This is an audio transcript of the Behind the Money podcast episode:Best Of: Inside Johnson & Johnson’s bankruptcy two-step’

Michela Tindera
Hey, everyone. Just to note that we’re taking a break this week. So instead, today we’re resharing one of our episodes. Now be sure to stick around till the end. We’ll have an update on what’s happened since this episode first came out last June. So let’s get on to the show.

On May 5th 2020, a couple named Val and Holly Johnson officially make a decision that has been stewing for months. They decide to file a lawsuit against one of the world’s largest healthcare companies, Johnson & Johnson. In their lawsuit, they say that Johnson & Johnson sold them talc-based baby powder that had asbestos in it — a known carcinogen.

Val Johnson
They conspired. This was not an accident that they did this.

Michela Tindera
That’s Val. He’s 61 years old, and he and his wife, Holly, say that Val’s use of Johnson’s baby powder led to his diagnosis of mesothelioma. He found out that he had this rare and deadly form of cancer just months earlier.

Val Johnson
If they would have taken care of this when they first knew about it, I would have never been sick. I would still be healthy today. I could be off hiking mountains and travelling and seeing the world and doing the many things I wanted to do.

Michela Tindera
It takes more than a year after they file their initial lawsuit, but eventually Val has his day in court.

Val Johnson
In court was very, very hard. I testified for, I think, it was a day and a half. J&J’s attorney was just nasty, mean. He accused me of, and I forget exactly how he put it, but he accused me of being like the people in the Salem witch trials.

Michela Tindera
After Val gives his testimony, he goes back home and waits. And on Tuesday, October 12th, he receives a phone call. And finally he gets some news. The jury on his trial had made their decision. They determined that Johnson & Johnson’s talc baby powder was an important factor in Val developing mesothelioma. And not only that, but also that Johnson & Johnson as a company had acted with, quote, “malice or fraud”, unquote, as well as negligence, which led to Val’s mesothelioma. The jury awards Val $27mn.

Val Johnson
I kind of felt like there was some justice in the world.

Michela Tindera
The decision wouldn’t change Val’s condition, but he knew that at least his wife Holly and his family would be taken care of after he dies. But then just two days later, Val gets another surprise. It turns out that Johnson & Johnson has undergone a unique legal manoeuvre known as the “Texas two-step”. It’s a funny-sounding name, but it has serious implications for Val and for thousands of others. Part of that manoeuvre involved hitting pause on all ongoing litigation it had with its creditors like Val. And this means that after all this time, Val’s verdict is now up in the air.

Val Johnson
It was devastating, heartbreaking to realise because with that it’s very unlikely I’ll even be around to hear how that turns out. I felt there was justice and then I felt there was not justice.

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Michela Tindera
It wasn’t just because of Val that Johnson & Johnson underwent the two-step. In the fall of last year, the company was facing nearly 40,000 lawsuits like Val’s. They were all from people alleging that one of its oldest products, its talc-based baby powder, had given them cancer. Companies weighed down by personal injury lawsuits argue that this unusual legal move is the best way to handle these sorts of claims. They say it provides for a more streamlined and equitable way to address thousands of these sorts of lawsuits. Critics argue that it’s slowing down justice and that it’s taking away people’s right to having their day in court. And other companies are watching Johnson & Johnson to see how their case will play out. On today’s episode, we examine whether Johnson & Johnson’s Texas two-step manoeuvre is setting a new precedent for corporations to evade accountability in America.

I’m Michela Tindera, and this is Behind the Money.

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Before Val’s diagnosis, he loved to go hiking where he lives now in Utah. His hikes put him on top of the world, almost literally.

Val Johnson
I climbed Mount Whitney. Its 14,500 and change-feet high. So I spent a year preparing for that and climbed it. And I did a couple of canyons here in Utah. One of the most famous ones that I did is the Narrows, Zion Narrows, which is about, I forget, something like 80-mile hike through the river. Beautiful.

Michela Tindera
But within a few years, things took a drastic turn.

Val Johnson
The doctor called me up and was on the phone, was like, “You have mesothelioma. Do you know what that is?” And I’m like, “I’ve heard of it, but I don’t really know what it is.” And he said, “It’s asbestos cancer.” It didn’t really register when I first heard it. I didn’t know hardly anything about it. And I’ve since learnt of course a lot more that it’s essentially a death sentence, that there’s not really any cure for it.

Michela Tindera
After he got that call from his doctor, Val was flabbergasted. He couldn’t think of how he had been exposed to a carcinogen like asbestos.

Val Johnson
At first glance it was like, how did I get mesothelioma? Where would it have come from? The, it’s typically, I guess from shipyards and construction sites and stuff, but I’ve always worked an office job.

Michela Tindera
Val says that after his diagnosis, he did some research online and he came across an investigation that had been published by Reuters back in 2018.

News clip
Now a bombshell report from Reuters says company documents show J&J knew from at least 1971 to the early 2000s that its raw talc and finished powders sometimes tested positive for small amounts of asbestos and failed to disclose it.

Val Johnson
I thought about it and then I’ve used Johnson & Johnson baby powder since I was four years old, and I’ve used it through almost all of my life.

Michela Tindera
Val says he used it on himself, and he used it on his children when they were babies. He also found another use for it later in life. One of his sons, Joey, was born with a chromosome deletion. He died in May 2019 when he was 26 years old. But throughout his life, he needed round-the-clock care. He wore diapers into his twenties, needed compression bandages to address bedsores, and also eventually wore a wetsuit so he wouldn’t scratch at his own skin. Val says he would apply baby powder to his son’s body to help with all of those things.

Val Johnson
And I had no idea that it had asbestos in it, obviously, or I wouldn’t have used it.

J&J advertisement
(Child speaking) Johnson’s baby powder from Johnson & Johnson. It’ll keep you comfortable. Take it from a baby.

Michela Tindera
If you had a baby or were a baby sometime over the last century, there’s a good chance that you’ve used some sort of Johnson’s baby product. Their wipes or lotions or shampoos, or perhaps their talc-based powder. With slogans like their shampoo’s “No more tears”, they promised products that were safe and gentle enough for babies. But that all changed with reports that asbestos was mixed in with its talc-based baby powder. J&J has said that its products are safe and has denied that its baby powder contains asbestos and causes cancer. But still, people began to sue the company. Here’s the FT’s US pharmaceuticals correspondent Jamie Smyth.

Jamie Smyth
A woman named Jacqueline Fox files a personal injury lawsuit against J&J. In it, she claims that she ended up with ovarian cancer after using Johnson’s baby powder for more than 35 years. Jacqueline dies before her case is decided. But a jury ends up awarding her family $72mn in 2016.

Michela Tindera
Later, her case is actually overturned on a technicality. But that opens a floodgate for future claims. In 2016, the year that Jacqueline’s family receives her verdict, it’s one of roughly 500 other cancer-related lawsuits filed against the company. Four years later, that number balloons to more than 25,000 complaints. To put that into perspective, Johnson & Johnson said in a court filing that by January 2020, they were being served with, on average, one or more ovarian cancer complaints every hour of the day, every single day of the week. J&J says that it’s won more of these cancer-related lawsuits than it’s lost, but it has lost at least one very large one.

Jamie Smyth
In 2018, a Missouri jury orders Johnson & Johnson to pay nearly $4.7bn in damages to a group of nearly two dozen women who claimed they got cancer from using Johnson’s talc products.

Michela Tindera
That $4.7bn figure was later reduced roughly in half. But J&J continues to appeal the case, and it gets pushed all the way up to the Supreme Court. But in June of last year, the Supreme Court declines to review the case. That means that J&J will have to pay out more than $2bn in damages. This is a big blow to Johnson & Johnson, and this is a big turn in our story. The moment where Jamie Smyth thinks everything changed.

Jamie Smyth
I think the key moment when J&J pushed the button on doing this Texas two-step mechanism was probably when the Supreme Court rejected that appeal. The company warned that the cost of the litigation could become unsustainable, and therefore it started to look for different ways that it could deal with it.

Michela Tindera
And this is where the Texas two-step enters the picture.

Jamie Smyth
This whole mechanism sort of relies on this 1989 statute that was passed by the Texas state legislature on divisive mergers.

Michela Tindera
That’s Jamie again. Jamie says the law was originally passed as a way to make it easier to do corporate spin-offs. But now, years later, it’s being used as step one in this Texas two-step move. So here’s how the whole thing works. Step one . . .

Jamie Smyth
First, you have to register as a corporate entity in Texas.

Michela Tindera
And then split into two. The divisive merger statute in Texas makes it an easier process to do this compared to other states. As it makes that split, it decides how to divvy up its assets and liabilities between the two parts.

Jamie Smyth
In Johnson & Johnson’s case, the company’s consumer products subsidiary that had been selling the talc baby powder and the existing pharmaceutical and medical device divisions keep their assets, the valuable, functioning parts of the company. Some people have dubbed this the GoodCo.

Michela Tindera
And a second company is set up to hold the liabilities. So in J&J’s case, they set up a new company.

Jamie Smyth
But a second company is formed as well to hold all the total liabilities. And this is called LTL Management, which we can call the BadCo.

Michela Tindera
So now there are two separate companies, and that’s step one. Now we can move on to step two.

Jamie Smyth
For step two, this new company that’s now holding the liabilities, what some called the BadCo, goes ahead and files for Chapter 11 bankruptcy.

Michela Tindera
So that’s how the two-step works. But there are a lot of disagreements over who this process is really benefiting: the company or the claimants? One disagreement is over the settlement. In Chapter 11, the idea is to come up with a settlement dollar figure that both the debtors and the creditors can agree on. And as you might guess, that can be easier said than done.

Jamie Smyth
There’s no certainty that these trusts have enough money to pay out all the victims, and that’s another key criticism of the system. So the use of the two-step mechanism really follows a pattern over recent years whereby debtors have deployed much more aggressive tactics to deal with creditors and bankruptcy cases.

Michela Tindera
Johnson & Johnson has already proposed setting up a $2bn settlement trust for victims. And the company denies that it’s walking away from its liabilities. But because there are thousands of talc claimants, those claimants say that’s not nearly enough. Still, J&J has said that going through the bankruptcy process actually ends up creating a more what they call equitable and efficient way of dividing and paying out money to victims. Jamie says that J&J has described the previous system of going through each case one by one, like a lottery system. A few claimants receive astronomical awards from juries, and others get nothing.

Jamie Smyth
They say it’s unfair. They claim it’s being abused by trial lawyers who they’re effectively saying are like ambulance chasers going on recruiting people for these cases. And they say they’ve really come under an unrelenting assault over the last five years.

Michela Tindera
There’s another concern, too. It has to do with something called an “automatic stay”. When a company goes into bankruptcy, the company is basically allowed to press pause on any lawsuits that have been filed against it. And that is exactly what happened with Val’s case. So as we mentioned at the beginning of the episode, the verdict in Val’s trial is delivered on October 12th 2021. Two days later, Johnson & Johnson’s new company created by the two-step, called LTL, files for bankruptcy. It’s not necessarily like Val was going to get a check for $27mn in the mail the week that he received his verdict. J&J appealed Val’s verdict before the pause kicked in. But now all of that is on hold while this bankruptcy process takes place.

Jamie Smyth
Given that many of these cancer sufferers do not have long to live, it really puts undue pressure on them to make settlements, even if such a settlement is far below what a jury would award.

Michela Tindera
Meanwhile, for the company, the pressure is sort of lifted. Because the assets and liabilities were split into two separate companies, the one with the assets is allowed to just continue on, sort of business as usual. Without companies feeling that pressure to settle, it raises the question: if J&J is able to section off its liabilities in this way, could that inspire other companies to do the same thing?

Jared Ellias
If you take the position that you, the company should be allowed to sort of sever the burdens from bankruptcy from the benefits from bankruptcies, you know, what’s to stop, for example, the next time you have a big oil spill?

Michela Tindera
That’s Jared Ellias. He’s a law professor and corporate bankruptcy expert at the UC Hastings College of the Law.

Jared Ellias
You now are terrified of all the lawsuits against you. So you do a Texas two-step. You put those liabilities into bankruptcy, and then you can just wait for years and litigate and stall a settlement. And during that time, evidence can spoil on people who are harmed, will die. And all of the sort of motivation to settle quickly just disappears when a company doesn’t have assets in bankruptcy.

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Michela Tindera
After J&J’s LTL Management filed for bankruptcy last October, it was immediately challenged by talc claimants.

Jamie Smyth
The talc claimants’ lawyers argued that, you know, J&J is in no way in financial trouble. It’s a corporation with a triple-A credit rating. It is worth almost half a trillion dollars. So it’s unfair to say that these potential payouts could, you know, could force it into bankruptcy. That was one of their key arguments.

Michela Tindera
The talc claimants also said that J&J manoeuvre was taking away their right to a jury trial and that it was putting an unfair cap on how much money they would receive in settlements. And then J&J argued that they were facing litigation costs of up to $190bn related to the cancer complaints. They said that amount of money posed a severe threat to the company’s finances. But after a hearing in February, the bankruptcy judge on the case denied the talc claimants’ motion to dismiss. He said that they hadn’t proven that J&J had acted in, quote, “bad faith”, unquote, by placing LTL into bankruptcy.

Jamie Smyth
He stated in the ruling that the bankruptcy court is the optimal venue for redressing the harms of both present and future talc claimants. He said it would be more efficient to do it this way rather than for J&J and the claimants to go through every single one of these 38,000 cases, which could take an awful long time. But it’s important to note that the legal debate really isn’t over yet.

Michela Tindera
After the decision in February, the talc claimants responded by filing an appeal. So this means that once again, the talc claimants will have the opportunity to try to prove that a bankruptcy court is not the right place to hear these sorts of cases. But still, there are concerns. If this case fails in the appeals court and Johnson & Johnson is allowed to proceed with its bankruptcy, it could establish a road map for more companies to use this Texas two-step manoeuvre.

Earlier this year, Jamie was reporting on the two-step when he picked up on something interesting.

Jamie Smyth
I started to notice that Jones Day kept popping up in these four different cases involving this procedure.

Michela Tindera
Jones Day is one of the largest law firms in the country. And Jamie says that Jones Day is the architect of the Texas two-step.

Jamie Smyth
So when you look through the court documents, it shows that Jones Day has successfully marketed the two-step mechanism to four companies. All of them are facing billions of dollars in asbestos-related personal injury litigation.

Michela Tindera
If you’re not familiar with how big law firms operate, it might sound weird that a law firm would market a specific bankruptcy manoeuvre to potential clients. But corporate bankruptcy expert Jared Ellias says that’s basically these lawyers’ jobs.

Jared Ellias
And so it appears that, you know, Jones Day is at the leading edge of implementing this new Texas two-step strategy, and that’s entirely in line with what their role as attorneys would suggest they should be doing. And the question is: will the courts tell them and their clients that this is wrong? Or are they, you know, pioneering a new way to use the bankruptcy system?

Michela Tindera
Right now, there are just four known examples of corporations that are using the Texas two-step. There’s Johnson & Johnson, but also affiliates of three other manufacturing businesses. There is a part of Georgia-Pacific as well as Trane Technologies and Saint-Gobain. The first company to use the Texas two-step was an affiliate of Georgia-Pacific, which is owned by the massive conglomerate Koch Industries. They first filed for bankruptcy in 2017 with the help of Jones Day. Jamie has reported that it’s been pretty lucrative for Jones Day to advise these companies over the last few years. In fact, records show that Jones Day has claimed more than $70mn in court-approved bankruptcy fees from these four companies.

Jamie Smyth
This is probably just a fraction of what the law firm has earned through this because these fees do not apply to the advisory fees which the company gets paid prior to filing for the bankruptcy.

Michela Tindera
Jones Day has declined to answer questions or comment on its role in the Texas two-step bankruptcy process. However, we did come across a recent recording from a panel that one attorney from Jones Day named Greg Gordon spoke on. He’s a partner at Jones Day’s office in Texas, where he specialises in Chapter 11 restructurings. And he’s worked on these Texas two-step cases for Jones Day. In late April, he spoke at the American Bankruptcy Institute’s annual spring meeting, and he says he’s quite fond of the two-step.

Greg Gordon
I, of course, think that divisional merger is the greatest innovation in the history of bankruptcy.

Michela Tindera
He also says that the J&J case was the worst he’s seen.

Greg Gordon
For many years, I’ve been involved with companies with asbestos liability, and those liabilities are very difficult for companies to deal with because of the thousands of claims they would get every year. And just the inability, frankly, to defend themselves and ended up settling those cases just to save defence costs was literally impossible to litigate the cases. But at least with asbestos, you had a situation where it was recognised that asbestos was a dangerous product.

Michela Tindera
But he says companies that made it known that asbestos was in their products had at least some sort of defence in court. Remember, J&J denies that their product contains asbestos.

Greg Gordon
When J&J came to us, I mean, their situation was far worse from the perspective of both the company and the claimants, because in only about five years they had ramped up from virtually zero cases, and these are cases based on an argument that Johnson’s baby powder causes disease, from literally nothing to they have almost 40,000 cases pending at the time of the filing. And that’s just an unbelievable scenario to me.

Michela Tindera
Greg also tells the panel that this makes it tough for J&J to litigate each and every one of these cases.

Greg Gordon
How do you deal with the fact you’re getting 10,000 more per year, and they’re anticipated to continue for the next 50 years? What do you do about that as a company, no matter how big you are? But then look at it from the standpoint of the claimants. It was awful from their perspective too because it was literally, and this gets reported in the press, but I think it’s true, it was literally like a lottery for the claimants. The large majority of the claimants lost.

Michela Tindera
J&J might be the worst two-step case Greg has seen, but it may not be the last one his firm works on. Jamie says there’s been interest from other companies to try out the two-step. This includes 3M, which is accused of producing defective earplugs for the US military. It’s faced hundreds of thousands of lawsuits, and it’s lost ten out of 16 trials as of this June.

Jamie Smyth
And this could be ripe for a Texas two-step style mechanism to try and help the company with those claims. There’s also Dow Chemical, which faces 9,000 claims tied to cancer.

Michela Tindera
More eyes will be watching how J&J‘s case unfolds. It’s caught the attention of members of Congress. There was a congressional hearing that discussed the two-step in February, and Senator Dick Durbin of Illinois has expressed interest in drafting legislation to reform this process. But then there is at least one person who isn’t paying attention too closely any more: Val.

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Val says that while sometimes friends will send him articles about the bankruptcy case, he hasn’t really kept up with what’s going on.

Val Johnson
I suspect I don’t have a lot longer to live. I keep getting worse and worse. The last three months have been very difficult. But (coughs), but I’m focused. Again, I always come back to the signs of a successful life. I can just still walk, and I can still drive. And I’m loving life and enjoying, you know, you go outside the day here and it’s 60 degrees or something. Our bulbs blossomed this week in our yard, and we have beautiful purple and yellow and white flowers growing in our yard. I came in from my drive, and I saw those in our front yard. I came in and my wife and I told her about the bulbs that were blossoming and I said, that makes me so happy. I’m focused on enjoying the life that I have, and I’m not really following it very much.

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Michela Tindera
When we first put out this episode last June, it seemed like we could be on the precipice of a whole new wave of companies using this Texas two-step style of bankruptcy. But flash forward to this year and a lot’s changed. At the end of the episode, we heard about this back and forth that was happening in the courts over the bankruptcy of Johnson & Johnson subsidiary LTL. The last thing we heard was that claimants were waiting to learn what decision the US Court of Appeals would make. And so in January of this year, after several months of waiting, it turned out that the appeals court decided to dismiss LTL’s bankruptcy, which was a major setback for Johnson & Johnson. It effectively said all those cases like Val Johnson’s back to civil court so they could be heard by juries instead of them all being lumped together in one big bankruptcy case. After that news broke in January, I got the chance to catch up with Val again. Here’s some of what he told me.

Val Johnson
I was super excited because it just seems to me that they shouldn’t be able to use bankruptcy to avoid liability for the product. And on the other hand, I was very — I don’t know what the right word is — but it’s very bothersome that mesothelioma patients don’t typically live long enough to ever go through the legal process. Johnson & Johnson claimed that they want to settle things as quickly and fairly as possible, but the truth is they want to drag it out as long as they can.

Michela Tindera
I asked Val about how this whole experience has made him feel. Is he bitter? Is he angry?

Val Johnson
I don’t want to spend my last days being angry, so I’m not angry. But it bothers me a lot because we have to be very careful with our money. I think my healthcare bills last year approached a half a million dollars, and that’s been very expensive for us. And we aren’t able to do a lot of things that we would rather do, be able to do because we don’t have the money.

Michela Tindera
So now it’s been a few months since that decision was made by the appeals court. So I wanted to check back in with my colleague Jamie Smith, who we heard throughout the episode to hear how this has continued to play out.

Hi, Jamie. Welcome back.

Jamie Smyth
Hi. Thanks for having me.

Michela Tindera
So, Jamie, what is Johnson & Johnson trying to do now? Are they still trying to keep their two-step alive?

Jamie Smyth
So J&J have tried two different strategies to rekindle their Texas two-step. First, they asked the US Court of Appeals to rehear their case, but that was denied, and the judge refused to hear the appeal. Then they tried to go to take this to the Supreme Court. But in the meantime, the bankruptcy judge overseeing the LTL bankruptcy intervened and dismissed the LTL bankruptcy altogether. So then the second thing is that in April, in a really controversial move, which was announced just an hour or so after LTL’s initial bankruptcy was dismissed, J&J filed for bankruptcy on behalf of LTL again. This was the same thing they did in the two-step.

Michela Tindera
So they’re trying to do the two-step again?

Jamie Smyth
Sort of, and they’ve tweaked it this time. So the company, if you remember, it claimed it had the support of a majority of talc claimants for a settlement. Remember we said that during the episode that J&J had set aside about 2bn in a trust for claimants when their LTL subsidiary had filed for bankruptcy. Well now, J&J said that they’re offering about $9bn to settle the claims.

Michela Tindera
Wow. OK. Well, so then what happened after that?

Jamie Smyth
So this dramatic intervention really divided the talc claimants. One group want to take the settlement and another are really bitterly opposed to the legal manoeuvre which has been deployed by J&J. It remains unclear whether this second bankruptcy is legal and is now being challenged in court.

Michela Tindera
So we heard about some other companies that were also trying to do this Texas two-step. And last year it sounded like there could be just this wave of other companies that could have also attempted this manoeuvre. So what happened there with those?

Jamie Smyth
Four other companies that had the Texas two-step process is in the works, it looks like claimants are now launching their own motions to dismiss those. So we’re seeing that with the subsidiary of Koch Industries that we talked about. We also talked about 3M now emboldened by the apparent success of J&J’s LTL unit last year. A 3M subsidiary applied for bankruptcy. But essentially this didn’t work out the way 3M wanted. A judge decided that the parent company would still have to fight the lawsuits in the civil courts rather than the bankruptcy court. There was another company, Dow Chemical, which analysts had suggested could well be a candidate for taking up the two-step. But really that seems unlikely now just because of this J&J ruling.

Michela Tindera
So, Jamie, overall today in May 2023, would you say is the Texas two-step dead or alive?

Jamie Smyth
So I think the Texas two-step really is on life support. You know, there’s a very good chance that it’s going to be killed off completely. And that really depends on the smattering of different appeals in different courts around the country. But crucially, it is also dependent on whether J&J’s second attempt to reach a bankruptcy settlement is successful or it’s drawn out. You know, all in all these recent rulings by the courts do suggest that these types of complex bankruptcy manoeuvres are going to face a lot more scrutiny from judges in the future, and I would predict fewer companies will decide to go this route because really it risks tying them up in lengthy litigation at a time when politicians in the media are much more focused on events taking place in the bankruptcy courts.

Michela Tindera
All right. Well, thanks again, Jamie.

Jamie Smyth
Thank you very much.

Michela Tindera
Behind the Money is hosted by me, Michela Tindera. Saffeya Ahmed is our producer. Topher Forhecz is our executive producer. Sound design and mixing by Sam Giovinco. Special thanks to Jessica Dye. Cheryl Brumley is the global head of audio. Thanks for listening. We’ll be back with a new episode next week. See you then.

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