December 21, 2024
In the ever-evolving landscape of bankruptcy law, recent court decisions have dramatically reshaped how companies can navigate financial distress and liability challenges. Two particularly significant developments have emerged: the Supreme Court's landmark ruling on third-party releases and the controversial "Texas Two-Step" bankruptcy strategy.
The Supreme Court recently delivered a decisive blow to non-consensual third-party releases in bankruptcy plans through its ruling in the Purdue Pharma case. This high-profile decision effectively ended the practice of forcing creditors to release claims against non-bankrupt third parties without their consent.
The Purdue case centered around the Sackler family's attempt to obtain immunity from opioid-related lawsuits in exchange for contributing $5.5 billion to Purdue's bankruptcy estate. While the Second Circuit had initially approved this arrangement, the Supreme Court ultimately ruled that the Bankruptcy Code does not authorize such releases without affected claimants' consent. The Court's reasoning was straightforward: bankruptcy's powerful tool of discharge should only be available to those who actually file for bankruptcy and put their assets on the table.
This ruling has far-reaching implications for future bankruptcy cases, particularly those involving mass tort claims. Companies can no longer rely on bankruptcy as a tool to shield related parties from liability without their explicit participation in the bankruptcy process.
Another significant trend in bankruptcy law has been the emergence—and subsequent judicial pushback against—the "Texas Two-Step" strategy. This creative approach involves companies facing mass tort litigation splitting into two entities under Texas law: one holding assets and another holding liabilities. The liability-laden entity then files for bankruptcy protection.
Johnson & Johnson's attempt to resolve its talc-related liabilities through this strategy provides a compelling case study. After creating LTL Management to hold its talc liabilities, J&J faced multiple setbacks in the bankruptcy courts. The Third Circuit's rejection of LTL's first bankruptcy filing, followed by the dismissal of its second attempt, has cast serious doubt on the viability of this strategy.
Similarly, 3M's attempt to resolve earplug-related claims through its subsidiary Aearo Technologies met with judicial skepticism. The bankruptcy court's dismissal of Aearo's filing, citing the company's robust financial health and 3M's backing, further reinforces the courts' growing resistance to such tactical bankruptcy filings.
The landscape may soon change even more dramatically with the introduction of the "Ending Corporate Bankruptcy Abuse Act of 2024." This bipartisan legislation aims to explicitly prohibit courts from extending bankruptcy protections to non-bankrupt affiliates in Texas Two-Step cases, potentially closing this controversial chapter in bankruptcy law.
1. Companies facing mass tort liability will need to reconsider their strategic options, as both non-consensual third-party releases and the Texas Two-Step strategy face significant legal hurdles.
2. Consensual releases remain viable, emphasizing the importance of negotiation and stakeholder buy-in for successful reorganizations.
3. Courts are increasingly focused on the fundamental purpose of bankruptcy protection, showing skepticism toward tactical filings by financially healthy entities.
These developments signal a return to bankruptcy's core principles: providing relief to genuinely distressed entities while ensuring fair treatment of creditors. As courts continue to refine these boundaries, businesses and their advisors must adapt their strategies accordingly.
The message from recent court decisions is clear: while bankruptcy remains a powerful tool for corporate reorganization, its protections cannot be extended indefinitely to shield non-bankrupt parties from liability without their explicit participation in the bankruptcy process and the consent of affected creditors.
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