Texas Two-Step Called Out in Third Circuit

In 2021, Johnson & Johnson filed for bankruptcy through a shell company it created especially for that purpose. The company was not in any financial distress — it was trying to avoid ongoing litigation over the safety of its talc products. This only-on-paper bankruptcy is a legal maneuver known as the “Texas two-step.” The bankruptcy was challenged in the U.S. Court of Appeals for the Third Circuit last summer. Public Justice member firm Tycko & Zavareei LLP submitted an amicus brief to the Third Circuit on our behalf, in support of plaintiffs suing Johnson & Johnson for its cancer-causing baby powder. Another member firm, Gupta Wessler, represented a committee of mesothelioma victims.

In January 2023, the Third Circuit published a decision strongly rebuking Johnson & Johnson’s attempt to enter bankruptcy while it was clearly financially solvent. The company’s request for rehearing in the Third Circuit was later denied. In April, Johnson & Johnson’s shell company filed for bankruptcy a second time. The proposed reorganization under the second bankruptcy includes $8.9 billion to settle present and future talc claims. This interview took place shortly after the Third Circuit decision, and does not contain or reflect the subjects’ views about the settlement.

Public Justice: Let’s start with what amicus briefs are and how you got involved with this one.

Allison Parr (Tycko & Zavareei): An amicus brief is a friend-of-the-court brief. They’re filed by individuals and entities that are non-parties but have an interest in the outcome of the case. Because of the work it does for consumers, Public Justice had things to say to the court that weren’t necessarily about this particular case law, but about public policy and potential real world outcomes from the case.

Glenn Chappell (Tycko & Zavareei): All of the attorneys here at TZ, or at least most of us, are members of Public Justice. Our managing and founding partner, Hassan Zavareei is a board member. He was contacted by Public Justice about our interest in writing the brief. I’m the chair of our appellate practice group, and when he asked me about it, I said, of course. Few cases offer a situation where the stakes are as high as they are for people trying to get their day in court.

Our goal was to zoom out a little bit and look at the case from a first principles perspective: What is the basic purpose of the bankruptcy system? When is it supposed to work and how’s it supposed to apply? We tried to break down the different mechanisms of the bankruptcy process and explain what they’re supposed to achieve, and why those mechanisms only work properly when you have a company or a person in deep financial distress, because those remedies are extraordinarily broad. They can greatly impact people’s right to recover their damages in civil actions.

Congress decided that it’s worthwhile to try to keep a company operating instead of liquidated. The bankruptcy system is meant to balance the desire to rehabilitate a debtor with the right of claimants to get their money back. So if you have a debtor that’s not in financial distress, all the burdens fall on the consumer and all the benefits flow to the company. We kept our brief focused on that, and we tried to point out some of the practical impacts. And to show the human impact of this decision, we also used the stories of some folks that had already gotten to a jury and received a verdict in their cases.

There’s the old adage: justice delayed is justice denied. And unfortunately, that’s precisely what companies like Johnson & Johnson are hoping for when they attempt to exit the civil justice system and try to use bankruptcy as an alternative.

What happens to clients when their claims get delayed with these maneuvers?

Glenn: Their claims go into bankruptcy, and it gives the bankruptcy court wide discretion over all those claims. It takes them out of the jury system and puts them in the hands of a different proceeding that’s much worse for victims. It gives the bankruptcy court vast power to adjudicate their claims and oftentimes, reduce the value of what they could recover in front of a jury for the purpose of resolving the bankruptcy proceeding.

Allison: Plaintiffs in the talc litigation filed their cases demanding a jury trial because they want to tell their story in front of a jury and receive adequate compensation for the harm that they’ve suffered. And in many of these cases, it’s really significant harm and severe health issues. It’s fundamentally unfair to have those claims adjudicated in a bankruptcy proceeding, which really isn’t designed to hear these claims in a fair way.

Deepak Gupta (Gupta Wessler): The sad news is that in these cases involving mesothelioma victims, the victims may die before they get in the courthouse door because it’s an extremely deadly and fast-acting cancer. That’s the worst case scenario. Even when that’s not the case, people may have to wait years and years. There’s the old adage: justice delayed is justice denied. And unfortunately, that’s precisely what companies like Johnson & Johnson are hoping for when they attempt to exit the civil justice system and try to use bankruptcy as an alternative.

The whole “Texas two-step” scheme seems to be part of a larger trend to sidestep the entire civil justice system. It starts with forced arbitration and if they can’t slap an arbitration clause on the side of a bottle of baby powder, they’re going to try some other way further down the line. Do you see a relationship between forced arbitration and these types of bankruptcy maneuvers?

Glenn: I think so, because in both instances, the goal is to take away the person’s right to have their claims tried before a jury of their peers. And this is a right that goes all the way back to the Seventh Amendment of our Constitution. Arbitration puts their case in the hands of a person that has a lot of unchecked power to decide their claims and very limited capability to review how they handle those claims on appeal. And the same thing is true for the bankruptcy court.

Bankruptcy laws are designed to only apply in a very narrow set of circumstances. And the reason that they’re so narrow is because the bankruptcy judge has so many powers, and the appellate review that you get from a bankruptcy ruling would be much more limited than it would be from the appeal of a trial verdict in court.

Allison: The bankruptcy system typically gives plaintiffs less opportunity to develop and present. It’s not a traditional trial court and it’s intended to just limit the rights of consumers.

Deepak: I think you can think about it almost as a problem of democracy. We have a system of government, we have a Seventh Amendment in the Constitution that guarantees everyone’s right to a jury trial. We vote for people and they pass laws, and those laws give us rights and the ability to enforce those rights in court. And when a company puts an arbitration clause into a contract with a consumer or worker, or a company like Johnson & Johnson tries to exit the court system with something like the Texas two-step, they’re trying to write their own rules. I’ve come to think of arbitration clauses that way, as private rules that try to trump the rules written by the people and their elected representatives. And I think that the bankruptcy process that Johnson & Johnson and other companies have tried to use is similar.

Besides these two tactics, are there other things that you see companies doing to avoid participating in the civil justice system?

Glenn: Arbitration and things like this bankruptcy are the two that come to my mind right away. Forced arbitration is the biggest tactic that they use, buried in long contracts of adhesion. I also think that companies often litigate cases very aggressively when they are in court, to try to get them kicked out early. Or they try to file interlocutory appeals or seek stays to slow things down. And those really have the same goal, which is to frustrate people’s right to get civil justice. So they’re all members of the same family in that regard.

Allison: Stays came to mind for me as well, because a company can file a motion to stay the proceedings and then, if that’s denied, they appeal it. There are a lot of ways to hold up cases and to delay the adjudication of these claims.

Deepak: We now have cases where ten years ago, there would’ve been no question about standing. There’s a consumer or a worker, there’s some law that’s been violated with respect to them, and now that’s been constitutionalized. Companies argue that you don’t have standing, you don’t have the right to even come in the courthouse door, and it’s not enough to say that we violated the law. You have to show an injury that would be regarded as an injury at the time that the Constitution was ratified in 1789.

Another thing is trying to make it really difficult to use the rules that allow for class actions. So cases that 10–20 years ago would’ve been a class action, those are now getting thrown out pretty frequently.

There are roadblocks that corporations, and the courts that are their willing partners, have tried to erect at every stage of the process. And that’s from the very beginning of the process with arbitration — do you even get to go to court? — to the very end. Let’s say you manage to get through all these roadblocks, and you convince a jury that a company has done something really, really terrible and you get punitive damages, then the courts have created constitutional law that limits those damages.

Right after the Third Circuit opinion was published, there was a Law 360 article about it, with legal experts and defense attorneys quoted as saying it’s still worth gambling the financial and legal resources to attempt a Texas two-step. What do you think of that reasoning?

Deepak: Oh, that’s horrifying. Maybe what that shows is the courts have to punish these companies for attempting it. This court concluded that what they did was in bad faith, it’s an abuse of the bankruptcy system. And that makes me wonder whether the companies need to be sanctioned in some way. I hope that the court of public opinion makes a difference here.

Glenn: I’m not surprised that’s the position that was taken, because if you look back at most of the justifications that have been put forward for this Texas two-step strategy, it’s always been efficiency, efficiency, efficiency.
There’s a focus on speed and efficiency, and finding the quickest way to adjudicate claims that’s cheapest for the company, but often there’s no focus on the cost to the victim. In our view, the Constitution and Congress have spoken as to what’s the fairest and most equitable way to adjudicate these claims, and that’s the civil justice system.

Allison: I wasn’t aware of that article, but it’s disheartening to hear that’s the stance corporate attorneys are going to take with their clients.

What does Johnson & Johnson really want here?

Glenn: Whatever keeps them out of the civil justice system, that’s what they want to achieve.

What do you think is the best outcome for this case?

Allison: The best outcome is for those injured by J&J’s talc products to be able to proceed in the civil justice system and be heard by juries of their peers, which is what the Constitution and our legal system contemplated and intended.