On July 18, 2021, Reuters reported that Johnson & Johnson (“JNJ”) was considering offloading its liabilities in connection with the talcum powder litigation through a bankruptcy strategy colloquially referred to as the “Texas Two-Step.” JNJ responded to the news source, claiming it has not yet decided on any particular course of action in the litigation. Nevertheless, some plaintiffs’ counsel fear that the plan, if implemented, could stall the litigation or result in lower settlement awards to talc victims.
The Texas Two-Step is a process that begins with a merger and is followed by bankruptcy. It arises from a unique provision under the Texas Business Organizations Code which broadly defines the term “merger” to include the division of an existing entity into two or more new entities.  Since a divisive merger is not treated as an assignment or transfer of assets or liabilities, it can be utilized to avoid certain transfer restrictions in contracts or alternatively, as a strategic alternative to traditional spinoffs or asset sales. The Texas statute also has been leveraged in the mass tort arena, at least in one instance, as a means to allocate liabilities in such a way as to trigger insolvency.
In the case, In re Bestwall LLC, Georgia-Pacific, LLC (“Old GP”) moved its headquarters to Texas to take advantage of the state’s divisive merger provisions—gifting one successor entity, Georgia Pacific LLC (“New GP”), with approximately $175 million in various assets and dumping the other resulting entity, Bestwall LLC (“Bestwall”), with all of its asbestos liabilities and limited assets.
As part of the transaction, New GP and Bestwall also entered into a funding agreement (“Funding Agreement”) that required, inter alia, New GP to provide funding to pay for all costs and expenses of Bestwall incurred in the normal course of its business before or during a bankruptcy proceeding, as well as to provide funding for a section 524(g) asbestos trust in the amount required by a confirmed plan of reorganization to the extent that Bestwall’s assets were insufficient to provide the requisite trust funding.
After the merger was complete, Bestwall relocated its headquarters to North Carolina due to favorable case law with respect to asbestos litigation and voluntarily filed for Chapter 11 bankruptcy protection.
In the bankruptcy proceeding, Bestwall brought a motion to prohibit and enjoin all current and future asbestos plaintiffs (“Asbestos Claimants”) from filing or continuing to prosecute any “Bestwall Asbestos Claims” against Old GP, New GP and non-debtor affiliates (“GP Parties”). The Court granted the motion.
In holding in favor of Bestwall, the Court concluded that if the Asbestos Claimants were permitted to commence or continue their claims against the GP Parties, then it would (1) defeat the fundamental purpose of Section 524(g), which permits a debtor to address in one forum all asbestos and third parties’ claims against it, (2) impair the ability of Bestwall’s personnel to address tasks necessary to pursue a plan of reorganization in bankruptcy, and (3) potentially deplete the assets of Bestwall since indemnification obligations would make judgments against the GP Parties on the Bestwall Asbestos Claims tantamount to judgments against the debtor.
The Court also disagreed with the arguments of the Asbestos Claimants related to due process and preemption, holding, in pertinent part, that “because of the Funding Agreement, the debtor’s ability to pay valid Bestwall Asbestos Claims after the 2017 Corporate Restructuring [was] identical to Old GP’s ability to pay before the restructuring.” Further, it reasoned that “Texas has adopted the Uniform Fraudulent Transfer Act (Tex. Bus. & Com. Code §§ 24.001, et seq.) and fraudulent transfer law is also part of the Bankruptcy Code (see, e.g. 11 U.S.C. § 548),” so if “a debtor used the Texas statute to commit a fraudulent transfer—creating the harm the [Asbestos Claimants] complain of—such law would be available to address such acts.”
In another case filed this year, the National Rifle Association (“NRA”) attempted to use the Texas Two-Step to change venue from New York to Texas. There, the Northern District of Texas Bankruptcy Court found cause to dismiss the action since, based on the totality of the circumstances, it concluded: “that the NRA’s bankruptcy petition was not filed in good faith but instead was filed as an effort to gain an unfair litigation advantage… and as an effort to avoid a regulatory scheme.”
Thus, while a company faced with significant mass tort claim exposure may pursue the Texas Two-Step bankruptcy as a strategic maneuver to transfer liabilities to another entity or perhaps incentivize smaller settlements, it will still remain subject to judicial scrutiny and laws prohibiting fraudulent transfers.
 Mike Spector, Jessica Dinapoli, and Dan Levine, Exclusive: J&J exploring putting talc liabilities into bankruptcy, Reuters (Jul. 19, 2021).
 Tex. Bus. Org. Code § 1.002(55)(A). Delaware, Arizona and Pennsylvania also permit divisive mergers. In Delaware, the application is limited to limited liability companies (Del. Limited Liab. Co. Act § 18-217). In Arizona, the statute provides additional protections for creditors since obligations of the existing entity are joint and several as to the surviving entities (29 Ariz. Rev Stat. § 2607). Similarly, Pennsylvania’s statute binds each resulting entity into any pre-existing security agreement that attaches to after-acquired collateral. See Barbara Goodstein and Jennifer A. Kratochvil, United States: Dividing Delaware LLCs, Mondaq Ltd. (Jan. 16, 2019).
 Byron Egan and William Hornberger, Structuring Divisive Mergers Under Delaware and Texas Statutes, Strafford Publications, Inc. (Apr. 23, 2019).
 Bestwall LLC v. Those Parties Listed on Appendix A (In re Bestwall LLC), 606 B.R. 243 (Bankr. W.D.N.C. 2019).
 Id.; See also, Ryan Boysen, Georgia-Pacific Affiliate’s Ch. 11 Slammed As ‘Sham’, Law360 (Aug. 16, 2018).
 Id. at 248.
 Id. at 247.
 Id. at 249-51.
 Id. at 252.
 In re NRA of Am., 628 B.R. 262 (Bankr. N.D. Tex. 2021).