In a decision likely to have significant impact on certain types of bankruptcy filings going forward, this morning, the Third Circuit Court of Appeals ordered the dismissal of the Chapter 11 bankruptcy case filed by Johnson & Johnson affiliate LTL Management LLC.

After completing a multi-step divisional merger under Texas law (which led to LTL holding J&J’s legacy talc liabilities along with certain funding arrangements, but no operating assets), LTL filed a chapter 11 bankruptcy petition in October 2021. Concurrent with its filing, LTL asked the bankruptcy court to issue an injunction shielding J&J and its other affiliates from continued talc litigation. An Official Committee of Talc Claimants and other parties moved to dismiss LTL’s bankruptcy case and opposed the issuance of a third-party injunction.

Following a five-day trial held in February 2022, the bankruptcy court denied the motions to dismiss and, in addition, granted LTL’s request for a third-party injunction. With respect to the motion to dismiss, the court held that LTL’s bankruptcy was filed in good faith because it served the valid purpose of managing and resolving LTL’s talc liabilities through a means consistent with the Bankruptcy Code. The court also held that LTL was in financial distress given the significant burdens of defending against talc litigation in thousands of separate lawsuits, notwithstanding that LTL had access to cash held by a J&J affiliate pursuant to a funding agreement.

On appeal, the Third Circuit reversed the bankruptcy court’s denial of the motions to dismiss. The court first stated that, while the bankruptcy court’s factual findings of financial distress were subject to highly-deferential clear error review, the court’s ultimate finding of good faith could be reviewed de novo and the Third Circuit therefore could evaluate whether it believed LTL’s financial distress was sufficient to entitle it to the protections of the Bankruptcy Code. The Third Circuit held that the good faith test “asks whether the debtor faces the kinds of problems that justify Chapter 11 relief” and in that regard, a debtor’s financial distress “must not only be apparent, but it must be immediate enough to justify a filing.” In applying this test, the court concluded that only the financial condition of LTL, and not of J&J and its other affiliates, was relevant to the analysis. The Third Circuit then compared the significant financial resources available to LTL (including up to $61.5 billion potentially available to it under the funding agreement) against the potential scope of talc-related costs and liabilities, particularly in light of LTL’s apparent successes at avoiding sizeable judgments and settlements, and held that LTL was not in the kind of immediate financial distress that could support a bankruptcy filing.

In holding that LTL’s bankruptcy case was not filed in good faith, the Third Circuit appears to have narrowed the justifications that permit a company to utilize the benefits of Chapter 11, emphasizing that merely managing litigation risk is not necessarily sufficient. The decision is likely to have a significant impact, particularly with respect to corporate entities previously considering using bankruptcy as a shield by implementing a “Texas two-step” made popular by LTL, among others.

More to come…