Actionable Ideas for Companies and Sponsors

Addressing Significant Litigation Liabilities through a “Texas Two-Step” Transaction

When dealing with mass tort liabilities through the state and local court systems, companies often must invest significant time and expense on their defense, while often encountering difficulties, including inconsistent rulings, inability to bind holdouts and inability to deal with future claimants.

As an alternative to the tort system, many companies have turned to chapter 11 bankruptcy to address their litigation liabilities as a way to enable resolution of their litigation liabilities in a single forum. While often a very favorable option, there are drawbacks that otherwise healthy companies would prefer to avoid, including significant expense and certain restrictions and oversight.

In a “Texas Two-Step,” a company undertakes a series of transactions to: (i) move its tort liabilities (along with certain assets) into a newly created Texas entity, “LitigationCo,” with the company’s remaining assets and liabilities moving to “NewCo,” and subsequently (ii) filing the LitigationCo under chapter 11 of the bankruptcy code. The initial step is set up as a divisive merger under the Texas Business Code, and as part of that transaction, NewCo will provide an uncapped funding agreement to LitigationCo in which it agrees to fund both expenses and potential future tort liabilities.

The Texas Two-Step enables a company to:

  • Avoid years of protracted litigation with open-ended exposures
  • Resolve all claims in a single forum (including potential future claims)
  • Estimate and cap tort liabilities
  • Ensure more consistent recoveries for similarly situated claimants
  • Keep a company’s valuable assets out of bankruptcy

Companies that have pursued a Texas Two-Step (or similar strategy) to address litigation liabilities include Johnson & Johnson (“LTL/J&J”), 3M (“Aearo/3M”), Georgia Pacific, O-I Glass, Ingersoll-Rand, Trane Technologies, and CertainTeed Corporation. 

O-1 Glass recently confirmed its chapter 11 plan and recent developments in the LTL/J&J case further suggest courts may be receptive to the strategy. The judge in LTL/J&J recently ruled that not only was the case commenced for a valid reorganizational purpose, but not considering the potential appropriateness of a Texas Two-Step (or other similar option) might be a breach of a company’s fiduciary duties. On the other hand, a bankruptcy judge’s decision in August 2022 in Aearo/3M denied the proposed structure, which was in part due to Aearo/3M failing to argue that the outstanding tort litigation was a financial danger to 3M. The LTL/J&J and Aearo/3M cases both are still subject to continued court hearings and appeals, but the differing outcomes emphasize the importance of having the appropriate financial and legal advisors.

As an initial step, diligence and analysis of the company’s liabilities would be required to determine the best strategy to address such liabilities, including consultation with legal counsel.