Ovarian cancer. Lung cancer. Mesothelioma. These deadly conditions are all linked to asbestos, a carcinogenic mineral found in underground deposits. It tends to form near talc, another naturally occurring mineral used in cosmetic products such as creams, lotions, and powders. Because of the potential for cross-contamination, the Food and Drug Administration (FDA) recommends that companies including talc as an ingredient exercise extreme caution in their excavation and testing process to prevent consumer asbestos exposure.

But according to thousands of plaintiffs, Johnson & Johnson (J&J) negligently left trace amounts of asbestos in its talc-based products, including its iconic baby powder – and they developed cancer and other severe illnesses as a result. Juries in several jurisdictions have sided with the injured parties in lawsuits, awarding them billions in damages.

Now J&J is using a legal loophole to try and shield its assets, valued at over $450 billion, and drastically reduce those talcum powder payouts. If it succeeds, more companies could employ this maneuver.

Why It Matters: J&J is attempting to use a bankruptcy filing tactic known as the “Texas two-step” to effectively release itself from liability for over $20 billion in damage payments to plaintiffs allegedly harmed by its talcum powder products. If it prevails in court, J&J’s invocation of the Texas two-step strategy would be the largest of its kind. And plaintiffs’ attorneys fear this could set a dangerous precedent whereby profitable corporations routinely use bankruptcy filings to avoid financial liability for negligence.

How It Works: J&J initiated the bankruptcy by creating a subsidiary company called LTL Management LLC. On October 14, 2021, LTL Management filed a petition for Chapter 11 protection in North Carolina bankruptcy court. But according to financial information listed on the petition, LTL Management exists solely to absorb J&J’s talc powder injury lawsuits. Those claims could now be reduced through lengthy bankruptcy litigation, leaving injured plaintiffs with diminished damage payouts.

The tactic of creating a new business entity for liability assumption is called a divisive merger, and only one state allows unfettered access to this option – Texas. Many jurisdictions permit a business to redistribute its assets and liabilities into a subsidiary (a tactic commonly known as a “spin-off”). But Texas allows a company to legally split into two or more entities and then transfer all its debts to the newly created enterprise– hence the term “Texas two-step.” In most states, this is considered a fraudulent transfer and grounds for civil or even criminal prosecution. But Texas business code defines a merger as operating “without…any transfer or assignment having occurred.” Based on this statute, there cannot be a fraudulent transfer since no transfer whatsoever has occurred.

In this instance, J&J established LTL Management in Texas to take advantage of its divisive merger option. Next, it transferred all its talcum powder lawsuit liabilities into LTL Management. It then requested a change of domicile to file for Chapter 11 in North Carolina, where statutes place the burden of proof on challengers to a bankruptcy filing and not the debtor. If this strategy prevails, J&J can avoid direct liability for talcum powder lawsuits and shield its billions in profits from being used to pay related damages.

What’s Next: Plaintiffs are fighting back – but an ultimate resolution to this issue could take years. Talc powder lawsuit attorneys began making moves this summer to block the Texas two-step filing after J&J revealed in settlement discussions that it was considering the maneuver. They requested that judges in multiple jurisdictions, including Delaware and New Jersey, grant a restraining order against J&J halting the bankruptcy on the grounds that its use of the divisive merger is considered fraudulent outside of Texas. But the requests were denied, and plaintiffs must now explore other avenues to preserve their damage payouts as the filing advances in court.

One such option is to bypass the stay of litigation that typically accompanies a corporate Chapter 11 filing. When a company files for bankruptcy, it legally becomes a debtor. Most civil actions (including lawsuits) against the debtor company and any related entities then halt for the inventory of its assets and liabilities. LTL Management has claimed in its bankruptcy filing brief that J&J, as its parent company, is also entitled to this litigation protection. But plaintiffs’ attorneys argue that since LTL Management didn’t file a standard motion requesting a stay of litigation extension to its related entities, J&J is open to civil action. As such, injured parties can still sue J&J for damages while LTL Management’s bankruptcy case moves forward.

Talcum powder lawsuit lawyers seem to have won the first round in this battle. On October 22, a federal bankruptcy judge ruled that lawsuits against J&J can continue during LTL Management’s bankruptcy proceedings. However, J&J will likely present additional evidence to support its position at a hearing next month. If it can convince the judge to grant stay of litigation protection, it could avoid talc powder lawsuits for the foreseeable future.

Plaintiffs may also seek a fraudulent transfer claim against J&J on the basis that it didn’t give due financial consideration to LTL Management when executing the divisive merger. Although J&J contributed $2 billion in talc settlement funds to LTL Management upon its creation, talc lawsuit attorneys argue that it will take billions more to fully compensate the thousands of people seeking restitution from the company. A fraudulent transfer lawsuit could potentially force J&J to provide additional talc powder damage funding to LTL Management.

Unfortunately for injured plaintiffs, the law makes it difficult to pursue this option. Any fraudulent transfer claims would become part of LTL Management’s Chapter 11 filing and thus eligible for bankruptcy negotiation. Federal bankruptcy code defers to a debtor’s “business judgment” when settling such claims – so creditors, including talcum powder plaintiffs, would be pressured to accept a lowball offer with limited avenues for recourse.

The Bottom Line: While J&J’s Texas two-step gambit makes its way through the lengthy litigation process, talcum powder lawsuit plaintiffs could face two choices: wait years for a payout that may never come or accept a slashed settlement for pennies on the dollar. As a result of the divisive merger, LTL Management currently holds over 35,000 talcum powder claims valued at roughly $500,000 each. Bankruptcy courts may highly reduce these claims as the Chapter 11 filing proceeds. LTL Management will then offer a global settlement to all plaintiffs based on the decreased claims. Should the plaintiffs refuse to accept, they risk waiting years for a higher payout as the case drags on and legal fees siphon away LTL Management’s damage funding. By the time both parties reach an agreement, there could be nothing left in the company’s financial reserves for payouts. Meanwhile, J&J’s damages stay capped, and its immense profits are protected.

This scenario is playing out right now in a similar mass tort asbestos contamination case. In 2017 Georgia-Pacific (GP), a pulp and paper manufacturer owned by conglomerate Koch Industries, utilized the Texas two-step to offload 64,000 asbestos injury claims into a new subsidiary, Bestwall, LLC. Bestwall received $177 million from its parent company for asbestos lawsuit payouts, a sum that plaintiffs’ attorneys criticized as “a nearly inconsequential asset value when compared with what old GP would owe.” Four years later, plaintiffs are still battling with GP in court for the higher payouts they say they deserve.

It remains to be seen if the Texas two-step strategy employed by J&J and other corporations will triumph. To date, the tactic has not completed the litigation process in any bankruptcy court. Talcum powder lawsuit attorneys warn that its success could embolden corporations to “hide behind bankruptcy” rather than accept financial responsibility for negligence. Some members of Congress are also fighting against the maneuver by sponsoring the Non-debtor Release Prohibition Act of 2021, which would strengthen bankruptcy regulations and make it harder for companies to use methods like the Texas two-step to cap damage liabilities. But only time will tell if this proposed legislation ever becomes law.

In the meantime, thousands of talc powder lawsuit plaintiffs are in litigation limbo. They claim that J&J knew for decades about asbestos contamination in its baby powder and hid the dangers even as its customers developed agonizing health conditions. J&J, for its part, continues to deny that its talc-based products were ever dangerous – even while pulling those products from the market last year amid mounting public criticism. And it continues to defend the Texas two-step maneuver as a legitimate way to resolve claims, setting the stage for a legal battle between individual plaintiffs and a global corporation.