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The Texas two-step shields parents
How the two-step works
The entity is put into financial distress on purpose. Once it files, the automatic stay and the channeling injunction take over, and the injunction gives a release to the non-debtors who help fund the plan. The parent gets complete protection. In the asbestos world this was pretty common.
Where courts stopped it
Johnson & Johnson has attempted it three times in the talc litigation and failed all three. In the 3M Combat Arms litigation, 3M tried to put Aearo into bankruptcy, and the court dismissed it because loading a subdivision or a new entity with liabilities was too cute. Bankruptcy is meant to protect debtors who are in trouble or insolvent, not to serve as a shield for a solvent parent.
Bankruptcy is also a poor place for an injured person. Claims get grouped together under a process called estimation, and an expert comes in to say all of those claims are worth the same amount. Federal courts can look at each claim and rule on motions in individual cases.
The version that survives
The two-step now looks dead, except where the debtor is truthful and pre-negotiates the plan of reorganization before filing. That happened once with a defense lawyer named Sheila Birnbaum, whose client had little by way of assets other than insurance policies. The plaintiffs' lawyers negotiated the plan with her, the client went into bankruptcy, and the process helped get the insurers to pay claimants.
How does a channeling injunction protect companies?
Section 524(g) of the Bankruptcy Code, added by Congress in 1994, lets a company facing asbestos claims set up a trust to pay current and future claimants. A channeling injunction then directs every such claim to the trust and bars suits against the company and certain related parties. The statute requires approval from 75 percent of the asbestos claimants who vote on the plan. The provision was written for asbestos, and courts have debated how far similar protection reaches in other mass torts.
Why did Texas law enable the two-step?
Texas allows a company to divide itself into two new companies through a divisional merger, after which the original company ceases to exist. The law lets the company assign assets to one new entity and liabilities to the other. Companies have used that division to place injury claims in one entity that could then file for bankruptcy. The Texas Business Organizations Code governs the process, and a few other states have similar statutes.
Why did the Supreme Court limit third-party releases?
In Harrington v. Purdue Pharma, decided in 2024, the Supreme Court ruled five to four that the Bankruptcy Code does not authorize releases that shield non-debtors from claims without the claimants' consent. The case involved a plan that would have protected the owners of a bankrupt drug maker. The ruling did not address consensual releases or the asbestos-specific provision in Section 524(g).
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