On direct appeal, the Third Circuit reversed the bankruptcy court and directed dismissal of the petition filed by LTL Management LLC, the subsidiary of Johnson & Johnson created to file in chapter 11 to deal with talc and asbestos claims arising from the sale of Johnson’s Baby Powder.

In his 40-page opinion yesterday, Circuit Judge Thomas L. Ambro held that “resort to Chapter 11 is appropriate only for entities facing financial distress.” LTL did not qualify because it has a $61.5 billion backstop from another J&J subsidiary and from the ultimate J&J parent. Judge Ambro said that the parent has $400 billion in equity value, a AAA credit rating, plus $31 billion in cash and marketable securities. He also noted that the parent had distributed $13 billion to shareholders in 2020 and 2021.

Judge Ambro pointedly declined to rule on whether LTL improperly used chapter 11 as a “litigation tactic.” Unless the debtor is in “financial distress,” this writer reads the opinion to mean that debtors may not justify the use of chapter 11 by contending that it’s superior to the tort system or multidistrict litigation in federal courts.

The Pre-Bankruptcy Divisional Merger

The J&J companies were faced with more than 38,000 talc claims. Most prominently, 20 plaintiffs had won a $2.24 billion judgment in state court. Of the 38 completed trials, Judge Ambro said that fewer than half had given monetary awards to the plaintiffs. In those cases where J&J didn’t win and that were not reversed on appeal, Judge Ambro said that the average award was $39.7 million.

Before bankruptcy, the companies had spent about $4.5 billion on verdicts, settlements and litigation expenses. In a statement to its auditors, J&J estimated that the companies’ probable liabilities for tort claims were $2.4 billion for the succeeding two years.

Just before the chapter 11 filing, the Johnson & Johnson parent created two new subsidiaries to compartmentalize tort liabilities. LTL was created to be the debtor, and the other took over J&J’s operating consumer businesses.

The debtor was first created as a limited liability company in Texas and converted to a North Carolina limited liability company. Two days after its creation, the debtor filed a chapter 11 petition in Charlotte, N.C.

The debtor took no business operations of its own but assumed liability for all talc-related claims. The debtor was given some non-operating assets and insurance receivables, plus $6 million in cash. The debtor was also the beneficiary of a so-called funding agreement.

Judge Ambro’s decision to dismiss was founded on the funding agreement. He explained that that the newly created sister corporation with the operating business and the J&J parent together committed to supply LTL with up to $61.5 billion in cash, representing the value of the consumer businesses.

“Most important, though,” Judge Ambro said that the funding agreement “gave LTL direct access to J&J’s exceptionally strong balance sheet,” which, he said, had $400 billion in equity value and $31 billion in cash and marketable securities.

Judge Ambro said that the “stated goal was to isolate the talc liabilities in a new subsidiary so that entity could file for Chapter 11 without subjecting [the operating company’s] entire operating enterprise to bankruptcy proceedings.”

The Transfer to New Jersey

LTL filed a chapter 11 petition in North Carolina that the bankruptcy judge soon transferred to New Jersey, where the official committee representing talc claimants filed a motion to dismiss the chapter 11 case under Section 1112(b), contending that the filing was in bad faith.

The New Jersey bankruptcy court denied the motion to dismiss, finding that LTL was in financial distress, had filed for a valid bankruptcy purpose and had not pursued bankruptcy for litigation advantage. Judge Ambro noted how the bankruptcy court had a “strong conviction” that the bankruptcy court possessed “a superior ability, compared to trial courts, to protect the talc claimants’ interests.”

The bankruptcy court also granted the debtor’s motion to spread the automatic stay by enjoining lawsuits against more than 600 nondebtors, including the parent and LTL’s affiliates. To read ABI’s report on denial of the dismissal motion, In re LTL Management LLC, 637 B.R. 396 (Bankr. D.N.J. Feb. 25, 2022), click here.

The bankruptcy court authorized a direct appeal, which the Third Circuit agreed to hear. The appeals court heard oral argument on September 19.

Third Circuit Precedent on Financial Distress

On the merits, Judge Ambro portrayed his opinion as being cabined by Third Circuit precedent, principally In re SGL Carbon Corp., 200 F.3d 154 (3d Cir. 1999), and NMSBPCSLDHB L.P. v. Integrated Telecom Express Inc. (In re Integrated Telecom Express Inc.), 384 F.3d 108 (3d Cir. 2004). Under those authorities, he said that the “particularly relevant” inquiries were whether there was a valid bankruptcy purpose and whether the filing was merely for tactical litigation advantage. Given his conclusions, Judge Ambro was only obliged to examine “valid bankruptcy purpose.”

“Our precedents show,” Judge Ambro said, that “a debtor who does not suffer from financial distress cannot demonstrate its Chapter 11 petition serves a valid bankruptcy purpose supporting good faith.” Conversely, “absent financial distress, there is no reason for Chapter 11 and no valid bankruptcy purpose.”

However, financial distress does not require insolvency. Without describing how much distress must be shown, Judge Ambro said that it must be “apparent” and “immediate enough to justify a filing.” In a mass tort case, he said that filing later rather than sooner is preferable, because the outcome of tort litigation will enable the bankruptcy court to estimate claims more accurately.

By way of comparison, Judge Ambro said that the bankruptcies of Johns Manville, A.H. Robbins and Dow Corning demonstrated “urgency” and a “compelling need for bankruptcy relief.”

Bankruptcy Court’s Findings Overturned

In applying the standard, Judge Ambro disagreed with the bankruptcy court and analyzed only the financial distress of LTL. He said that the bankruptcy court’s finding of LTS’s financial distress was “untenable,” given the $61.5 billion payment right” against the consumer products operating company and parent J&J.

Specifically, Judge Ambro said that the funding agreement gave “LTL direct access to J&J’s exceptionally strong balance sheet.” He said that the bankruptcy court “hardly considered” LTL’s payment right.

With regard to LTL’s potential liabilities, Judge Ambro questioned whether the bankruptcy court had made “factual findings” but instead developed “back-of-the-envelope forecasts of hypothetical worst-case scenarios.” He said that the bankruptcy court ignored the “possibility of meaningful settlement” and “successful defense” in assuming that “most, if not all, would go to and succeed at trial.”

For Judge Ambro, it was “clear” that “LTL did not have any likely need in the present or the near-term, or even in the long-term, to exhaust its funding rights to pay talc liabilities.” He could “infer only that LTL, at the time of its filing, was highly solvent with access to cash to meet comfortably its liabilities as they came due for the foreseeable future.”

But what if circumstances change and there are other judgments for $2.24 billion? “Perhaps at that time,” Judge Ambro said, “LTL could show that it belonged in bankruptcy.”

“Because LTL was not in financial distress,” Judge Ambro held that “it cannot show its petition served a valid bankruptcy purpose and was filed in good faith under Code § 1112(b).” He also said there were no “unusual circumstances” under Section 1112(b)(2) to avert dismissal.

By calling for the dismissal of the chapter 11 case, Judge Ambro said that the appeal from the broadened stay was moot.