From the latest opinion in Johnson & Johnson’s second “Baby Powder” reorganization, it’s unclear whether the bankruptcy judge will eventually dismiss the chapter 11 case or allow the debtor to proceed toward confirmation of a plan dealing with tens of thousands of talc claims.
J&J put its subsidiary LTL Management LLC back into chapter 11 two hours after the bankruptcy court dismissed the first case pursuant to the Third Circuit’s mandate. Reversing the bankruptcy court on a direct appeal, the Court of Appeals had ruled in January that the first LTL chapter 11 case was not filed in good faith because there was no “financial distress.” See In re LTL Management LLC, 58 F.4th 738, 64 F.4th 84 (3d Cir. Jan. 30, 2023). To read ABI’s report on LTL II, click here.
For the time being at least, Bankruptcy Judge Michael B. Kaplan of Trenton, N.J., is allowing the new case to remain in chapter 11. He is permitting talc plaintiffs to conduct discovery and motion practice, but he won’t permit trials. However, he is keeping a lid on the multidistrict litigation.
The Old and New Chapter 11 Cases
The J&J companies were facing almost 40,000 claims, alleging that talc in its baby power contained traces of asbestos. Just before the first chapter 11 filing in October 2021, the J&J parent created two new subsidiaries. LTL was created to be the debtor. It had no ongoing businesses and was given all of the talc liabilities, while the other newly created subsidiary took J&J’s operating consumer businesses.
To obviate an otherwise egregious fraudulent transfer, the J&J parent and affiliates gave LTL a so-called funding agreement providing the debtor with perhaps $61.5 billion to cover talc liabilities. Talc claimants mounted a dismissal motion, which Judge Kaplan denied in February 2022. See In re LTL Management LLC, 637 B.R. 396 (Bankr. D.N.J. Feb. 25, 2022). To read ABI’s report on LTL I, click here.
After the Third Circuit reversed and directed dismissal in January, the debtor unsuccessfully sought rehearing and a stay pending a petition for certiorari to the Supreme Court. When those efforts failed, Judge Kaplan entered an order dismissing the first chapter 11 case, but LTL filed a second petition two hours later in Judge Kaplan’s court.
The new filing was different. J&J said that the plan proposed in the second reorganization has support from at least 60,000 claimants. The J&J companies had terminated the original $61.5 billion funding agreement. In its place, LTL has a new agreement where the parent and affiliates will fund a trust to pay chapter 11 claims.
Soon after the new filing, Judge Kaplan entered a temporary restraining order imposing a stay on talc lawsuits. The new TRO protected both LTL and potentially hundreds of other nondebtor third parties, including the J&J parent and affiliates. As required on issuance of a TRO, Judge Kaplan scheduled a preliminary injunction hearing to be held on April 18. Two days later, he issued his opinion from the bench, vacating the original TRO while imposing a more limited preliminary injunction.
On April 27, Judge Kaplan filed a 31-page written opinion, which, he said, was “intended to clarify and supplement the oral opinion.”
Jurisdiction
Some talc claimants opposed the injunction and argued that Judge Kaplan should dismiss the new filing summarily. In his written opinion on April 27, Judge Kaplan first dealt with the objectors’ argument that the court lacked jurisdiction to impose a stay protecting nondebtors.
Judge Kaplan ruled that the court had jurisdiction because the dispute was a “core” proceeding. He saw jurisdiction with regard to third-party injunctions resulting from indemnification obligations and “potential adverse” impacts on the estate and the prospects for reorganization.
Judge Kaplan saw “[n]othing . . . in the Third Circuit’s Opinion” in LTL II to change his analysis in LTL I that the bankruptcy court has jurisdiction.
Power to Issue a Third-Party Stay
Having established jurisdiction, Judge Kaplan analyzed his statutory power to impose a stay protecting nondebtor third parties.
Judge Kaplan found statutory authority in Section 362(a)(1), because talc lawsuits could liquidate claims against the debtor. He also saw power under Section 362(a)(3), because insurance policies are estate assets.
In addition, Judge Kaplan found the requisite “unusual circumstances” required by the Third Circuit before staying actions against nondebtors.
Judge Kaplan spent the better part of his opinion addressing the propriety of an injunction under Section 105(a), which permits the court to issue “any order” that is “necessary or appropriate to carry out the provisions” of the Bankruptcy Code. To invoke Section 105(a), the debtor must show the usual four requisites for an injunction, which Judge Kaplan dealt with, one by one.
Good Faith
Regarding the good faith requirement for an injunction, Judge Kaplan said that the changed circumstances resulting from the second filing “raise more questions regarding financial distress and good faith than they answer.”
Today, Judge Kaplan said, there are more than 100,000 talc claims, more than double the initial 40,000 claims. He said that “it remains unclear whether the increased volume of claims adds to — or creates — financial distress for this Debtor.”
On the other hand, Judge Kaplan said that the debtor’s “funding sources” had been reduced from “approximately $61 billion” to “potentially upwards of $30 billion.” He said that “the reduction certainly appears to be manufactured . . . in direct response to the Third Circuit’s ruling.”
“Nevertheless,” Judge Kaplan said, “it is unclear whether this reduction in funding adds to — or creates — financial distress for this Debtor.”
Expounding on the decline in the funding arrangement, Judge Kaplan said that “it remains unclear whether the transactions give rise to fraudulent transfer liability for the benefit of the Debtor’s creditors.” As to actual fraud, the judge found himself “unable to conclude on this record whether there has been an actual intent to hinder, delay, and defraud creditors.”
While the issue of good faith was “undeniably” implicated by the motion to expand the stay, Judge Kaplan saw the record as “too uncertain and undeveloped for this Court to exercise its sua sponte dismissal authority.” He added that the question of financial distress “remains an open one for now.” Similarly, he said that “the Court cannot make a determination as to whether a fraudulent transfer occurred on this record.”
Looking to the future, Judge Kaplan said he was “skeptical and will require well-supported and timely showings by the Debtor that this reorganization continues to have a chance of success.”
Irreparable Injury and Harm to Talc Claimants
Judge Kaplan found “nothing in the Third Circuit’s decision regarding Debtor’s financial distress [that] precludes this Court from concluding that, in the present circumstances, Debtor will suffer irreparable harm if Talc Claims are allowed to proceed to trial.”
Weighing the harm to the debtor against the harm to objecting talc claimants, Judge Kaplan said that the claimants had their claims “stalled” during the first chapter 11 case and “should not lose more valuable time.” He is therefore permitting claimants to “proceed with litigation up to the point of trial.” However, he is allowing the stay “to remain in place” regarding the multidistrict litigation at least until another hearing on May 22.
Public Interest
Judge Kaplan said he “continues to believe that — assuming the bankruptcy is found to be in good faith — claim resolution through the bankruptcy process is in the public interest, especially when it is supported by the talc claimants themselves.” He also said that a settlement trust would benefit claimants “by streamlining the claim recovery process” and by protecting “the needs of future trust claimants.”
A Limited Preliminary Injunction
Judge Kaplan dissolved the TRO to allow discovery, motion practice and the filing of new suits. In place of the TRO, he imposed what he called “a far more limited preliminary injunction” to persist until June 15. The preliminary injunction will “prohibit the commencement or continuation of any trial against any of the Protected Parties.” He kept the TRO in place regarding the multidistrict litigation.
To avoid statutes of limitations from lapsing, Judge Kaplan said that the preliminary injunction would retain the injunction for unfiled claims until a claimant gives notice of intent to file suit.
Judge Kaplan will revisit the injunction once again at a hearing on May 22. In the meantime, he will conduct a status conference to set a schedule for a hearing on the motions to dismiss that have been lodged by objecting talc creditors.
Observations
The Third Circuit’s dismissal opinion in January was devoid of dicta suggesting whether LTL would be ineligible for bankruptcy under any other circumstances. Judge Kaplan declined to read between the lines in search of a policy hidden somewhere in the words written by Third Circuit Judge Thomas L. Ambro.
For example, Judge Ambro pointedly declined to rule on whether LTL improperly used chapter 11 as a “litigation tactic.” LTL II, id., 58 F.4th at 763, fn. 19. The Third Circuit has therefore said nothing overtly to disabuse Judge Kaplan of his belief that chapter 11, compared to the tort system, represents “a more beneficial and equitable path toward resolving Debtor’s ongoing talc-related liabilities.” LTL I, id., 637 B.R. at 409.
When it comes time for him to rule on the motions to dismiss the new chapter 11 case, Judge Kaplan will doubtless address the larger question of whether a family of solvent companies may invoke chapter 11 to resolve mass tort claims when they have sufficient assets to deal with the claims outside of bankruptcy.
The motions to dismiss will put J&J and LTL between a rock and a hard place. If the financial backing for the plan is more than sufficient to pay talc claims in full, the case may once again be subject to dismissal for lack of financial distress. If the financial backing is insufficient to cover claims fully, the shortfall could give rise to a multi-billion-dollar fraudulent transfer, raising the specter of dismissal for a bad faith filing.
If there is a possible fraudulent transfer, what’s the standard to justify dismissal? Must the objecting creditors establish a fraudulent transfer by final judgment? Or is dismissal warranted if the objectors only show a plausible or prima facie claim for fraudulent transfer?
On the other hand, support for a plan by the required supermajority could breathe life into the chapter 11 case. However, confirmation of a plan might raise the question of whether dissenting creditors are entitled to opt out if the debtor is solvent.
Scholarly Commentary
“I think Judge Kaplan is being appropriately careful,” Prof. Robert M. Lawless told ABI. The professor said he has “deep skepticism about LTL 2.0 and [does] not see any reasonable defense to a fraudulent transfer action. As an academic, however, my opinions need not be careful, nor do I have to provide parties due process.”
Prof. Lawless continued:
This opinion is only about a temporary stay for non-debtors, and it is a limited stay that only prevents parties from going to trial and liquidating those claims. Other proceedings in the talc cases can go forward.
Judge Kaplan expresses skepticism about the bankruptcy case, saying the debtor has an “uphill battle.”
LTL 2.0 is a highly visible chapter 11 case with complex, unprecedented issues. Reasonable people can differ over whether Judge Kaplan should have extended protections to the non-debtors.
It is certainly understandable, however, that Judge Kaplan took some steps to preserve the status quo so that the big issues in the case like good faith and fraudulent transfers can be heard with more detailed evidence and fully briefed arguments.
Prof. Lawless is the Max L. Rowe Professor of Law and co-director of the Program on Law, Behavior & Social Science at the University of Illinois College of Law.
From the latest opinion in Johnson & Johnson’s second “Baby Powder” reorganization, it’s unclear whether the bankruptcy judge will eventually dismiss the chapter 11 case or allow the debtor to proceed toward confirmation of a plan dealing with tens of thousands of talc claims.
J&J put its subsidiary LTL Management LLC back into chapter 11 two hours after the bankruptcy court dismissed the first case pursuant to the Third Circuit’s mandate. Reversing the bankruptcy court on a direct appeal, the Court of Appeals had ruled in January that the first LTL chapter 11 case was not filed in good faith because there was no “financial distress.” See In re LTL Management LLC, 58 F.4th 738, 64 F.4th 84 (3d Cir. Jan. 30, 2023).
For the time being at least, Bankruptcy Judge Michael B. Kaplan of Trenton, N.J., is allowing the new case to remain in chapter 11. He is permitting talc plaintiffs to conduct discovery and motion practice, but he won’t permit trials. However, he is keeping a lid on the multidistrict litigation.