Gene J. Puskar/AP Photo
Since 2017, Johnson & Johnson has spent about $4.5 billion in jury awards, settlements, and legal costs fighting claims related to its baby powder products.
A couple of years ago, Maureen Tkacik wrote for the Prospect about the ways in which large companies, picking up a tactic pioneered by the private equity industry, avoid accountability and stiff untold victims of illegal business practices. One of the more popular innovations in this arena is called the “Texas Two-Step.” Using Texas law, a company splits into two entities: one with all of the liability claims, and one with all of the productive assets. Then the entity saddled with liability files for bankruptcy, shortchanging the victims for pennies on the dollar while the rest of the company moves on.
Johnson & Johnson was the most notable practitioner of the two-step, attempting to extinguish claims that, for a century, it sold talc baby powder laced with asbestos, which victims say caused tens of thousands of cases of ovarian cancer and mesothelioma. But yesterday, the Third Circuit Court of Appeals invalidated J&J’s two-step in a unanimous ruling. If upheld—the company has promised to appeal—over 38,000 ovarian cancer cases and over 400 mesothelioma cases could go forward to jury trials, without getting in line for whatever scraps came out of the bankruptcy.
I’d like to say that this has implications that go well beyond Johnson & Johnson. But I’ve read the ruling, and unfortunately it does not shut down the Texas Two-Step, only the way in which J&J set it up. Companies in the future would simply have to ensure that the “bad” company due for bankruptcy is truly bad, and unable to continue as a going concern.
To file bankruptcy legally, an entity must be in financial distress. LTL, the “bad” entity created by Johnson & Johnson in 2021, did indeed have all of the liabilities of the talc claims and none of the assets. But LTL also held a funding support agreement from Johnson & Johnson and its consumer subsidiary equal to the value of the subsidiary on the date of the split: $61.5 billion. The court called this “not unlike an ATM disguised as a contract.”
The Third Circuit panel does some quick math to show that this sum would be more than sufficient to handle future claims. Since 2017, Johnson & Johnson has spent about $4.5 billion in jury awards, settlements, and legal costs fighting the talc claims. J&J’s own financial disclosures suggested that the expected loss for the next two years would be about $2.4 billion. At that run rate, LTL would not exhaust the $61.5 billion to which it was legally entitled for decades. Maybe that could change with a few enormous jury awards, but LTL would only be able to file for bankruptcy at that time, not before the fact to preempt those large payouts.
In other words, while J&J attempted to split off the bad company from the good one, the funding agreement still connected the two. Therefore, it was an illegal bankruptcy, because LTL still could have made all payments for a long time. If Johnson & Johnson had set up the split differently, without a funding backstop for LTL, it almost certainly would have survived the court challenge.
Indeed, the court writes in its conclusion: “We mean not to discourage lawyers from being inventive and management from experimenting with novel solutions.” They do not fully invalidate the two-step, which has been used by many companies to avoid liability for cancer and other harms, and they do not challenge J&J’s claim that such a tactic is more equitable and efficient. “This is a call that awaits another day and another case,” the court writes.
So thousands or potentially millions more consumers and their families must endure the strategies multibillion-dollar companies use to evade justice, and hope that their perpetrator’s lawyers don’t learn from J&J’s mistake. The court could have simply called the two-step antithetical to the bankruptcy process, and barred large, profitable companies (Johnson & Johnson leaked $13 billion in profits to shareholders in 2020, and again in 2021) from even attempting it. But sadly, two-step practitioners can still try to dance.
