, and they'd have to buy it back if they were going to buy it back. And it's worth $60 billion, so that, I think, is easy.

 

The second question: I think you have to give the full asset value to make a two-step not a fraudulent transfer and legal under Texas law. So I don't think you can undercut it to make it, "I'm only going to give 10 percent of my assets because I want to file." To me, that sounds not only as a constructive fraudulent transfer, but an actual fraud fraudulent transfer, actual intent. So I think they did it right, and they can't change that.

 

Lindsey Simon:  Yeah. Absolutely. I think that giving anything less than the value would make the Texas two-step hot button, front and center, right? So far, I agree it's kind of a red herring. I think everyone has it in mind when they see what's going on, but the opinion didn't turn on that. If they didn't fund it fully, I don't think there's any way it would have been approved.

 

So the input—how much money, what are our assets—I don't know that that could change in this case. And these really big companies with plenty of money, like that number, maybe you can finagle it, but not in the way that I think would lead to it. The bigger question is, what is our exposure? And so, I think that's where the attention will get focused. How can we make financial distress? How can we meet that threshold by getting our cases in a way that makes them look like maybe they are worth more than we hope they will be worth and then hopefully reduce that down once we get into bankruptcy? If I were wearing my debtors' counsel hat, that's what I would think about doing.

 

Sam Fendler:  Right. Well, we have about five minutes left, so I'll pose two large questions, and you can infuse these into your final remarks. Professor Casey, we'll start with you. A couple of things we've been talking about: Number one—and I think this has been unanswered by the circuit court—how are we to understand the role of bankruptcy law in addressing mass tort liability going forward? And likewise, at least in the Third Circuit, even though the opinion did not say anything about the Texas two-step, is the Texas two-step essentially null and void in the Third Circuit following the opinion?

 

Anthony Casey:  So I think it's worth remembering that the debtor didn't choose the Third Circuit, actually. The debtor chose the Fourth Circuit in North Carolina. So I know Professor Simon mentioned, normally, you get to choose your judge, but there are limits and venue transfer here.

 

I probably thought after they got the bankruptcy opinion, "Oh, that was actually a fortuitous venue transfer" because the bankruptcy opinion was so supportive, even more, I think, supportive than some of the rulings out of the North Carolina bankruptcy courts. But this this opinion, I think, makes filing a Texas two-step-type case in the Third Circuit very unlikely, but it was already -- They were not doing that. So that's that part.

 

The first part—and Professor Simon pointed this out earlier—there's other cases going on right now that are going to tell us a lot. The 3M case, the issue on appeals, I understand, is the injunctive issue and it's whether or not they denied the injunction against the parent because the parent was argued to be solvent.

 

And so, the Third Circuit was saying, can you file when you're not in financial distress? The Seventh Circuit has -- The current question is, can you get an injunction against the parent, a third-party injunction, when they're not in financial distress, but there's then motions to dismiss based on LTL that might work their way up?

 

But I actually think the Purdue case is the most important because the third-party releases are the key to these mass tort settlements. There's a reason the Texas two-steps are not in Texas, right? Third-party releases are very hard in the Fifth Circuit, and that's why we're not talking about the Fifth Circuit today.

 

If the Second Circuit says third-party releases are out, then mass torts are looking at the Fourth Circuit. And if they say -- So that, to me, is the key because once those are out, you're kind of saying you can't get the global settlement in bankruptcy, so you're going to look for the global settlement outside of bankruptcy. And to me, that would be unfortunate, because—and I think Professor Simon would agree—there are cost savings, and this is a way to get to the outcome quicker and, I think, more equitably among the claimants.

 

My place where I vehemently agree is there is a leverage shift that's going on, and then my disagreement is, how do we fix the leverage shift? I don't think it's dismissal or not allowing releases. I think it's doing things like the judge did in Purdue where you have a robust process.

 

And you might even -- In a paper that I wrote recently with a colleague, Josh Macy, we talk about, there are extreme things you could do. And we talk about exclusivity, and we talk about denying certain types of injunctions, but that can all be done in bankruptcy if you're really worried about negotiation leverage. That's where I think this should go, but if we get three circuits that say no third-party releases, mass torts are not going to be going to bankruptcy court much going forward.

 

Lindsey Simon:  I think that might be the issue that we disagree most on. I actually think, even if Purdue comes out and says -- And to be clear, we're not talking about all non-data releases. We're talking about non-consensual non-data releases, right? So I think if the Second Circuit comes down and says, "Well, in this circuit, we will not allow non-consensual ones," I do think the other reasons why companies filed the consolidation, the automatic stay, I think it will still be worth their while to use bankruptcy as a forum.

 

I think they will still try to propose a plan of reorganization, I think they will use time and negotiation to get as many people as possible to agree to the settlement, and then they'll consent to give the release because most plaintiffs will take the money and sign the release, and they'll move on. That's what we see in MDLs in many cases.

 

So I think bankruptcy as a form, it will still deal with these mass tort cases for the very well-funded defendants. I think we'll also see them for the not-for-profits. I think mass tort and bankruptcy is not ending, right? We're talking about Johnson & Johnson, 3M. We're talking about money cases. There are plenty of non-money cases that will continue to be there.

 

And I do still think the defendants who have a choice whether to fight it out in MDL or look at bankruptcy, as long as it's known, right? We don't have this uncertainty where they go in with one plan and then come out with another and the law changes. That is the expensive uncertainty that I imagine businesses don't want to finance, but if we know, "Okay, I can't get my non-debtor release without consent, but here are the three ways we can structure the plan to get as many as possible and reduce the pool of holdouts, and then we can just litigate those," that, to me, seems like the smarter play that I think companies will still do.

 

Anthony Casey:  I amend my answer. I actually agree with that last bit. I think Professor Simon is right.

 

Sam Fendler:  Excellent. Well, that's all the time we have. To Professors Casey and Simon, and on behalf of The Federalist Society, I want to thank you very much for sharing both your expertise and your time with us today and helping us understand this case and some of its intricacies and larger ramifications. It was very helpful, very good discussion.

 

I also want to thank our audience for joining us. We greatly appreciate your participation. Please check out our website, fedsoc.org, or you can follow us on all major social media platforms @fedsoc to stay up to date with announcements and upcoming webinars. Thank you all again once more for tuning in, and we are adjourned.

 

 

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