© Reuters. FILE PHOTO: A bottle of Johnson and Johnson Baby Powder is seen in an illustrative photo taken in New York, February 24, 2016. REUTERS/Shannon Stapleton/Illustration
By Tom Hals, Mike Spector and Dan Levine
(Reuters) – A U.S. appeals court on Monday rejected an attempt by Johnson & Johnson (NYSE:) to dump tens of thousands of claims over its talc products in bankruptcy court. The ruling marked the first major repudiation of an emerging legal strategy with the potential to upend US corporate responsibility law.
J&J is among the top four companies that have filed so-called two-step Texas bankruptcies to avoid potentially massive exposure to lawsuits. The tactic is to create a subsidiary to absorb the liabilities and immediately file for Chapter 11.
The court ruled that the health care conglomerate improperly placed its subsidiary in bankruptcy even though it was facing no financial hardship. J&J’s two-step plan sought to stop more than 38,000 lawsuits from plaintiffs alleging that the company’s baby powder and other talc products caused cancer. The appeals court ruling revives those lawsuits.
Last year, Reuters detailed the secret planning of the two Texas passes by Johnson & Johnson and other major firms in a series of reports exploring corporate attempts to evade lawsuits through bankruptcy.
Monday’s decision by the US Court of Appeals for the Third Circuit in Philadelphia threw out the bankruptcy filed by the J&J subsidiary in 2021. Prior to the filing, J&J had faced costs of $3.5 billion in verdicts and settlements.
J&J shares closed down 3.7%, the biggest one-day percentage drop in two years. The company said in a statement that it would challenge the ruling and that its talc products are safe.
Lawyers for the plaintiffs and some legal experts have argued that the two steps could set a dangerous precedent, providing a blueprint for any corporation to easily avoid undesirable litigation. The appeals court decision could force companies considering the strategy to consider its risks more carefully, two legal experts said.
“It’s a rejection of the notion that any company anywhere can use the same tactic to get rid of its massive tort liability,” said Lindsey Simon, a professor at the University of Georgia School of Law.
Bankruptcy filings generally suspend litigation in trial courts, forcing plaintiffs into often time-consuming settlement negotiations and leaving them unable to pursue their cases in the courts where they originally filed.
The Third Circuit’s ruling does not apply to three other Texas two-step bankruptcies filed by subsidiaries of Georgia Pacific, owned by Koch Industries, global construction giant Saint-Gobain and Trane Technologies (NYSE:). Those cases fall under the jurisdiction of the 4th Circuit Court of Appeals. 3M attempted a similar move, which is currently pending in the 7th Circuit.
Saint-Gobain said in a statement that the Third Circuit’s ruling “has no direct effect” in its subsidiary’s Chapter 11 case. The company said it remains confident that the subsidiary will reach a “final, full and fair resolution with the asbestos claimants.”
The other companies did not comment on the 3rd Circuit ruling or did not immediately respond to inquiries. All have previously advocated two-step bankruptcies as the best way to pay claims fairly. Attorneys for the plaintiffs have countered that the Texas two-step is an inappropriate manipulation of the bankruptcy system. The strategy uses a Texas law to split an existing company in two, creating the new subsidiary to take on the lawsuits.
New Jersey-based Johnson & Johnson, valued at more than $400 billion, said the bankruptcy of its subsidiary was initiated in good faith. J&J initially committed $2 billion to the subsidiary to settle talc claims and reached an agreement to finance an eventual settlement approved by a bankruptcy judge.
“Resolving this matter as quickly and efficiently as possible is in the best interest of the claimants and all interested parties,” J&J said.
A three-judge panel on the appeals court rejected J&J’s argument, finding that the company’s subsidiary, LTL Management, was created solely to seek Chapter 11 protection, but had no legitimate need to do so. Only a debtor in financial difficulty can file for bankruptcy, the panel ruled. The judges noted that J&J assured that it would give LTL a lot of money to pay off the talc plaintiffs.
“Good intentions, such as protecting the J&J brand or comprehensively resolving litigation, are not enough on their own,” the judges said in a 56-page opinion. “LTL, at the time of filing, was highly solvent with access to cash to comfortably meet its obligations.”
‘PLATON PROJECT’
The decision could force J&J to fight talc lawsuits for years in trial courts. The company has a mixed track record of fighting suits thus far. Although the firm received significant judgments in some cases before filing for bankruptcy, more than 1,500 lawsuits were dismissed and most of the cases that reached trial resulted in verdicts in favor of J&J, judgments in favor of the company on appeal, or mistrials, according to court documents from its subsidiary.
A December 2018 Reuters investigation revealed that J&J officials had known for decades about evidence showing that the company’s talc sometimes contained traces of carcinogenic asbestos, but withheld that information from regulators and the public. J&J has said that its talc does not contain asbestos and does not cause cancer.
Facing unrelenting litigation, J&J enlisted the Jones Day law firm, which had helped other companies file two-step bankruptcies in Texas to address asbestos-related lawsuits.
The J&J effort, as Reuters reported last year, was dubbed internally “Project Plato,” and the employees who worked on it signed confidentiality agreements. A company lawyer warned them not to tell anyone, not even their spouses, about the plan.
Jones Day did not immediately respond to a request for comment.
The Texas detour has drawn criticism from Democratic lawmakers in Washington and inspired proposed legislation that would severely restrict the practice.
Sen. Sheldon Whitehouse, D-Rhode Island, applauded Monday’s appeals court decision. Whitehouse presided over the first congressional hearing looking at two-step bankruptcies in February of last year.
“Bankruptcy is meant to give honest debtors in unfortunate circumstances a fresh start,” he said, not to allow “large, highly profitable corporations” to avoid liability for wrongdoing with a legal “deceitful game.”
