[Texas Two-Step and the Future of Mass Tort Bankruptcy Series] Vertical Forum Shopping in Bankruptcy

By Jonathan C. Lipson (Temple University-Beasley School of Law)

Note: This is the second in a series of posts on the Texas Two Step, the bankruptcy of LTL Management, and the future of mass tort bankruptcies.  Check the HLS Bankruptcy Roundtable throughout the summer for additional contributing posts by academics from institutions across the country.

The first post in this series can be found here.

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Jonathan C. Lipson

Forum shopping has long been an issue in chapter 11 reorganization, chiefly because liberal venue rules permit gamesmanship.  Section 1408 of the Judicial Code allows a corporate debtor to “bootstrap” into the bankruptcy court of any district where at least one entity in the group was formed.  If a forum is chosen “strategically,” Professors Lynn LoPucki and Bill Whitford first warned (in 1991), “the choice can have an important effect on the distribution of the losses emanating from a bankruptcy reorganization.”

They were describing what may be called “horizontal” forum shopping:  picking among the nation’s roughly 200 bankruptcy panels to find the one the debtor considers best for its situation.  Cases such as LTL Management and Purdue Pharma suggest there is another kind to think about, a variation on what proceduralists call “vertical” forum shopping.

Vertical forum shopping typically concerns competition between state and federal courts, and the rule of decision they apply (i.e., Erie v. Tompkins).  Bankruptcy has a similar state-federal dynamic, but also presents the potential for broader, and more problematic, competitions.

LTL involves the chapter 11 reorganization of Johnson & Johnson’s tort-feasing talc subsidiary.  The debtor had been formed shortly before bankruptcy in a controversial “divisive merger,” which many viewed as little more than a fancied-up fraudulent transfer.  Talc plaintiffs moved to dismiss the case on grounds that it was not commenced in good faith.

In a thorough and thoughtful opinion, U.S. Bankruptcy Judge Michael Kaplan denied the motion because he believed the economic benefits of reorganization appeared to outweigh alternatives.  But, the motion to dismiss also raised “a far more significant issue: which judicial system—the state/federal court trial system,” or chapter 11 “serves best the interests of th[e] bankruptcy estate, comprised primarily of present and future tort claimants with serious financial and physical injuries.”

This question—which system?—is bankruptcy’s version of vertical forum shopping.

On one hand, Judge Kaplan is probably right about the economics:  chapter 11 is likely to pay more to more talc claimants than litigation in other courts.  Nonbankruptcy litigation might produce a few outsize winners—billion-dollar verdicts or multi-million-dollar settlements—but there may be little left for most judgment creditors to collect.

On the other hand, chapter 11’s distributive benefits can trade off against what we might call “dignitary” interests, including individual rights to a “day in court” and a jury trial.  Congress intended to preserve some dignitary protections in chapter 11 cases, including the right to a jury trial of contingent and unliquidated personal injury and wrongful death claims.  But the rise of channeling injunctions and nondebtor releases has undermined those protections.

In Purdue Pharma, for example, the debtor’s controversial plan would give personal injury creditors a bare right to a jury trial against the company, and cap recoveries at about $48,000—surely not enough to cover the cost of the trial.  Worse, it would eliminate the right entirely as to the Sackler family, which owned and controlled the company when it committed two sets of confessed drug crimes.  The viability of those releases is pending before the Second Circuit Court of Appeals.

Vertical forum shopping in chapter 11 can threaten not only the role of other courts, but also other branches of government.  Again, while LTL spotted the issue, Purdue crystallized it.

A supplemental injunction at the beginning of Purdue halted administrative and regulatory actions against Purdue and the Sacklers.  While this left the possibility of criminal prosecution, the U.S. Department of Justice negotiated deals with the Sacklers and Purdue that made it practically impossible for states to prosecute (and, of course, many preferred to settle with the Sacklers rather than fight, anyway).

Purdue Pharma and LTL are likely to be very different cases.  The bankruptcy judge and the debtors in Purdue resisted important efforts to vindicate dignitary concerns, such as a bellwether trial of allegations against the Sacklers or a fulsome examination of them.  Tragically, the lack of those efforts may have undercut the Sacklers’ proposed payout, leading the judge to declare himself “bitter.”

In LTL, by contrast, Judge Kaplan and the debtors have signaled a willingness to deploy these types of mechanisms, should the case remain in bankruptcy.

At this point, it is too early to know.  Angered by the brazen nature of the divisive merger, the talc plaintiffs have appealed to the Third Circuit.

I discuss dignitary issues implicated by vertical forum shopping in chapter 11 in a draft paper, The Problem of Social Debt, which I can share if you email me (jlipson [at] temple [dot] edu).

[Texas Two-Step and the Future of Mass Tort Bankruptcy Series] Introduction to LTL Management’s Bankruptcy

By Jin Lee and Amelia Ricketts (Harvard Law School)

Note: This is the first in a series of posts on the Texas Two Step, the bankruptcy of LTL Management, and the future of mass tort bankruptcies.  Check the HLS Bankruptcy Roundtable throughout the summer for additional contributing posts by academics from institutions across the country.

Jin Lee
Amelia Ricketts

Judge Kaplan’s recent decision not to dismiss the LTL Management (LTL)/Johnson & Johnson (J&J) bankruptcy has further stirred controversy about the hotly debated Texas Two-Step Maneuver, and put an end to speculation on how the bankruptcy court would rule on J&J’s Texas Two-Step bankruptcy filing.  (The decision has been appealed directly to the Third Circuit).

The court rejected tort claimants’ arguments that LTL’s filing violated the good faith requirement for Chapter 11 filings or warranted “for cause” dismissal under Section 1112.  Judge Kaplan held that the filing was an appropriate use of the Bankruptcy Code to maximize value available to creditors, commenting that the bankruptcy court would be the “optimal” venue to resolve tort claimants’ treatment.  The judge emphasized compliance with the terms of the Texas divisional merger statute as evidence of J&J’s good faith.  He also viewed the funding agreement among LTL, J&J, and J&J’s consumer division subsidiary as providing LTL with appropriate capitalization to meet the talc claimants’ needs.  As a result, Judge Kaplan concluded that the talc claimants’ interests would be best served by the bankruptcy process and denied their motion to dismiss.

The full post discussing the case is available here: Introduction to LTL Management’s Bankruptcy.