February 9, 2022

Whitehouse Chairs Courts Subcommittee Hearing on Corporate Abuse of Bankruptcy to Avoid Accountability

Chairman Whitehouse seeks “sensible way to solve” this growing trend in bankruptcy law that’s “neither efficient nor fair”

Washington, DC – Yesterday, Chairman Sheldon Whitehouse (D-RI) led the Senate Judiciary Subcommittee on Federal Courts, Oversight, Agency Action, and Federal Rights in a hearing entitled, “Abusing Chapter 11: Corporate Efforts to Side-Step Accountability Through Bankruptcy.” The hearing examined the growing trend of corporate actors using a bankruptcy procedure known as the “Texas Two-Step” to attempt to evade tort liabilities and make it more burdensome for tort plaintiffs to recover. Chairman Whitehouse closed the hearing with the following statement and the path forward for a legislative solution to the issue:

“It does not make sense for a $450 billion corporation with 38,000 people with potentially lethal injuries to be able to carve off $2 billion . . . and walk away from the responsibility for what it did. And with respect to the questions of fairness and efficiency, there’s a larger scope for fairness here, in which it looks like big companies are getting away with dodging real responsibilities by using complicated trickery that ordinary people don’t have access to. [T]he result [is] that they create delays that cause people like Ms. Naranjo to get actually no recovery in her lifetime. So, that’s neither efficient nor fair.”

Whitehouse added, “I hope we can find a sensible way to solve this.”

The subcommittee heard from the following witnesses. Included here is the witnesses’ written testimony:

  • The Honorable Judith K. Fitzgerald, Shareholder, Tucker Arensberg, P.C. [testimony]
  • Mr. David A. Skeel, Jr., S. Samuel Arsht Professor of Corporate Law, University of Pennsylvania Law School [testimony]
  • Ms. Kimberly Ann Naranjo [testimony]
  • Mr. Paul H. Zumbro, Cravath, Swaine & Moore LLP [testimony]
  • Mr. Kevin C. Maclay, Caplin & Drysdale [testimony]

Video of the hearing can be found here.

Text of Whitehouse’s as-delivered opening remarks is below.

We are here to address a novel and rather troubling circumstance that is emerging in bankruptcy law.

Imagine that a big corporation wreaks serious harm on you and your family. You sue for damages to cover hospital bills, or to care for a family member. But when you do, you discover that your claim against the company — a company that is out there operating, apparently thriving in the marketplace – your claim is somehow in bankruptcy court that may not be heard for months or years, and it may never be paid.

Sadly, this situation is not imaginary. The so-called Texas Two-Step has mired tens of thousands of claims in bankruptcy proceedings.

It is bankruptcy’s aim to grant honest but unfortunate debtors a fresh start, while doing the utmost to make creditors whole. But in recent years, large corporations on solid financial footing have found a bankruptcy trick to shirk responsibility for hurting Americans.

Here’s how it works:

  • First, a corporation with claims against it from people that have been harmed transforms into a Texas corporate entity.
  • Second, that new entity exploits a Texas law allowing something called a “divisive merger,” splitting the corporation into two corporations. Company one is saddled with the claims; company two takes the corporate assets.
  • The company saddled with the claims then files for bankruptcy, perhaps in North Carolina where the Fourth Circuit makes it nearly impossible for victims to have the company’s filing dismissed for bad faith. Victims harmed by the corporation are left in bankruptcy proceedings that can take years to resolve, condemned to receive only a fraction of what they’re owed.
  • Meanwhile, the company with the corporate assets continues business as usual, shed of the claims.

That’s the “Texas Two-Step.” Although, to be fair, the same thing can potentially be done under Delaware law.

The originator of this move is perhaps the most prolific industrial polluter in American history, Koch Industries. In 2017, it used the Texas Two-Step to dump its subsidiary’s asbestos liabilities. Victims are still tied up in the bankruptcy process, as are asbestos claimants in ensuing copycat cases.

Johnson & Johnson—one of the biggest and richest companies in the world—last year faced over 38,000 lawsuits alleging that its talc-based baby powder contained asbestos and caused ovarian cancer and mesothelioma. Johnson & Johnson followed the Koch Industries model, and hatched a shell company that took on the talc liability and filed for bankruptcy. Johnson & Johnson now seeks a stay of all those claims, pending bankruptcy proceedings.

This move presents four big concerns:

First, it violates the fundamental principle of bankruptcy that a company is forgiven its debts but it must offer up all its assets to creditors. Then it gets a fresh start. The Texas Two-Step separates the assets from the liabilities in violation of this basic principle.

Second, it denies people their day in court. The civil jury has been a bastion of individual rights throughout our history, allowing people a vital check on the most powerful forces arrayed against them. The Texas Two-Step denies victims a jury of their peers, defeating the Seventh Amendment in our Bill of Rights.

Third, it encourages forum-shopping. Johnson & Johnson had no particular reason to file for bankruptcy in North Carolina; in fact, Johnson & Johnson’s Texan liability shell only existed for two days before it filed bankruptcy. Outcomes in court should not be determined by strategic forum shopping.

Finally, the Texas Two-Step mires victims in protracted proceedings, robbing them of precious time. Asbestos victims can die of mesothelioma and other types of cancers before their claims are heard. That is a blot on our legal system.

So far, this trick has hit asbestos victims, but once this Two-Step strategy catches on, it could deprive all sorts of victims of the compensation they’re due, and undermine the integrity of other creditor-debtor relationships. Hiding assets in a bankruptcy is a serious wrong; the Texas Two-Step uses a trick of corporate law to hide assets in plain view, with courts’ connivance.

I thank Senator Kennedy for his bipartisan approach to this hearing. I hope that we can work in a bipartisan fashion to address this abuse of our bankruptcy process and to make sure that injured victims get their day in court as our constitution entitles them to.

Rich Davidson (202) 228-6291 (press office)

Press Contact

Meaghan McCabe, (202) 224-2921