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Plenary insolvency proceedings

In last year's edition of this review, we discussed the emerging trend of international airlines taking advantage of the Bankruptcy Code's liberal eligibility requirements for qualifying as a debtor in a US bankruptcy case. We discussed further developments in the Avianca case, and explored the cases of two other Latin American airlines, LATAM and Aeroméxico. This year's edition will discuss the emerging trend of what is being referred to as the 'Texas-Two-Step' transaction, whereby corporations facing mass tort liability effectuate a divisional merger under Texas corporate law in order to spin their tort liability off into separate corporate entities, which then file for bankruptcy protection. The Texas-Two-Step allows companies to leverage the benefits of bankruptcy protection for mass tort claims resolutions without subjecting a healthy operating company to Chapter 11 proceedings. We will explore the use and treatment of the Texas-Two-Step in three ongoing Chapter 11 proceedings: CertainTeed Corporation, Trane Technologies and Johnson & Johnson.

i CertainTeed Corporation

Saint-Gobain is one of the world's largest building material companies, with more than 180,000 employees and operations in 68 countries.70 Prior to the Chapter 11 cases discussed below, a subsidiary of Saint-Gobain, CertainTeed Corporation (Old CT), was embroiled in asbestos litigation stemming from asbestos cement pipe and asphalt roofing products manufactured or sold, or both, by the company.71 The asbestos litigation has been ongoing for approximately 40 years and was expected to continue for several more decades.72 The company was paying anywhere from US$80 million to US$160 million a year in defence costs for asbestos claims and anywhere from US$20 million to US$30 million per year in defence costs for mesothelioma cases.73 In October 2019, Old CT underwent a divisional merger whereby Old CT ceased to exist and two new entities were created: DBMP LLC (DBMP) and CertainTeed LLC (New CT).74 As a result of the merger, DBMP became solely responsible for the asbestos-related liabilities of Old CT and received some of its assets, including US$25 million in cash, a surety bond with respect to the appeal of certain asbestos-related judgment and equity interests of an operating subsidiary, Millwork & Panel LLC, with a fair market value of US$150 million.75 New CT received all remaining Old CT assets and became solely responsible for all non-asbestos-related liabilities.76 New CT and DBMP were also parties to a funding agreement that obligated New CT to, among other things, pay all of DBMP's costs and expenses, including the cost of administering the Chapter 11 cases, to the extent that distributions from Millwork & Panel were insufficient to pay such costs and to provide funding for an asbestos trust under Section 524(g) of the Bankruptcy Code if distributions and DBMP's other assets were insufficient.77 The funding agreement did not impose any repayment obligations on DBMP and was not a loan. On 24 January 2020 (the Petition Date), DBMP filed for bankruptcy protection in the Western District of North Carolina citing the burden of the asbestos litigation.

On the Petition Date, DBMP filed a motion seeking a temporary restraining order (TRO) barring the prosecution of asbestos-related claims in other courts against DBMP, New CT, Old CT, certain non-debtor affiliates and certain third-party distributors of Old CT's products, arguing that the injunction was necessary to prevent harm to DBMP.78 Enforcement of the stay is crucial to Texas-Two-Step divisional merger: if the stay is not enforced and plaintiffs are able to pursue New CT and Old CT for asbestos-related claims, then the purpose of the DBMP bankruptcy and divisional merger would be subverted. Three days later, the court granted the TRO,79 granting DBMP and New CT the benefit of an automatic stay with respect to the asbestos-related claims without dragging New CT into the chapter 11 cases. The extension of the automatic stay was opposed by many of the asbestos-related litigation plaintiffs and, on 13 January 2021, the official committee of asbestos personal injury claimants (the ACC) filed a motion to lift the automatic stay on asbestos-related litigation.80 Although the court denied the ACC's motion, the court noted that the Texas-Two-Step divisional merger had negative effects on the rights of the asbestos claimants, stating that '[g]iven the prepetition machinations which created DBMP and New CertainTeed, with one obtaining most of the enterprise value and the other all of the asbestos liabilities, the Representatives' question the Debtor's good intentions.'81 The court was also hesitant to endorse the notion that the Texas divisional merger statute used to effectuate the merger insulated the transaction from fraudulent transfer claims or prevents recovery from New CT.82

A notable ruling in the DBMP Chapter 11 cases was the court's decision to allow parallel and duelling proceedings of DBMP (claims estimation) and the ACC (challenging the divisional merger) in an effort to reach a consensual plan. On 29 July 2021, DBMP filed an estimation motion, arguing that a determination of tort liability is crucial to confirming a consensual plan.83 On 23 August 2021, the ACC brought a derivative standing motion to pursue litigation to unwind the 2019 divisional merger84 and filed a complaint seeking consolidation of DBMP and Old CT.85 The ACC argued that the divisional merger only allocated 3 per cent of the assets of Old CT to DBMP despite receiving sole responsibility for Old CT's tort liability; meanwhile New CT emerged from the merger free to pay its equity holders ahead of the asbestos claimants.86 Although the court ruled in favour of the ACC's motion for derivative standing, the court also granted the debtor's earlier filed motion to estimate the asbestos-related claims.87

As hinted at above, a crucial point of contention in the DBMP Chapter 11 cases is whether the Texas-Two-Step transaction used to create DBMP and New CT is effectively a fraudulent conveyance. On 21 January 2022, the ACC filed a complaint against Saint-Gobain, New CT and Old CT, alleging that the divisional merger is a fraudulent conveyance.88 In its complaint, the ACC argued that the merger 'significantly hindered, delayed, and sought to fraudulently reduce or eliminate the ability of asbestos victims to recover what was, is, or will be due to them'.89 On 6 May 2022, DBMP filed a motion to dismiss the ACC's fraudulent transfer complaint, relying heavily on the decision in Johnson & Johnson (discussed below), where the court refused to grant a motion to dismiss the Chapter 11 filing and holding that there is nothing improper or illegal about utilising a divisional merger statute.90 In response to the debtor's motion, the ACC filed its opposition seeking a declaration that the merger and transfer of tort liability is 'void as unconscionable, and should be disregarded'.91 The debtor's motion to dismiss the fraudulent transaction claim was later dismissed.92 The court reasoned that the ACC has an adequate complaint, and held that applying the plain meaning of fraudulent transfers under the plain meaning of the bankruptcy code 'is subject to absurd results'.93 The court further stated that it cannot be the intent of the Texas merger statue to allow a company to create a 'GoodCo and a BadCo without any party being able to sue' because such a transaction 'leaves the door open to wholesale fraud'.94

At the time of writing, DBMP LLC does not have a confirmed plan and the case continues down dual estimation and litigation paths.

ii Trane Technologies

Trane Technologies is a global climate innovator that aims to bring climate solutions to the housing and transportation sectors.95 Trane Technologies became Ingersoll Rand plc through a merger in 2020.

On 1 May 2020, Ingersoll Rand plc (Old IRNJ) and one of its operating subsidiaries, Trane US Inc (Old Trane) each underwent divisional mergers:

  1. Old IRNJ spun out Aldrich Pump (Aldrich) and Trane Technologies Company LLC (New Trane Technologies); and
  2. Old Trane spun out Murray Boiler (Murray) and Trane US Inc (New Trane).96

Old IRNJ and Old Trane were routinely named in over 5,000 mesothelioma and mesothelioma-related claims every year for their use of asbestos containing components in the industrial equipment that they manufactured.97 The expected cost of defending asbestos-related claims is approximately US$100 million.98 Aldrich and Murray received the asbestos-related liabilities of Old IRNJ and Old Trane, respectively.99 Aldrich received US$26.2 million in cash, and a 100 per cent equity interest in 200 Park, a company that manufactures parts for commercial HVAC machines and has a fair market value of US$32 million. 100 Murray received US$16.1 million in cash and a 100 per cent equity interest in ClimateLabs, which provides laboratory testing and reporting services and had an estimated fair market value of approximately US$25 million.101 Aldrich and Murray's aggregate value was approximately US$75 million, not including additional cash amounts of approximately US$5 million.102 Lastly, the debtors, New Trane Technologies and New Trane, were parties to a funding agreement that obligated New Trane Technologies and New Trane to, among other things, pay all of Aldrich and Murray's respective costs and expenses, including the costs of administering and the Chapter 11 cases to the extent that distributions from 200 Park and ClimateLabs are insufficient to pay such costs.103 The funding agreements also provide funding for an asbestos trust under Section 524(g) of the Bankruptcy Code if such distributions and the debtors' other assets are insufficient. Weeks after the merger, on 18 July 2020 (the Petition Date), Aldrich and Murray filed for bankruptcy protection in the US Bankruptcy Court for the Western District of North Carolina, before the same judge overseeing DBMP Chapter 11 cases, citing the 'burden of managing, defending, and resolving' the asbestos-related claims for decades to come.104

On the Petition Date, the debtors filed a motion seeking a preliminary injunction enforcing an automatic stay as to, among other protected parties, Old Trane, Old IRNJ and some of the debtors' non-debtor affiliates, including the New Trane Technologies and New Trane.105 The debtors also sought a declaratory judgment that the automatic stay prohibits both the commencement and continuation of asbestos-related lawsuits while the Chapter 11 cases are pending.106 Although it granted the injunction, the court raised its concern with respect to the Texas-Two-Step manoeuvre that allocated all asbestos-related claims to the debtor.107

Taking its cue from the DBMP court's decision to allow parallel and duelling proceedings by DBMP, on 19 October 2021, the official asbestos claimants committee (the ACC) filed a motion for standing to bring claims to avoid the 2020 Texas divisional merger.108 The court ruled as it did in DBMP and granted the ACC's motion along with the debtors' earlier filed motion to estimate the asbestos claims.109 As a result, the court sent the Chapter 11 cases down dual paths, reasoning that, if the parties intend to litigate rather than negotiate, then both sides should be allowed to pursue their 'preferred course'.110 The court later denied the debtors' motion, filed on 14 March 2022, to stay all litigation brought by the official asbestos claimants' committee, reasoning that it would be inappropriate to permit only one side to pursue its 'preferred course'.111 The parties are currently negotiating competing proposed forms of estimation case management procedures. On 7 July 2022, the bankruptcy administer of the Western District of North Carolina filed a motion requesting the court to send the debtors and the ACC into mediation to try and resolve 'all issues necessary' to determine the debtors present and future asbestos claimants.112 The motion argues that successful mediation would do away with the need for the dual litigation and estimation paths and that unsuccessful mediation would, at the very least, provide both parties with more information.113 A hearing on the mediation motion is scheduled for 25 August 2022.

As previewed above, early in the Aldrich and Murray Chapter 11 cases, the court raised concern over the apparent harm that the divisional merger had on asbestos plaintiffs, noting that the divisional merger and subsequent liability allocations to Aldrich and Murray 'bear all of the hallmarks of an intentional fraudulent transfer' and that the transaction has negative effects on the rights of asbestos claimants.114 On 12 June 2022, the ACC commenced two derivative suits aimed at attacking the Texas-Two-Step transaction: the ACC sought to unwind the transactions as intentional or constructive fraudulent transfers and the ACC separately brought a breach of fiduciary duties claims against the debtors' parent company and its affiliates for entering into a 'series of self-dealing transaction' aimed at avoiding its existing asbestos liabilities. A hearing for this motion is scheduled for 25 August 2022.

At the time of writing, the Aldrich and Murray cases, like the DBMP case, continue to proceed on dual paths.

iii Johnson & Johnson

Johnson & Johnson is an American multinational corporation that develops medical devices, pharmaceuticals and consumer packaged goods. Johnson & Johnson Consumer Inc (Old JJCI) was engaged in mass-tort litigation over its use of allegedly cancer-causing talc powder in its products, including Johnson's Baby Powder, which was anticipated to continue for several decades.115 The company was paying anywhere from US$10 million to US$20 million in defence costs on a monthly basis in addition to US$3.5 million in indemnity costs in connection with various settlements and verdicts.116 On 12 October 2021, Old JJCI used a divisional merger whereby Old JJCI ceased to exist and two new entities were created: LTL Management (LTL) and its direct parent, Johnson & Johnson Consumer Inc (New JJCI).117 As a result of the merger, LTL was saddled with sole responsibility for the talc-related litigation of Old JJCI and received some of Old JJCI's assets and New JJCI received all remaining assets and liabilities.118 Additionally, LTL received US$6 million in cash and the equity in Royalty A&M LLC, a royalty management and finance business, which has an estimated fair market value of US$367.1 million.119 LTL has access to additional funds needed to cover talc-related litigation costs through a funding agreement that obligates New JJCI to provide funding.120 As of the petition date, LTL was valued at $373.1 million.121 On 14 October, 2021 (the Petition Date), LTL commenced Chapter 11 cases in the United States Bankruptcy Court for the Western District of North Carolina citing the heavy burden of the talc-related liabilities.

A key dispute that arose at the outset of the LTL Chapter 11 cases was whether to grant the debtors motion to enforce an automatic stay as to non-debtor affiliates and other defendants in the talc litigation cases pending throughout the country. On the Petition Date, LTL filed a motion seeking a temporary restraining order barring the prosecution of talc-related claims in other courts against LTL, its affiliates and certain other third party defendants.122 At a hearing on 22 October 2021, the court granted the temporary restraining order only as to LTL and Old JJCI but not as to New JJCI and any other affiliates or any retailers, distributors or insurers.123 The court noted grave concerns as to whether Johnson & Johnson itself may have talc-related liability that is independent of the old JJCI and LTL.124 Among other things, the court reasoned that LTL and Johnson & Johnson did not yet identify documents to support their assertion that LTL and old JCII are solely responsible for all talc-related claims.125 The court commented on the use of the Texas-Two-Step divisional merger, stating that it is either 'a brilliant strategy' that allows corporations to take advantage of the mass tort injunction provisions of the bankruptcy code without subjecting the entire enterprise to Chapter 11 or a 'manifestly unfair' strategy that is detrimental to plaintiffs.126 LTL's motion was vehemently opposed by, among others, a group of mesothelioma claimants (the MDL Plaintiffs) and holders of talc personal injury claims.127

On 16 November 2021, the Chapter 11 cases were transferred to the United States Bankruptcy Court for the District of New Jersey.128 The court reasoned that, among other factors, because over 35,000 of the 38,000 pending talc-litigation cases are pending in New Jersey, the transfer is in the interest of justice and is focused on the convenience of the parties.129 The court modified the existing stay ruling by the court in the Western District of North Carolina that only covered LTL and Old JJCI, and ordered an expanded 60-day stay of the talc-related claims that also covered Johnson & Johnson and its affiliates and retailers.130 The court reasoned that claims against the parties protected by the automatic stay are essentially claims against the debtor and thus would have an effect on the estate.131 The court relied on a transfer agreement from 1979 whereby talc claims were transferred to Old JJCI, and, because of the divisional merger, have presently been transferred to LTL.132 On 20 July 2022, a group of mesothelioma and ovarian cancer litigation plaintiffs (the Official Committee of Talc Claimants (TCC)) filed a motion asking the court to modify the stay to allow continued litigation of 12 cases located in 'venues across the country' that the TCC argue 'are ready to be tried now'.133 The TCC argues that litigation of these 12 cases is essential to movement towards a consensual plan because the question of whether LTL has any liability to tort claimants is a major sticking point between LTL and the TCC and the resolution of the 12 cases would provide useful data points on this issue.134 On 28 July 2022, the court issued a bench ruling denying the TCC's request.135 The court reasoned that allowing the suits to proceed would not meaningfully advance the Chapter 11 cases.136

The court's commentary on the Texas-Two-Step transaction previewed the second key issue for the LTL Chapter 11 cases. The TCC filed a statement that alleged, among other things, that LTL's bankruptcy filing was 'untethered to any legitimate chapter 11 purpose'.137 On 1 December 2021, the TCC filed a motion to dismiss the Chapter 11 cases on the grounds that LTL did not file for bankruptcy in good faith, arguing that LTL is a 'mere instrumentality' of Old JJCI and that the true purpose of the bankruptcy proceeding is to protect Old JJCI and its assets.138 Additionally, the TCC allege that divisional merger and creation of LTL violated applicable law because the sole purpose of the transaction was to 'hinder and delay talc claimants in pursuit of their claims by separating the liability for those claims from the assets backing such claims'.139 Several legal scholars later stepped forward, urging the LTL court to dismiss what they called a 'sham' Chapter 11 case.140 A brief submitted by various bankruptcy professors called the Texas-Two-Step strategy 'a novel and dangerous tactic', an 'alarming recent trend' and a 'direct attack on the fundamental integrity of the chapter 11 system'.141 On 25 February 2022, the court held that the LTL Chapter 11 case was not filed in bad faith.142 The court found that the bankruptcy had a valid purpose aimed at preserving corporate value and that the fact that the Old JJCI sought to limit its exposure to present and future talc-related liability claims is unsurprising.143 The court went on to voice its 'strong conviction that the bankruptcy court is the optimal venue for redressing the harms of both present and future talc claimants in this case – ensuring a meaningful, timely and equitable recovery'.144 That decision is on appeal to the US Court of Appeals for the Third Circuit.

At the time of writing, LTL Management does not have a confirmed plan.

Ancillary insolvency proceedings

In this year's edition of the review, we will describe two significant court decisions involving novel issues relating to the application of foreign law in a United States Chapter 15 proceeding – Culligan Ltd and Modern Land (China) Co.

i Modern Land (China) Co

Modern Land (China) Co is incorporated in the Cayman Islands and has its shares listed on the Stock Exchange of Hong Kong. Modern Land is the ultimate holding company for a number of other companies that conduct real estate investment and development in both the United States and China.145 In 2021, market concerns over the operations of Chinese developers intensified due to a reduction in lending for real estate development.146 That, coupled with the impact of the covid-19 pandemic led Modern Land to face liquidity pressures and, consequently, to fail to meet its repayment obligations due in October 2021 and February 2022, triggering multiple events of default. On 14 April 2022, Modern Land filed a scheme of arrangement with the Cayman Court.147

A critical question before the court was, under Chapter 15 of the Bankruptcy Code, whether a bankruptcy court can recognise and enforce a scheme of arrangement sanctioned by a court in the Cayman Islands (the debtor's place of incorporation) if the scheme modifies or discharges New York law governed debt.

Prior to commencement of Modern Land's Chapter 15 cases, on 6 June 2022, the High Court of Hong Kong issued an opinion questioning (in dicta) whether a United States' order recognising a foreign scheme of arrangement would discharge debt governed by US law. The High Court suggested that recognition under Chapter 15 would be limited to the jurisdiction of the United States and that the scheme of arrangement would not discharge the debt. The High Court cited the decision from the English Court of Appeal, Antony Gibbs and Sons v. La Société et Commerciales des Metaux (1890) 25 QBD 399 (Gibbs), which provides that debt can only be discharged or compromised under the law of a jurisdiction other than the situs of the governing law if the holder of such debt submits to the jurisdiction of the foreign court.148 By that reasoning, creditors who did not submit to the offshore jurisdiction would not be bound to the scheme and could pursue their remedies elsewhere.

On 18 July 2022, the United States Bankruptcy Court for the Southern District Court of New York granted recognition of Modern Land's proposed scheme of arrangement, which contemplates discharging New York governed debt.149 The bankruptcy court noted that the scheme was a genuine debt restructuring of a distressed company and, as such, Modern Land is permitted to compromise the creditor's guarantee rights under the Scheme.150

With respect to the High Court opinion suggesting that recognition under Chapter 15 would not constitute a substantive discharge of New York law governed debt and would only be limited to the jurisdiction of the United States, the bankruptcy court found that the High Court misunderstood and misinterpreted relevant US law.151 The bankruptcy court noted that the High Court relied on a prior bankruptcy decision authored by the same judge, In re Agrokor dd, 591, B.R. 163, 169 (Bankr SDNY 2018) (Agrokor), and specifically its explanation that 'Section 1520(a)(1) provides that the automatic stay will apply to all the debtor's property that is located within the territorial jurisdiction of the United States.'152 The bankruptcy court explained that the High Court misunderstood the decision in Agrokar and noted that many other decisions in the United States have recognised and enforced foreign court sanctioned schemes that contemplate modifying or discharging New York law governed debt. Furthermore, the bankruptcy court in Agrokor held that the Gibbs rule is incompatible with Chapter 15 and with modern international insolvency law.153 The bankruptcy court held that, so long as a foreign court properly exercised its jurisdiction over a foreign debtor and the foreign court's procedures, a decision of the foreign court approving a scheme or plan that modifies or discharges New York law governed debt is enforceable.154 Thus, in recognising and enforcing Modern Land's proposed scheme, the discharge of the existing notes and issuance of the replacement notes is deemed binding and effective.

ii Culligan Ltd

Culligan Ltd was a Bermuda-incorporated exempted holding company for direct and indirect subsidiaries that distributed water purification and filtration units through franchise dealers in North America.155 Culligan underwent a series of out-of-court restructurings between 2006 and 2017 before formally entering into a Bermuda-court supervised liquidation on 2 July 2019.156

Culligan's 2006 corporate restructuring became subject to litigation proceedings in the Supreme Court of New York.157 Through the 2006 corporate restructurings, Culligan borrowed more than US$850 million to refinance US$400 million of outstanding debt, repay US$200 million to an investor, Clayton Dubilier & Rice, LLC (CDR), and pay a $375 million dividend to shareholders.158

On 30 May 2012, some of Culligan's minority shareholders, consisting of 71 of the total 262 of Culligan water dealers and holding approximately 3.8 per cent of Culligan's shares (collectively, the plaintiffs) commenced a derivative proceeding against Culligan's directors, controlling shareholders, and certain other defendants.159 The plaintiffs alleged that Culligan violated New York law in assuming debt and paying its shareholders and investors as part of the 2006 restructuring despite having insufficient capital.160 On 29 April 2013, Culligan's majority shareholders authorised the company to enter into a members' voluntary liquidation (MVL) under applicable Bermuda law.161 The MVL liquidators then notified the New York plaintiffs of the MVL and expressed their view that the New York litigation should not proceed.162 The New York plaintiffs disagreed with the MVL liquidators and proceeded to file several amended complaints.163 In June 2017, through a winding-up proceeding in Bermuda in connection with the MVL, approximately US$400,000 was disbursed to 56 of the 71 plaintiffs in the New York litigation.164 As of June 2019, Culligan had approximately US$37,000 remaining in payment obligations to 15 remaining unpaid New York plaintiffs.165 On 22 June 2020, the court-appointed MVL liquidators sought an order from the Bermuda court preventing the New York plaintiffs from bringing proceedings against Culligan anywhere in the world.166 Because the New York plaintiffs are not within the jurisdiction of the Bermuda Court, Culligan was granted leave to serve the New York plaintiffs out of the jurisdiction.167 As a result of the expected additional liabilities that would arise from the New York litigation, Culligan became insolvent, and, on 2 July 2019, the Bermuda court converted Culligan's MVL into a court-supervised liquidation.168

On 17 September 2020, Culligan's foreign representatives filed a Chapter 15 petition in the Southern District of New York, seeking recognition of the Bermuda liquidation proceedings as foreign main proceedings. Additionally, the foreign representatives sought an order confirming that the automatic stay precluded the New York litigation from proceeding, reasoning that risk of ongoing litigation 'may further deplete the dwindling assets of the Debtor and frustrate the Bermuda liquidation proceedings'.169 The New York plaintiffs opposed Culligan's recognition petition, characterising the petition as a bad faith filing intending to enjoin the New York litigation and circumvent the state court's adverse rulings.170

Here, the Chapter 15 court was faced with the question of whether a Chapter 15 court may deny recognition of foreign proceedings where stakeholders assert that the Chapter 15 proceeding was commenced in bad faith. The court held that an allegation of a bad faith filing is not a sufficient basis for denying recognition and granted the debtors request.171 Although the court agreed that there was evidence to suggest Culligan commenced the Chapter 15 proceedings as a means to disrupt and end the New York litigation, the court determined that Section 1506 of the Bankruptcy Code does not prohibit recognition in situations where the debtors acted in bad faith, except in instances where granting recognition would be manifestly contrary to the public policy of the United States.172 The court noted that, unlike Chapter 11 proceedings, where bankruptcy proceedings can be dismissed for cause pursuant to Section 1112(b), recognition under Chapter 15 proceedings is subject to the public policy exception of Section 1506.173 The court asserted that the public policy exception of Section 1506 is intended only to be used in exceptional circumstances that concern matters of fundamental importance to the United States.174