Litigation Update: In re: LTL Management

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Nick Marr:  Welcome, everyone, to this Federalist Society virtual event, as this afternoon, March 9, 2022, we’re hearing a litigation update on a case called In re: LTL Management. I’m Nick Marr, Assistant Director of Practice Groups here at The Federalist Society. As always, please note that expressions of opinion on today’s call are those of our expert.

 

      We have a great program planned for you today and a great expert. It’s my pleasure to introduce to you Professor Anthony Casey. He’s Deputy Dean, Donald M. Ephraim Professor of Law and Economics, and the Faculty Director of The Center on Law and Finance at the University of Chicago Law School. I’m very pleased to be joined by Professor Casey. Thanks very much for taking the time to be with us. Professor Casey’s going to give a 10–15-minute overview of the case, give the updates, chat a little bit about where the case might be going, and then we’ll have a little bit of moderated question-and-answer portion of the call. We’ll be looking to you, the audience, towards the end of the hour for your questions, so have those in mind for when we get to that portion of the call. With that, Professor Casey, thanks for being with us. The floor is yours.

 

Prof. Anthony Casey:  Thanks. Thanks for having me. It’s exciting to talk about this pretty fascinating case. So my update is on In re: LTL Management LLC, and it’s a case in the bankruptcy court in New Jersey. Folks might be more familiar with it as the Johnson & Johnson talc subsidiary bankruptcy. That’s how you might hear about it in the press. And while there’s a lot going on in the case, I’m going to focus today on a ruling last month, denying a motion to dismiss, and this ruling –kind of goes to the heart of the case, but it also goes to the heart of our bankruptcy law more generally.

 

      Before I get to the ruling itself, we have to have a little background so we can understand the importance of the case and the importance of the ruling—so big picture, simplifying a lot. We all know Johnson & Johnson is one of the largest companies in the world. As with most large companies, Johnson & Johnson is arranged into several subsidiary entities. Relevant for this update, one of the businesses within the Johnson & Johnson enterprise is its baby powder business. And since around 1979, that business has been located in a subsidiary entity. It’s had lots of names and gone through different forms, but currently, we’re referring to it in the case -- and the judge talks about it as old JJCI. So I’ll talk about old JJCI, and that’s where the baby powder business was.

 

      Over the last decade, there’s been a surge in litigation alleging that baby powder and related products containing talc cause ovarian cancer or mesothelioma. Nearly 40,000 of those cases have been filed against either old JJCI, Johnson & Johnson, or both. The rate of filing also suggests that tens of thousands more cases are on their way. Meanwhile, the few cases that have gone to verdict have had varied outcomes, basically from 0 to 4 billion. So that’s the range of case outcomes when you get -- when one of these suits is brought. So the company’s facing thousands of cases with a huge range of expected outcomes.

 

      In response to this, Johnson & Johnson initiated a series of restructuring transactions to resolve the liabilities, and that plan is what ultimately gets us into the LTL bankruptcy. Again, I’m simplifying a lot here, but the basic move was that Johnson & Johnson split old JJCI into two new companies, and it did this pursuant to a Texas law that allows such a split, often referred to as a divisional or divisive merger. The result of that transaction was that old JJCI became two new entities—new JJCI and LTL. That’s our debtor in this case. That divisional merger also allowed it to allocate assets and liabilities among those two companies, and that’s part of the Texas law. Now, new JJCI came out of the transaction basically with most of the assets, and LTL came out with the talc-related liabilities. Two days later—and this is still part of the resolution plan—LTL filed for Chapter 11 bankruptcy.

 

      Now, that process of a divisional merger, followed right away by a Chapter 11 filing, has become known as the Texas two-step because this transaction is most commonly allowed in Texas. It’s been utilized in a handful of mass tort bankruptcies in recent years. Now, here’s the key part. If what I’d laid out so far were the entirety of the transaction, there would be a huge problem. Right? Separating assets from liabilities can leave creditors with no recourse. Were that to happen, the law would deem a transaction like this a fraudulent transfer, and Texas law would likely invalidate the merger. As a result, the law requires -- to be valid, a transaction like this needs value to be provided to make sure the creditors are not worse off because of the transaction.

 

      In order to provide that value, Johnson & Johnson and new JJCI agreed to fund any talc-related liability of LTL, the debtor, up to the value of the assets of old JJCI at the time of the merger. So we create these two new entities where there’s this funding agreement that says the liabilities will be paid up to the value before this merger divided the two entities, so we’re going to pay up to the value of old JJCI all the liabilities that LTL ends up with. In that way, the asset value of JJCI was not separated from the liabilities because the funding agreement brought it with. That was the state of things when LTL filed for bankruptcy. Case was originally filed in a bankruptcy court in North Carolina, but that court transferred venue to the New Jersey bankruptcy court, and the New Jersey court is the one that ultimately ruled on the motion to dismiss, which concerns us, and which I want to talk about today.

 

      In the motion to dismiss, the committee representing the talc claimants asked the bankruptcy court to dismiss the case, arguing that it was not filed in good faith. The debtors, you can expect, disagreed. So the question to the court was, was this case—this bankruptcy Chapter 11 case—initiated in good faith? And that question turns really on why. Why did LTL file, and why did -- why the Texas two-step? If the answers are consistent with the purpose of bankruptcy law, we don’t -- we have a good faith filing. If not, we don’t. As the court put it, and as other courts have put it, the law generally requires that a Chapter 11 bankruptcy should be seeking to preserve going concern value or seeking to maximize the value available to satisfy creditors.

 

      The motion to dismiss basically argued that Johnson & Johnson had structured this whole thing, not for that purpose, but rather as a litigation tactic to pay fewer damages on talc liability. In their view, no value in the bankruptcy proceeding, just a way to force a lower payment. The court denied this motion and pretty soundly rejected those arguments. And here’s just a brief quote, which is an example of the way the court viewed it. “Let’s be clear,” the court said. “The filing of a Chapter 11 case with the expressed aim of addressing present and future liabilities associated with ongoing global personal injury -- claims to preserve corporate value is unquestionably a proper purpose under the bankruptcy code.”

 

      So the view of the court was, first, Johnson & Johnson had opted to use bankruptcy because bankruptcy proceedings are more well suited to the global resolution of mass tort cases than the alternative litigation options—think case action, MDL, state litigation. And thus, the bankruptcy court viewed it -- this proceeding reduces the administrative cost and preserves value. Second, the court held the view that Johnson & Johnson had created a structure that actually increased the funds available to claimants because the funding agreement that happened with the divisional merger guaranteed the availability of the full value of old JJCI and put the promise of the payment by Johnson & Johnson behind that guarantee. Because of that, the court said you actually increase your available funds, not decrease it. The court also noted that, as a result of the transaction, not a single asset had been cut off from the reach of creditors. Nothing about the structure had reduced the creditors and claimants’ ability to go after value. So in light of these two points, the court reasoned the purpose of the structure was plainly not to reduce liability but rather to facilitate a quick resolution of the current and future talc claims.

 

      We got to put a little meat on that. What does it mean to resolve the claims in bankruptcy, and what does that look like? So just as in any litigation, you’re going to have a question of liability. For the bankruptcy proceeding, the first question will be total liability. Just like outside a bankruptcy, the parties will have representatives, and those representatives will litigate or settle that question of what the total liability could be. If they don’t come to a settlement, the bankruptcy court’s going to have to set that amount. And here’s a key point that the court—bankruptcy court—focused on and that parties were arguing about, but the bankruptcy process has to set that value. Outside of bankruptcy, the courts have to set that value. To be clear, in any setting, inside or outside bankruptcy, at the end of the day, a value has to be set. The question is what process you use to set that value. Do you do it case by case as part of an MDL system or state litigation, waiting for future cases to arise before you can address them? Or do you do it in one proceeding in a bankruptcy court that covers all present and future claims? That’s the question. Which process is available?

 

      Once that amount is set—and, again, by settlement or litigation—a bankruptcy plan would create a trust that contains the value, and the claimants’ future incurrence go to that trust to get their distribution. So that’s the idea behind the bankruptcy resolution. That’s the intended outcome. We determine the value by settlement or litigation. We get a plan. The plan creates a trust. Claimants go to that trust. And we do it all in one proceeding. The benefits of this system include certainty, especially the ability to resolve future claims—and that’s not available outside of bankruptcy—the uniformity of treatment across those claims, and the equity across claims—everyone is in the same proceeding. It’s less of a lottery system of -- in the MDL or in the state law litigation.

 

      Now, absolutely—and the court recognized this, and it has to be noted—this is a different process than litigating outside of bankruptcy. It’s a process, but it’s different. The court here took the view that different is not worse. In probably one of its stronger statements, it said, “What the court regards as folly is this contention that the tort system offers the only fair and just pathway.” So the court was saying, “Yeah, there’s a tort system. There’s MDL. There’s state law litigation, and there’s bankruptcy. And there’s not just one system, and that system isn’t the only fair one, so it’s appropriate for a debtor to file bankruptcy in order to opt into this system.” That was the court’s view, and that answers the, “Why bankruptcy?” So there’s your bankruptcy purpose in the court’s view.

 

      There’s still one looming question, though. Why the two-step? Why the creation of LTL before the bankruptcy? According to the claimants in the motion to dismiss, if Johnson & Johnson wanted to use bankruptcy, the parent company, Johnson & Johnson, should have filed itself. The court view this as a red herring, and it really was not having none of it. In the court’s view, the purpose of this case was to resolve tens of thousands of talc-related claims. Right? That’s where the distress falls. That’s what we’re trying to resolve. Those claimants who, of the talc -- those talc claimants, present and future, are the ones who will be affected by, and their representatives will have to vote on the bankruptcy plan. So the important thing is that their claims are in the proceeding and they are represented, not everyone else. Right? The court asks, “Why do we want to pull every single other contract that Johnson & Johnson has, every single other counterparty, every employee, every single stakeholder of the entire Johnson & Johnson enterprise into this proceeding to get a resolution that involves those claimants? All that will do is increase the cost and the procedural maneuvering among the parties. If you file all of Johnson & Johnson, that’s what you get; everything comes into the proceeding.” And the court asks, “Why would we do that?”

 

      To add a little perspective on that, a bankruptcy filing of Johnson & Johnson—the entire enterprise—would, in asset value, be second only to the Lehman Brothers bankruptcy. It’d be second largest bankruptcy in history. The cost of that proceeding would be enormous, and it would increase exponentially as -- from what we’re talking about here because you’re adding so many extra parties and extra interests and extra contracts. So the bankruptcy court’s ruling pretty bluntly asks, “What’s the point of that?” Now, some of my colleagues in the Academy think the cost is the point. So in their view, the debtor only gets the benefit of bankruptcy if the debtor feels the pain of bankruptcy. Now, to me, and I think to the court here, this gets it completely wrong. The bankruptcy system, Chapter 11, is about preserving value. It’s not about destroying value. The law does not require the debtor to destroy value, shut down operations, or lay off workers in a sort of ritual to prove its good faith. That’s not the Chapter 11 rules. It hasn’t been in the code since ’78. It’s not there now. It's not what Chapter 11 is intended to do. So the court says you don’t have to punish yourself and destroy value in order to take advantage of the system to preserve value, and that’s the way it viewed this filing.

 

      Finally, it is worth addressing one thing, and that’s the question of abuse. So claimants, in their motion, are not wrong to say the Texas two-step and a Chapter 11—Chapter 11s in general, actually—are subject to abuse. There’s two big risks of abuse going on. First, as I noted earlier, asset value could be diverted from creditors. The court here found that the funding agreement eliminated that risk, but that’s not always necessarily true. There needs to be robust protections to make sure assets aren’t diverted from creditors’ reach. Most obviously, we have state law measures that can be pursued if a divisional merger, or anything like a spin, an asset sale, anything like that -- if it’s used to divert value, we have state law measures and bankruptcy measures to undo that or to remedy that.

 

      The second risk is what if the debtor tries to push through a plan that provides too little value for the claimants? Right? And that’s a possible risk in any bankruptcy. There’s a risk that the debtor bets on its ability to slip one over on the system. In response to this risk, the bankruptcy system has two protections. The first is judicial oversight. The judge in the case has to approve the plan, has to resolve value disputes, and the judge will be looking for attempts to abuse the system that way. But the more important protection is that the plan has to be negotiated with and voted on by the claimants.

 

      It’s important to note that the mass tort bankruptcies you hear about in the news—the Purdue case and other ones—the plans in those cases have been approved with well over 90 percent of the claimants voting in favor. Right? Here, and in those cases, the debtor—and here the debtor in Johnson & Johnson—have a strong incentive to get to that same place—incentive to negotiate with those claims, to fund a plan that gets that level of support, that over 75, over 90 percent support that they get in favor of the plan. The way the court put it in ruling on the motion to dismiss was the only way that Johnson & Johnson and new JJCI resolve their liability in this bankruptcy is a plan in which, and this is the quote, “in which Johnson & Johnson’s and JJCI’s role and funding contributions warrants a release is both a matter of fact and law.” They have to get to that outcome, get to that support level where they’re gaining the support, both of the claimants and of the court.

 

      So the big picture—this is my big-picture take on the dismissal—is there are always opportunities for abuse in any proceeding and in bankruptcy proceeding, but it doesn’t make sense to shut down the system completely to avoid that abuse when we have other protections available. And I think the court got it right in avoiding that remedy and saying, “No, there are other measures to protect against abuse.”

 

      Now, before I open up to questions, just a quick what’s next, because updating on a case like this, it’s important to think about where bankruptcy law is and what this means. It’s a really strange time in bankruptcy law because, at the same time, filings are down right now. There are fewer large bankruptcies, but the attention is way up. So high-profile bankruptcies—Purdue, Boy Scouts, Johnson & Johnson—all these cases are really high profile and getting noticed in a way that other bankruptcy cases didn’t, while bankruptcy filings are, in general, down.

 

      And as we watch these cases, there are going to be, and this -- especially here, additional rulings of large importance. It’s worth watching those because these -- this small group of high-profile cases will lead to precedent that is certain to have major impact on future mass tort cases but, perhaps, on all Chapter 11 cases depending on how broadly the rulings are and how broad the issues they’re ruling on become. So we should watch these to say, “All right, what does the Second Circuit say in Purdue Pharma. If this case, LTL, in the Third Circuit -- what ends up happening there?” Those are going to be important things to watch in thinking about both mass tort and bankruptcy, generally. Thanks.

 

Nick Marr:  Thanks very much, Professor. That’s a great overview. For the audience questions, we’ll go to those in a bit. If you have some right now, you can submit them via the chat function. They’ll pop up here, and I’ll ask them at the appropriate time. I have a couple questions first to begin, Professor. First one that comes to mind is you mentioned the dynamics of, basically, if I got this right, fewer filings but more attention on these cases. What makes bankruptcy, and, specifically, what makes this particular case so controversial? I would think that many, many companies have gone through bankruptcy or go through it. Could you speak a little bit to that dynamic?

 

Prof. Anthony Casey:  Yeah. So it’s interesting to kind of look big picture of why all the attention. I don’t think it’s just this case. There was a lot of media attention around the Purdue bankruptcy. There was a lot of media attention around the Boy Scouts bankruptcy, and there’s a few others where we’re -- for other reasons, nonbankruptcy reasons, they were in the press as well. Then, the similar issues are playing out—mass tort-type issues—in this case as well, so that brings some attention. And then, Johnson & Johnson, as I said at the beginning, is in the top 15/20 largest companies in the world, so we’re talking about a bankruptcy that’s resolving a high-profile litigation issue with a very large and high-profile company that everyone knows the name of. Right? It's as household a name as you’ll get. So that’s the start as to why there’s attention.

 

      Then the reason why some of these cases have been controversial attention is they -- the Texas two-step is not -- like I said, there’s been a handful of cases, so it’s not exactly the way cases have been done decades ago. Right? It’s not the same exact structure. It’s a slightly different structure to get to an outcome in a mass tort setting. And mass tort settings are complicated, and there’re different structures utilized. But mass tort cases are complicated because a lot of people have a lot at stake, and that raises the level of controversy just right there, like, “Okay, there’s a lot at stake here. There are billions and billions of dollars at stake.” And so, people have an incentive to bring that forward and bring that -- get that attention going. So I think all of those factors get you to a point where people are watching this. And as I said at the very end, the effects of Purdue and Boy Scouts and Johnson & Johnson in these cases on mass tort can be very important. Right? If these structures are successful, that’s an important thing. If this had been dismissed, it would have been a huge deal, and, in part, people would have had to really think about the way they’re structuring settlements.

 

Nick Marr:  That makes sense. Kind of a more fundamentals, theoretical question for you to kind of provide some context to that is, can you talk a little bit about the pros and cons of the mass tort system, and are the pros good? Are they enough to keep people in that system, if you can follow the question? And is there something about the cons of it that make bankruptcy appealing, an appealing path? Does that make sense?

 

Prof. Anthony Casey:  Yeah, yeah. Certainly, the way the court viewed -- I think the court took a -- the bankruptcy court took a fairly negative view of the alternative MDL, a class-action system, not in general but as a tool to resolve these types of mass torts, in particular, ones with future claimants. Right? So if you have a case with future claimants, you’re not going to be able to resolve those claims in the MDL situation, in a class-action situation, in a state law litigation. There’s really not a mechanism for resolving that, and it creates a problem because the current victims are chasing the same resources as the future victims. And this has been a problem in asbestos for years. And this is why we’ve seen bankruptcy as the remedy or as the structural solution in many asbestos cases. So the first and fundamental issue is that future claimant problem.

 

      Then there are questions about just centralizing and resolving in how many proceedings. If you have a multi-district litigation, you’re going to centralize some things but not all things, and you’re going to settle some cases individually and not be able to do the global settlement that is sought here. And that global settlement can be really valuable, again, because we’re talking about the same source of funds that the current and future victims are pursuing. That’s not to say -- that is my view. That’s not to say that the litigation system is completely -- sole litigation outside out of bankruptcy is completely broken, but I do agree with the court that it is fair to say that’s not the only process out there, and bankruptcy can be a very valuable and useful process.

 

      In my view, what I’ve written about in my scholarship, is that bankruptcy exists to form a system and framework for negotiating multilateral disputes when negotiating is problematic, and there’s so many parties, and there’ll be holdouts. And that’s exactly this problem. And so, bankruptcy can’t solve -- be a tool for solving this problem. It’s not doing what it’s supposed to do. Right? There are other multilateral bargaining areas where bankruptcy serves as a framework, but it’s the same problem and the same idea here. So I think the court focused, in some detail, on the negatives of the other system, and there are those, but then my work’s been focusing on the positives of this system. It really is designed for this type of negotiation, and that’s why it’s a valuable alternative in these mass tort cases, again, especially with future claims.

 

Nick Marr:  That’s great. Then we have a lot of great questions coming in, so I’m going to get to those very quickly. Just real quick on the tail end of that, I wonder -- kind of flip the question around. So you mentioned bankruptcy is that it can be a good system for resolving these kinds of conflicts. What are some notable drawbacks, if you will? What are some cons to the bankruptcy system?

 

Prof. Anthony Casey:  So one thing people have noted is -- and this is what I meant when I said it’s a different process. And so, in nonbankruptcy litigation, there is this idea that you’re going to get this day in court. Now, it doesn’t go away with bankruptcy. You’ll be able to litigate with the -- you’ll have a representative in the bankruptcy proceeding, and then the fund is set up, and you’ll make a claim against the fund, and there are opportunities there. But it’s not the same. And so, when you say to someone—especially someone who’s not a lawyer—you say, “You’re not getting that day in this court; the debtor decided to put in this court,” I fully get why someone’s like, “Wait, the debtor told me what court I have to go to.” That is a cost to solving this way.

 

       Now, what I said earlier about the 90 percent—so, think Purdue—you have 110,000ish claims, and you have 108,000 or something -- 90 some percent of those claims want to settle now, and they think this is a settlement that’s going to get money to them right away. And then a small percentage don’t. And to be clear, that’s all victims. Right? That’s all tort victims that we’re talking about. It's a dispute within the group. And so, one cost is this group wants to have that day in that court, and the other group wants relief and remedy now. And so, there is a trade-off there. And so, you have to say, “All right. We’re choosing one process rather than another.”

 

      It’ll be a more centralized, one representative or one smaller groups of representatives. There’ll be less variance is the good thing of bankruptcy. I mean, the flip side is some tort plaintiff's benefit from variance, and some get disadvantaged by it. And so, if you were one who thought you would benefit from variance, then making it more certain and less variance, the total amount—I’m not talking about changing the total amount—but the distribution can change. And depending on who you are, you have a different view of whether that’s good or bad.

 

Nick Marr:  So we’re continuing to get some great questions. I’ll just do one more, and then we’ll go right to audience questions. And thank you to the audience for these great questions. I’m reading them; they’re very good. I’m wondering about -- you were kind of explaining the LTL structure and the old -- all those different names. What do you say about the -- criticism that I’ve heard of divisional mergers is basically—and I think you mentioned this -- mentioned this or alluded to this—basically, they’re a way to reduce payouts, or they could be a way to reduce payouts. What do you have to say in response to that, if anything? And maybe one thing to address is, are there already things in place that prevent this, basically, fraudulent behavior?

 

Prof. Anthony Casey:  So to be clear, the reduction of payouts would come from, as I said at the beginning, separating assets from liabilities. This divisional merger—and in the recent asbestos cases—they all had these funding agreements with them. The funding agreement here says the talc liability will be funded up to the value of JJCI’s assets at the time of the merger, and if those assets go up, the value of the funding goes up with it. It’s hard to see how that reduces the available payout. Right? It’s like we sold the assets for their true value, which always is our -- or that’s always fine to sell assets for their true value, and then we have that funding from the cash available. So it’s odd that you would think that that would lower payouts.

 

      Now, what I think the argument is, is the bankruptcy court is going to set that number low. And that number -- why would Johnson & Johnson go do this if they didn’t expect the bankruptcy to set that number lower? As I said, a debtor might bet on lowballing and pulling one over on the system. That’s possible. I have no reason to think -- and I think the bankruptcy judge, for good reason, didn’t think that bankruptcy judges are more prone to underestimate claims than other judges. Like, why is it just inherently that bankruptcy will get that number wrong? That’s the pushback on the, “Oh, this is used to reduce liability.”

 

      The bankruptcy court is going to have to set a number. And people keep saying, “Oh, they’re going to cap a number.” Well, if you call that a cap, then at the end of the day, when all the other cases are litigated, they will be capped at whatever those add up to. The question is, “What’s the total of those claims, and which system do we think gets that right?” I actually don’t know that either system has a dominance on getting it right. Then the question is, “If we don’t know which gets it right and they’re both expected, which gets it done most efficiently and most cheaply and without wasting resources that either can go to the state -- the tort claimants or to the valuable enterprise?” Right? We don’t want to waste money for the sake of wasting money.

 

      And so, it’s not clear to me why you say, “Oh, it’ll reduce value.” As you said at the end of your question, if there are other measures, if a divisional merger didn’t include a funding agreement, it would be invalidated, either under the Texas statute or under fraudulent transfer law. If you got to the point in the bankruptcy where the -- J&J or new JJCI refused to honor the agreement, the bankruptcy court will take action. And so, there are measures to stop that underpayment. I think the counter-worry is, “Oh, but the bankruptcy judge is just inherently going to undervalue.” And that’s the part I take some issue. I don’t see why that’s true.

 

Nick Marr:  Very interesting. Well, I’ll come back maybe at the end, but we’ve got to get to the audience questions. These are great. We have quite a few on the Two-Step Act in Texas. I’ll try to combine them in a couple points. The first one is, can you re-explain what is this --

 

Prof. Anthony Casey:  Yeah.

 

Nick Marr:  -- just in a nutshell?

 

Prof. Anthony Casey:  It’s a law that’s been available in Texas since, I think, 1989ish. There’s a version you can do in Delaware and, apparently, statutes in Arizona, Pennsylvania, where it might be allowed. It’s just a part of a statute that says you can have a merger that results in two entities and allocate assets and liabilities between them. But that basically what it says. And it’s weird to call that a merger because it’s actually a division, so that’s why people refer to it as a divisional merger or divisive merger. It just says you can have an entity that then turns into two and allocates liabilities and assets between it. There’s nothing magic about that. You could do a spin-off without doing that that ended with assets and liabilities allocated. You could do an asset sale that ended up with assets and liabilities allocated. You could just have an asset transfer.

 

      Now, in all of those transactions, you’ve got to worry if you’re transferring assets without value coming in for them to be available for those liabilities because that’s a fraudulent transfer. So in some sense, the Texas two-step -- well, the second step is the bankruptcy filing. The Texas divisional merger is just one quick way to get to, “We’re going to separate the assets and liabilities, and then figure out the value to make sure it’s not a fraudulent transfer, which is the funding agreement.”

 

Nick Marr:  Yeah. Makes sense. Relatedly, we have a question about, specifically, can you go into again maybe how did the court resolve the two-step issue in this case? And then, bringing fraudulent conveyance into it, can you explain how that plays in?

 

Prof. Anthony Casey:  So the court here said, “First, this is allowed under state law. It happened under state law, so there’s nothing—starting point—inherently wrong with divisional merger.” And I think that has to be right. Bankruptcy will look to the law of the state about what transactions -- again, putting aside fraudulent transfers but just how you structure an entity. Right? And so, that’s first step. That’s okay. It was done consistent with the Texas statute. The Texas statute independently would require to make sure the creditors aren’t worse off because of the allocation, which is a separate protection against fraudulent transfer from fraudulent transfer law. The court said, “All right, it does that.” The funding agreement provides that value and, as I noted, actually provides, in the court’s view, more value, which makes it consistent with the Texas statute, also consistent with any fraudulent transfer law the way -- that’s the way the court looked at it. “There’s no fraudulent transfer here because you weren’t doing it to move assets away, and you didn’t move assets away—or, at least, asset value away—given the funding arrangement.”

 

      So at that point, the court says, “The Texas two-step is not what this is about. This is about this filing to resolve this question: is there a bankruptcy purpose to do that? There is. That’s the opting into this system to resolve the mass torts. The fact that this other transaction happened before you did it was just part of a system, a structure to opt in to this system, and it’s fine as long as you provided that value. If it didn’t provide that value, again, you would have maybe a different outcome in this motion to dismiss. You would have perhaps fraudulent transfer arguments in the bankruptcy court. You would have fraudulent transfer cases outside of court or even before the filing, and you’d have a challenge under the tax Texas statute.”

 

Nick Marr:  Makes sense. Well, we’ve also got questions about the background history of these kinds of divisional merger laws and then the future of them. So first, the question is about -- basically, it seems like these divisional merger laws are relatively new. Do you know what inspired them? What made them come about? Okay.

 

Prof. Anthony Casey:  Yeah. So as I understand -- the Texas statute, like I said, has been since the ‘80s, and it was not -- this wasn’t in the vision of what was going on. It wasn’t like, “Oh, we’re going to create a structure for bankruptcy resolution mass torts.” Right? That doesn’t mean it’s not valuable for that, it’s just -- I don’t believe that was where it was created. I think it was just part of the way the Texas statute defined mergers and allows companies to structure their entities. Then, as I said, there’s been a handful of these cases, starting with asbestos cases, where they use this as a structure to then isolate the liabilities that would then go into bankruptcy to be resolved. And the value of that is -- this is when I talked about bringing -- do we want to bring in the entire enterprise when all we’re trying to resolve is the thousands of tort claimants. And when you couple that with the funding agreement, the courts have said—and this is in North Carolina, where most of these have been filed—the courts have said that is a valid structure and a valid reason to file.

 

      And so, then, as courts say it works, people use it. Right? And there’s this sometimes-nefarious story: look, that court said it was okay, then people jumped on the bandwagon. And the court here in New Jersey is like, “Yeah, that’s the point because the bandwagon is saving value for everyone involved.” Now, if you disagree with that, then there’s a problem with this, but the bankruptcy court in New Jersey was pretty clear in its view that this structure allows a process that is A) easier, quicker, and beneficial-to-everyone way to resolve mass tort. And it doesn’t take value away from the claimants; therefore, it’s consistent with bankruptcy law. And the fact that the two-step just made it more clean and simply is fine because bankruptcy’s not a punishment. It’s a process to preserve value. So beyond that, I don’t think there is much history or, at least, not that I’m aware of in the text. I think it just was on the books and then was used for this.

 

Nick Marr:  Oh, great. So then we have a question about the future of these laws. Do you think that -- what’s in the works in terms of what Congress is thinking about doing? Specifically, this person’s next question is, “Would that kind of federal law be positioned to override something like Texas’s law?” Or you mentioned a couple other states—I think Delaware, Pennsylvania. If you --.

 

Prof. Anthony Casey:  So there’s been legislation bounced around in Congress and some hearings on this, both about the releases in Purdue and the divisional mergers. The one that was drafted was really broad, and it was a -- basically said that if a transaction—and they had to write it this way because they wanted not a lot of loopholes on it—if a transaction results in the separation -- something along the lines of, in the separation of liability and assets, the entity that result -- an entity that results can’t file for bankruptcy. Now, as you can imagine, given everything I’ve said, I’m not a big fan of a law to make this structure -- to outlaw this structure to begin with. But even assuming we said, “All right, we want to get rid of the Texas two-step,” that legislation would do so much more because there are lots of transactions that result in assets transferring from entity to entity. And what happens if you say those entities can never file for bankruptcy? The case gets dismissed. Well, that’s a cost to these transactions that might be totally unrelated to any of this, but, even for these transactions, then, all right, the claimants are going to have to pursue a claim in a state court, and Texas will still have this law that says this is a valid transaction.

 

      So it’s not clear who that benefits or how that plays out. Right? It will be a different process, and bankruptcy will be off-limits. But what happens if down the road, there’s not a cent and there’s very little left, and there’s a race against the assets, and you can’t file because the statute covered it? So I think the drafters are aware of this issue, but if legislation does come out, it will be very different than what’s been put out right now because it’s so blunt and broad that I think it would be problematic, beyond whether or not you think two-steps are valuable transactions or not.

 

Nick Marr:  Good. Well, because this is a Federalist Society audience, we have two questions, actually, about the Seventh Amendment. Basically, the questions are, “Doesn’t this process --” I assume this is the bankruptcy process, but I’m not sure. Maybe the questioner can clarify. “Doesn’t this process essentially kill the Seventh Amendment, right to trial by jury for torts?” Also, another question, “Are there concerns with the Seventh Amendment and the right to jury trial in these mass tort cases? How is this issue addressed?”

Prof. Anthony Casey:  Yeah.

 

Nick Marr:  Both are kind of --

 

[CROSSTALK]

 

Prof. Anthony Casey:  So these claims were brought up in the motion to dismiss, and the court talks about it. One point the court makes, and worth noting, is the -- now we’re talking about whether or not setting up this settlement fund—this fund that’s going to be where we go for our claims—is constitutional. The court points out, there’s a provision in § 524 (g) that specifically, for asbestos cases, envisions this exact outcome. So point one -- Congress, at least when passing that, thought this was consistent with the Seventh Amendment. Those cases have proceeded without being ruled unconstitutional under the Seventh Amendment. So while there is a claim made, if true—if it violated Seventh Amendment—we would be saying § 524 is unconstitutional. The way courts have point -- what courts have pointed out is you can structure the fund in a way that preserves the right to your jury trial. Right? You’re just saying, here’s the available funding. And now, you can agree to your claim, or you can litigate with the fund over what your claim is or get into the litigation there.

 

      I think about this question, but I’m not a con law scholar by my -- it’s not my day job, but I will say the cases are -- no court has said yet that violates the Seventh Amendment, and it would be a radical moment to say, “All right, all we’ve done in asbestos has been unconstitutional. The statute that was passed is unconstitutional. Settlement funds in all these bankruptcies are subject to that challenge.” And ultimately, that’s where the court, in this case, and in most cases, have come out.

 

Nick Marr:  Great. Well, we have some more questions related to the specifics of this case, so let’s return there. Let’s see. One is -- I just scrolled past -- oh. “How will the bankruptcy matter interfere with the MDL that is,” the questioner said, “said to be scheduled for trial within a couple months from now? Is it going to postpone it? What should the claimants in the MDL expect this year?”

 

Prof. Anthony Casey:  Yeah. There are injunctions to postpone the litigation, so they’re going to try to channel all the litigation into the bankruptcy. And so, the short-term will be to stay that. And then if there’s a settlement and a fund and a plan, again, the plan would have channeling injunctions, which would say, “Your claims go from -- the claims you would bring elsewhere go to the fund we’re setting up.” So that’s kind of the vision of it all is to bring this to one focal point where we’re resolving it here. We’re setting up that fund. The fund exists going forward. Current claimants come there. Future claimants, when their claims arise, come there. And I can imagine, we’re talking about 50 years of future claimants. Right? So this fund is there and all the litigation. The resolution, not -- the filing doesn’t permanently do this. This is the goal if it gets confirmed—and the court pointed out you’ll have to have support and get to that point—if it were confirmed, would be to channel everything into that process. And in the interim, we put a stay on.

 

Nick Marr:  That makes sense. We’ve got another question about -- and this one’s actually related to a question I had, so I’ll tack it onto the end. “Could the settlement value with claimants be so large that Johnson & Johnson itself will have to declare bankruptcy?” Related, my question is -- we might have touched on this briefly, but why create this separate entity, LTL? Why not just go with the whole company itself in the beginning?

 

Prof. Anthony Casey:  Yeah. So the “why create,” I think, gets to that point I was talking about trying not to bring everything in. And then it goes to your question. If the liabilities are less than the asset value of old JJCI -- we don’t know what they are, but if they were less than that value -- and the court talks about that being 60 billion dollars. And if that’s the right value and if the claims come in under that, then we can resolve this much more cleanly.

 

      Now, if the claims turn out to be a lot worse, it does change things. The arguments in the bankruptcy from the claimants’ class went in both directions, and the court talks about this. In one of them, they’re like, “Oh, you’re limiting our liability because the assets might not be enough, and then they shouldn’t be allowed to file because there’s no insolvency.” Well, if the assets greatly exceed 60 -- oh, I’m sorry -- if the claims greatly exceed 60 billion dollars, then you’re getting to -- first, the question is, are they claims just against JJCI, or are they claims valid against Johnson & Johnson? The filing in the two-step didn’t change anything on that.

     

      Now, the resolution in the settlement goal would be to resolve all of this. But if the claim was high enough and a plan couldn’t get through, you’d have claims against -- you’d try to bring those claims against Johnson & Johnson. Again, without digging into the claims, I don’t know whether those would succeed. It probably would have this variance. We’re talking about 40,000 claims, again, ranging from 0 to 4 billion. So it’s possible that a world in which this bankruptcy isn’t filed, you could start running up against, “Wow, we’re taking all the value from one of the largest companies in the world.” I think J&J is probably 400-to-500-billion-dollar value. I don’t think they think, and I don’t think -- people said that these claims are 400 billion dollars, but there is billions of dollars of potential liability in each claim and in the cost of litigating these. So if you just went through all the assets of the funding agreement, then you’d have a different case. And if there’s no plan, those claims would be out there still, and you’d have to figure out what to do with them. If Johnson & Johnson wants to settle those, they’re -- that’s something the judge talks about—what contribution gets to an outcome where they can get a release from liability or an injunction.

 

Nick Marr:  Yeah. That’s great. So let’s see -- audience questions. And just for the audience, we have about nine minutes left, so if you have additional questions, please send them now. Let’s see. So we did the Texas two-step. Well, kind of related to the liabilities and funds that we just talked about, there’s a question about “Is there any estimation right now as to what the ultimate liabilities will be?” And also, “Are there limitations to the funding agreement, or is this up to the court? What’s the process there?”

 

Prof. Anthony Casey:  So the first question -- I don’t know of a -- there’s no official estimation. I imagine plaintiffs’ lawyers have their estimate. I imagine debtors’ lawyers probably have a sense of where they estimated. I would guess that it’s -- there’s a lot of -- it’s a wide range of possibility, and you want to see how the strength of the cases plays out. And whether it’s right, the 10,000 cases are coming. So I don’t think there’s an official number now. There will have to ultimately be an official estimation of the total liability, again, either by settlement or litigation. I would imagine today, if you ask the parties and they said what it was, they would be at different points. And that’s why I said some court has to set liability, and we got to decide which process will do that by settlement or litigation. So that’s that. There was an important second question, which was?

 

Nick Marr:  Is there a -- the person asked about a funding limit? Is there --?

 

Prof. Anthony Casey:  Oh, yeah. So the agreement limit says that Johnson & Johnson and new JJCI, which is the entity where the assets went, will fund up to -- the talc liability up to the value of the old JJCI assets. Now, there’s a little bit -- it’s a complicated agreement because there’s a separate subsidiary revenue stream that’s going to come in first that the debtor owned, and that’ll pay first. But once that’s expended, then the funding agreement is really capped by the value of the assets premerger. Now, the assets premerger, but the value can go up, so the idea is, if the asset value goes up over time, then the valuation, when we get to that point, would look to that.

 

      So in that sense, the funding agreement is capped at the value of the debtor -- the premerger entity, which, if we didn’t have the Texas two-step, which is where you would have started with. Separately, to your point about Johnson & Johnson, they’re not -- there’s no release of them in the funding agreement, and the court talks about this when it says the way that they’ll resolve this is getting to an outcome that resolves -- that either gets support or convinces the court. There might be additional funding that comes through that. Right? There’s going to be a negotiation. The parties are going to see what the liabilities look like and see what the landscape is, and they’re going to negotiate, and you’ll have to get to that 75, 90 percent. So in that sense, there’s no limit, but the agreement itself is to get the parties where they would have been pre-division. And that’s the limit because that’s the way -- if JJCI had filed, that would have been the limit as well.

 

Nick Marr:  Makes sense. Let’s see. We have just a few more minutes left, so we’ll get a couple more questions in. Someone asked, “What does the federal Rule of Evidence 702 have to do with Texas two-step and/or J&J litigation?” So I guess extra testimony kind of thing.  

 

Prof. Anthony Casey:  So the claim estimation process happens in the bankruptcy court, if I understand the question. The rules for claims estimation are a little vague in a sense of it doesn’t say we’re going to have this type of hearing, this type of proceeding. So the judge has to decide, and judges will usually say, “We’re going to have a more robust proceeding, if we’re estimating large claims that are very central to the process.” At that point, they’ll want expert testimony, and at that point, we get to hearings or filings, and those will bring in the rules of evidence.

 

      And so, you’ll have your “Are you qualified expert?” And I imagine there’ll be two types of experts that we -- at least, two types of experts that a court would want to hear from: one, the experts on the claims—the substantive claims themselves—like what’s the evidence of damage? What’s the evidence of causation? And damage -- I mean that there was damage. And then you’ll have experts on valuation. What’s the value of those claims? And if there’s a dispute over the funding agreement, you’ll have experts on the value of the assets. Right? So you’ll have financial experts come in and say, “This is the value of the assets that were in old JJCI,” which happens in -- I don’t want to say all, but most contentious bankruptcies or complicated bankruptcies have valuation issues. And you bring in experts, and you face all the issues you do with experts in any litigation.

 

Nick Marr:  Well, I’ll take the moderator’s prerogative here with the last question. And thank you to everyone who submitted questions. Going back to our discussion of Congress legislating in this area. Basically, my question is, is bankruptcy reform or this kind of new legislation -- is that -- I mean, you could say the answer colloquially -- the answer, or is there a reform to be had for our tort system.

 

Prof. Anthony Casey:  So first off, I think there are things in a bankruptcy code that can be reformed, and there are issues on the table certainly worth discussing. Right? So three big issues in proposed legislation are third-party releases, Texas two-step, and venue. Venue’s complicated, and there are non-legislative responses that have been going on at courts. And there are full-venue skeptics who say the system is corrupt. There are those in the middle who say, “It’s not that it’s broken-broken, but the fact that you can choose one judge in certain courts, that’s problematic.” So there are questions that we want to think about in bankruptcy reform, and that’s all on the table right now.

 

      If we’re asking specifically here, I think I’ll go back to -- the Texas -- this structure is not the problem. In some senses, it’s a valuable tool. So certainly, resolution that makes that prohibited, I would think, is problematic. The current proposal is even more problematic because it goes too broad. All right. Now, what about tort resolution? I would love if we had provision that said this is exactly how we’re going to resolve all mass tort liability. Now, if I was sitting down in a room with policymakers, I might say, “Well, we should consider that we want to funnel all of these to bankruptcy courts; we should consider that. We should compare the MDL system. In certain types of cases, we should compare the class-action system, which is hard when you have different damages, like these cases, and we should prepare the bankruptcy system.”

 

      I think § 524 (g) came into existence because of problems with the nonbankruptcy system with asbestos cases, so that’s how that comes about. So I would think reform -- if we’re worried about mass tort, which is -- I’m not going to say broken because the system is -- it’s a complicated problem that the system has to deal with, but if we want to make it better, we should think about systemic reform. And that should include bankruptcy courts. I guess that’s where I end up. And these cases are an example of how that might work in a positive way.

 

Nick Marr:  That makes good sense. Well, we’ve come to the end of our time. Professor, thank you very much for your time participating in this discussion. I really enjoyed it, and I hope you did as well.

 

Prof. Anthony Casey:  Yeah. Thank you very much for having me.

 

Nick Marr:  Yeah. Thank you. And on behalf of The Federalist Society, I want to thank our audience for calling in. You had great questions. These were really great. I host a lot of these, and not all of them have as many or as good of questions, so thank you very much. And be sure to keep an eye on your emails and on our website for announcements about upcoming events, just like this one. But until the next one, we are adjourned. Thank you all very much.

 

[Music]

 

Dean Reuter:  Thank you for listening to this episode of Teleforum, a podcast of The Federalist Society’s practice groups. For more information about The Federalist Society, the practice groups, and to become a Federalist Society member, please visit our website at fedsoc.org.