Bestwall: The Texas Two-Step Gets Political

Previous Coverage of Mass Torts & Bankruptcy

Last year we published a two-part series at the intersection of mass torts and bankruptcy. Part 1 of that series, which can be accessed here, explored Purdue Pharma and “third-party releases” that were granted in favor of the Sacklers, which owned Purdue. Part 1 also explored what “third-party releases” are, why they are used, and the Supreme Court’s decision to review the case. In December 2023, we also published our analysis of the Supreme Court’s recent consideration of the whether third-party releases are authorized under the Bankruptcy Code. That report can be found here.

By contrast, Part 2 of our series, which can be accessed here, explored a series of other pending mass-tort bankruptcy cases. Those cases included Georgia Pacific’s attempt to address its asbestos exposure through the bankruptcy of Bestwall LLC; Johnson & Johnson’s attempt to address its talc exposure through the bankruptcy of LTL Management; and 3M’s attempt to address its earplug exposure with the bankruptcy of Aearo Technologies. Part 2 also explored the so-called “Texas Two Step” divisional merger strategy that many companies have used to separate good assets from bad liabilities in an effort to protect overall equity and enterprise value. We encourage our readers to review Parts 1 and 2 for general background information on mass torts and bankruptcy.

This note discusses Bestwall and recent filings made in the U.S. Supreme Court (the “Supreme Court”).

History of Bestwall & The Texas Two Step

As discussed in Part 2 of our primer, Georgia Pacific, a well-known American company that makes tissue, pulp, packaging and building products, was founded in 1927 under the name of Georgia Hardwood Lumber Company, Inc. In 1965, the company (“Old GP”) merged with a company called Bestwall Gypsum Company (“BGC”), which manufactured asbestos-containing products like wallboard and compounds. After the BGC acquisition, Old GP continued to manufacture and sell asbestos-related products, but ceased to do so in the late 1970s after it was bombarded with asbestos-related personal injury lawsuits.

Fast-forward to the present: Old GP – now a subsidiary of Koch Industries – decided to do something to manage pending asbestos claims, which numbered over 64,000. Old GP therefore underwent a corporate restructuring transaction in July 2017 that involved a so-called “divisional merger” under Texas law. The divisional merger split Old GP into two companies: (1) Georgia-Pacific LLC (“New GP”) and (2) Bestwall LLC (the “Bestwall”). Old GP’s assets and liabilities were then split between Bestwall and New GP, with Bestwall receiving Old GP’s asbestos liabilities and certain assets, and New GP receiving none of the asbestos liabilities and the remaining assets.

The idea was to place Bestwall into bankruptcy and keep New GP out of bankruptcy with the goal of managing the asbestos exposure through the bankruptcy process on an expedited timeframe. This would protect equity value and remove the asbestos litigation from the tort system, which involves litigation on a case-by-case basis with unpredictable outcomes and exorbitant costs. Bestwall would then seek to use the bankruptcy process to channel asbestos-related claims to Bestwall and away from New GP by (1) seeking to halt litigation against New GP through the Bestwall bankruptcy proceeding and (2) obtaining a third-party release—much like the Sacklers obtained in Purdue—for claims against New GP. This is process, coupled with the divisional merger, is known as the “Texas Two-Step.”

Bestwall and New GP then entered into a funding agreement that required New GP to provide Bestwall with funding to establish an asbestos settlement trust in a future bankruptcy case to the extent that Bestwall’s assets were otherwise insufficient to pay asbestos claims in bankruptcy. The funding agreement was designed to give asbestos creditors of Old GP a source of recovery (i.e., so creditors are not financially harmed by the maneuver) because their legal claims were (at least as a technical matter) now properly assertable against Bestwall and not Old GP. The following illustrates the July 2017 transaction:

Bestwall Filed for Bankruptcy & Litigation Ensued

Bestwall filed for chapter 11 in the U.S. Bankruptcy Court for the Western District of North Carolina (the “N.C. Bankruptcy Court”) shortly after completing the divisional merger described above. In addition to the 64,000 asbestos-related claims pending against Bestwall, tens of thousands of additional claims were anticipated over the coming decades. The primary purpose of the bankruptcy was to “channel” the asbestos claims to an asbestos settlement trust created pursuant to section 524(g) of the Bankruptcy Code, with New GP acting as a funding source for that trust under the funding agreement. It made sense, then, that one of the first actions taken in the bankruptcy was to seek an injunction halting litigation against Bestwall’s affiliates, including New GP and Koch Industries.

After a series of consensual agreements to stay pending litigation, the Bankruptcy Court entered a preliminary injunction on July 29, 2019, and enjoined the litigation against Bestwall and its affiliates (including Georgia Pacific and Koch). In January 2022, the U.S. District Court for the Western District of North Carolina affirmed that decision, and in June 2023, the U.S. Court of Appeals for the Fourth Circuit (the “Fourth Circuit”) affirmed in a 2-1 decision. The primary issue on appeal was whether the N.C. Bankruptcy Court had jurisdiction to grant the preliminary injunction, and if so, whether the N.C. Bankruptcy Court appropriately considered the merits of granting the injunction, specifically on the question of whether Bestwall could show that it had a realistic possibility of successfully reorganizing under chapter 11. The majority concluded that the N.C. Bankruptcy Court had jurisdiction and that its granting of a preliminary injunction was appropriate. The dissent, however, argued that the N.C. Bankruptcy Court did not have jurisdiction to enjoin claims against a person that has not filed for bankruptcy, and that the 2017 restructuring transaction was nothing more than attempt to manufacture jurisdiction and a corporate shell game to shelter New GP from asbestos liability without ever filing for bankruptcy.

Several parties petitioned the Fourth Circuit to rehear the case “en banc” (meaning all judges sitting on the Fourth Circuit would hear the case together). They argued that the panel’s ruling undermines the ability of states to protect consumers; that the Fourth Circuit will become a haven for “Texas Two Step” bankruptcy cases; and that New GP should not be protected from litigation because it did not file for bankruptcy. On August 7, 2023, the Fourth Circuit, in an 8-5 vote, denied the petition to rehear the case en banc.

Asbestos Claimants Seek U.S. Supreme Court Review

On December 20, 2023, the Official Committee of Asbestos Claimants (the “Asbestos Committee”) filed a petition for a writ of certiorari seeking review the Fourth Circuit’s June 2023 decision. The Asbestos Committee asks the Supreme Court to grant review on one of the following three legal questions: (1) whether the Texas Two-Step divisional merger strategy employed by Georgia Pacific was presumptively improper because Georgia Pacific manufactured jurisdiction by using the strategy; (2) whether the bankruptcy court had so-called “related-to” jurisdiction over claims against Bestwall’s affiliates (Georgia Pacific and Koch) such that it could enjoin litigation against them; and (3) whether the bankruptcy court has the power under § 105 of the Bankruptcy Code—which otherwise gives bankruptcy judges the power to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title”—to issue the sweeping injunction staying claims against Bestwall’s affiliates (Georgia Pacific and Koch).

In the alternative, the Asbestos Committee asks the Supreme Court to hold its appeal in abeyance pending the Supreme Court’s resolution of the Purdue Pharma case, which also addresses the scope of § 105 of the Bankruptcy Code. In doing so, if the Supreme Court reverses in Purdue Pharma, the court could remand Bestwall back to the Fourth Circuit for reconsideration.

Politicians Weigh In as Amici Parties

On January 22, 2024, two amicus curiae briefs were filed, urging the Supreme Court to grant review and reverse Fourth Circuit. The term “amicus curiae” is Latin for “friends of the court,” which means that the briefs are offered by persons not directly involved in the case, but who possess an interest in the outcome.

The first brief was filed by over twenty state attorneys general (AGs) who argue that the “Texas Two-Step” hampers the states’ ability to safeguard consumers by enabling solvent companies to limit their liability in tort cases. This maneuver, the AGs argue, not only curtails the states’ regulatory authority over corporate misconduct but is also infringes upon their sovereign powers to enforce applicable state laws against wrongdoers.

The second brief was filed by a bipartisan group of U.S. Senators—namely, Sen. Durbin of Illinois (D), Sen. Whitehouse of Rhode Island (D), and Sen. Hawley of Missouri (R). The Senators argue that a growing number of wealthy corporations are using the bankruptcy system to “exempt themselves from mass-tort litigation.” They maintain that bankruptcy courts were never empowered by Congress to halt lawsuits against non-debtor affiliates and lack both jurisdiction and legislative backing to do so. The Senators denounce the Texas Two-Step as a blatant manipulation of bankruptcy law.

Thoughts & Takeaways

Although Bestwall may not attract the same level of media coverage as high-profile bankruptcy cases like Purdue Pharma or LTL Management (a subsidiary of Johnson & Johnson), Bestwall is critically important in the world of mass torts. It stands as the pioneer of the “Texas Two-Step” strategy, and it established clear precedent for other companies to follow. This strategy was notably emulated by Johnson & Johnson in its attempt to manage its talc exposure through the bankruptcy of LTL Management, and similarly by 3M to address liabilities from its earplug products through Aearo Technologies’ bankruptcy. Furthermore, according to a recent report by Bloomberg, Johnson & Johnson is considering commencing a third bankruptcy proceeding for its subsidiary, LTL Management. This suggests that the Texas Two-Step continues to have ardent followers.

Nonetheless, the enduring viability of the Texas Two-Step is shrouded in uncertainty and controversy, as evidenced by the recent filings of numerous political actors. There is also no shortage of interest within the academic community. In the end, though, we believe that the Supreme Court’s anticipated ruling on third-party releases in the Purdue Pharma case, which is expected by June 2024, is poised to be a pivotal moment in determining its fate. Our previous commentary has expressed skepticism over whether third-party releases—which is an essential component of the Texas Two-Step strategy—will survive at the Supreme Court. This suggests, perhaps, that the Texas Two-Step may be on borrowed time. But at this point it is too early to speculate on how the Supreme Court will dispense with the Asbestos Committee’s petition because the deadline to file responsive briefs is not until March 22, 2024. What is less speculative, though, is our prediction that 2024 will be a defining year in determining whether chapter 11 can be a viable strategy for solvent companies to manage their mass tort exposure outside of the tort system while protecting equity value at the same time.

 

Mark Lightner, Esq.
Head of Special Situations Legal Research

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