Companies stuffed lawsuits into a shell company and declared it bankrupt to freeze the cases

A large company facing thousands of injury claims found a way to borrow someone else's bankruptcy. It would split off a new shell company, stuff that shell with all the lawsuits, push it into financial distress on purpose, and then file that shell for bankruptcy.

Bankruptcy then did the heavy lifting. Filing triggers an automatic stay, a federal freeze that stops lawsuits in their tracks, and the company would ask for a channeling injunction, a court order that steers all the claims into the bankrupt shell and extends legal protection to the parent company that helps pay for the deal.

That is the maneuver lawyers call the Texas two-step, and Johnson and Johnson has tried it three times in its long running talcum powder litigation to shield the parent company, according to Christopher Seeger, a founding partner of the plaintiffs firm Seeger Weiss who was recently appointed lead negotiation counsel for plaintiffs in that case. All three attempts have failed.

Seeger was involved in a similar fight in litigation over 3M combat earplugs, where a subsidiary called Arrow was put into bankruptcy. Seeger says "we got the bankruptcy dismissed because it was a little bit too cute," calling it "really a bastardization of what the code was intended for, which is to protect debtors who are in trouble or insolvent."

Seeger says he thinks the two-step is dead, except in one narrow situation where a company is truthful about what it is doing and negotiates the bankruptcy payout plan with plaintiffs lawyers before it files. In that case, he says, a company that truly needs bankruptcy for finality and peace, for example to resolve future claims, could do it in good faith and together with the lawyers bringing the cases.

He once did that with Sheila Birnbaum, a prominent defense lawyer who recently retired, whose client had little except insurance policies. They jointly negotiated the bankruptcy plan so the filing helped get the insurers to pay claimants.

The main problem for plaintiffs is how bankruptcy values claims. In a regular federal trial court, a judge can examine cases one by one, hear motions, and weigh medical records. Bankruptcy has no such tool. It uses a process called estimation, in which claims are lumped together and an expert declares they are collectively worth some number, without studying what made each person sick and what each claim is truly worth.