The (Possible) End of the Texas Two-Step?

On July 23, 2024, U.S. Senators Sheldon Whitehouse (D-RI) and Josh Hawley (R-MO) and representatives Emilia Sykes (D-OH) and Lance Gooden (R-TX) introduced the Ending Corporate Bankruptcy Abuse Act (“ECBA”).  The purpose of the ECBA is an attempt to end the so-called “Texas Two-Step” that has been pervasive in recent years.  One such use of this process can be found in the Johnson & Johnson bankruptcy cases dealing with talc-related injury claims. 

For those unfamiliar with it, the “Texas Two-Step” is maneuver used by corporations to avoid paying out massive tort injury claims while continuing to do business, as follows:

1. A corporation with a lot of tort injury claims and liabilities creates a Texas corporate entity.
2. The new Texas entity then undertakes a “divisive merger” that splits the corporation into two companies, one saddled with tort liabilities and containing few assets and the other one containing almost all of the assets and no tort liabilities.
3. The company with few assets files for bankruptcy as a separate entity, but gets an automatic stay for both itself and for its companion company holding the business asset, stopping all pending litigation against them.
4. Injury victims are relegated to now have to spend years challenging BadCo’s bankruptcy while GoodCo goes about business as usual.

The proposed new law, the ECBA, would change the use of the Texas Two-Step as follows: 

1.         Instructs courts to presume Texas Two-Step filings as bad-faith bankruptcies: Courts would presume a bankruptcy has been filed in bad faith if it shows clear indicia of the Texas Two-Step, including: was venue manufactured specifically for the case; was the bankruptcy filing intended to gain a tactical litigation advantage; was the debtor was formed as result of a recent divisional merger; did the debtor engage in what would be considered a fraudulent transfer; or does the debtor not have a valid reorganizational purpose.

2.         Prohibits stays of litigation in Texas Two-Step cases: Stays of litigation against a debtor’s non-bankrupt affiliates would be prohibited where the debtor engaged in a Texas Two-Step maneuver within the previous (4) four years. The bill would add a Texas Two-Step exception to the Bankruptcy Code’s statutory litigation stay, which would ensure that the statutory stay will not block litigation against the affiliate holding all the assets and conducting business. This provision is narrow and is designed to apply to bankruptcies involving mass-tort/injury cases affecting more than 100 individuals.

The bill itself, which can be accessed here, has bipartisan support.  But because the bill is very new, and this is an election year, it remains to be seen where it might go.  If interested, you can go to www.congress.gov, and follow the instructions to get alerts when there are actions taken with respect to this bill. 

These materials were authored by Kathleen A. Cashman-Kramer, Of Counsel at Fennemore LLP (KCashman-Kramer@Fennemorelaw.com).

Best regards,
Insolvency Law Committee

Co-Chair
Joseph Boufadel
Salvato Boufadel LLP
Jboufadel@salvatoboufadel.com

Co-Chair
Kathleen A. Cashman-Kramer
Fennemore LLP
kcashman-kramer@fennemorelaw.com

Co-Vice Chair
Matthew Pham
Allen Matkins Leck Gamble Mallory & Natsis LLP
mpham@allenmatkins.com

Co-Vice Chair
Jessica Bagdanov
BG Law LLP  
jbagdanov@bg.law

Secretary
Meredith King
Franklin Soto Leeds LLP
mking@fsl.law

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