Court of Appeals Ruling Sets Precedent, Limiting Use of Bankruptcy for Litigation Shielding

Philadelphia, PA – The Third Circuit Court of Appeals handed down a decision today that could significantly impact future bankruptcy filings. The court ordered the dismissal of the Chapter 11 bankruptcy case filed by LTL Management LLC, an affiliate of Johnson & Johnson.

LTL had filed for bankruptcy after completing a divisional merger, which left it with the responsibility of managing Johnson & Johnson’s talc liabilities. They sought bankruptcy protection along with an injunction to shield Johnson & Johnson and its other affiliates from ongoing talc litigation. However, an Official Committee of Talc Claimants and other parties opposed the bankruptcy case and injunction.

The bankruptcy court initially denied the motions to dismiss and granted LTL’s request for a third-party injunction. They determined that the bankruptcy was filed in good faith and that LTL faced significant financial distress due to the burden of defending against numerous talc lawsuits. The court also considered that LTL had access to funds from a Johnson & Johnson affiliate.

On appeal, the Third Circuit reversed the bankruptcy court’s decision. They held that the good faith test for bankruptcy filings requires the debtor to face immediate financial problems that justify Chapter 11 relief. The court concluded that LTL did not meet this requirement, particularly considering the significant financial resources available to them. They cited LTL’s potential access to up to $61.5 billion under the funding agreement and their previous success in avoiding substantial judgments and settlements related to talc litigation.

The Third Circuit’s ruling narrows the justifications for utilizing Chapter 11 benefits. Mere management of litigation risk is no longer sufficient for a bankruptcy filing. This decision is expected to have a broad impact, especially for corporate entities that had considered using the “Texas two-step” strategy, popularized by LTL, to shield themselves through bankruptcy.

The implications of this ruling are significant for future bankruptcy cases, particularly those involving companies managing substantial liabilities. The focus on immediate financial distress and the availability of resources will influence the strategic decisions of corporate entities facing potential bankruptcy. This decision redefines the threshold for filing in good faith and underscores the need for a more immediate and urgent need for bankruptcy protection.

Further analysis and commentary on the Third Circuit’s ruling are expected in the coming days as legal experts and stakeholders assess the implications for future bankruptcy filings and the strategies employed by companies to address financial distress.