A Texas two-step bankruptcy is a two-step bankruptcy strategy under US bankruptcy law in which a solvent parent company spins off liabilities into a new company, and then has that new company declare bankruptcy. In the first step, the parent company undergoes a Texas divisive merger, which allows companies to split off their liabilities from their assets. In the second step, the newly created spin-off declares a chapter 11 bankruptcy, usually in North Carolina, where bankruptcy courts are perceived to be more open to this scheme. The Texas two-step allows solvent companies to shield their assets from litigants using protections that are normally reserved for bankrupt companies. The goal of a Texas two-step is for the parent company to gain a third-party release of all liabilities it assigned to its spinoff, thus preventing litigants from pursuing those claims against the parent.
Texas divisive merger
Typically, a corporate merger involves two entities joining together so that the assets and liabilities of both become the assets and liabilities of the new, merged company. A Texas divisive merger achieves the opposite result: instead of two companies joining to become one, one company splits to become two. Corporate divisions or spin-offs are allowed in many jurisdictions, but the Texas divisive merger is distinctive because it treats the division as a merger. Notably, in a Texas two-step bankruptcy the parent company still maintains control over the spin-off by appointing its board and executives.
Subsequent Chapter 11 bankruptcy
Once the parent company has created a spin-off containing the parent's former liabilities, the spin-off declares chapter 11 bankruptcy but remains in control as a debtor in possession. The chapter 11 bankruptcy automatically stays (halts) litigation against the spin-off, and the spin-off can further move to stay all litigation against its parent, which courts permit when the bankrupt company shows that litigation against the third party (here the parent) substantially harms the debtor's ability to complete a bankruptcy plan. However, while the spin-off is under the oversight of the bankruptcy court, the parent company can continue to operate normally. For instance, when Johnson & Johnson entered into a Texas two-step through its spin-off LTL Management LLC, J&J's other divisions continued to operate unencumbered, and J&J maintained its AAA credit rating.
The final goal of a company doing a Texas two-step is to get the court to approve a bankruptcy plan that includes a third-party release for the parent. Such a release prevents all litigants from recovering for their harms from the parent company. Third-party releases are controversial in their own right, but are explicitly allowed in asbestos-related bankruptcies, and have been used successfully in non-asbestos cases.
Cases
While Texas divisive mergers have existed since 1989, only four companies have employed them to facilitate a subsequent bankruptcy to shield the parent company from tort liabilities as part of a Texas two-step. All four companies were represented by law firm Jones Day.
In 2017, Koch Industries-owned Georgia-Pacific spun off its liabilities from paper and building products that contained asbestos into a new entity called Bestwall through a Texas divisive merger. Bestwall declared bankruptcy in North Carolina three months later.
In 2019, Saint-Gobain similarly spun off liabilities from building products produced by its North American subsidiary CertainTeed that contained asbestos into DBMP, which had no operations. DBMP filed for bankruptcy in North Carolina three months later.
In 2020, Trane Technologies followed the same pattern and spun off its asbestos-related liabilities into Aldrich Pump and Murray Boiler, both of which declared bankruptcy seven weeks later in North Carolina.
In 2021, Johnson & Johnson began the largest Texas two-step bankruptcy when it created LTL Management LLC to hold its asbestos-containing talc powder liabilities via a Texas divisive merger. On October 14, 2021, LTL Management LLC declared bankruptcy in North Carolina. On January 30, 2023 the 3rd Circuit Court of Appeals ruled after an appeal that LTL's bankruptcy should be dismissed on the grounds that LTL was not in financial distress, reversing a previous ruling by the Bankruptcy Court. On April 4, 2023, LTL filed for a second bankruptcy. On July 28, 2023, Chief Judge Michael Kaplan of the U.S. Bankruptcy Court in New Jersey dismissed the second bankruptcy.