Time to Ditch the Texas Two-Step for a New Mass Tort Strategy

The so-called Texas Two-Step bankruptcy cases, which used corporate restructuring of solvent companies followed by a bankruptcy filing to stall mass tort liability, have failed. The list of failed attempts includes Best Wall, DBMP, Aldrich Pump/Murray Boiler, and most recently, LTL.

None of these companies have obtained a confirmed Chapter 11 plan of reorganization providing the desired relief: a channeling injunction covering current and future claims against the debtor and its affiliates. The failure has been spectacular and the coverage, including from the US Senate, extremely heated.

The Texas Two-Step has polluted the dialogue about the legitimate interest of a public company in obtaining “finality” with respect to both current and future claims, and plaintiffs’ legitimate interest to have their claims determined or settled in the tort system and paid in full.

The Two-Step

The first step involves separating current and future mass tort liabilities from the company’s operating assets. This is legitimate, provided the entity with the tort liabilities is fully capitalized and thus is able to meet its obligations in the tort system.

But the second step—immediately putting the liable entity into bankruptcy—is a disaster. Why did these companies take the second step? The answer is two-fold.

First, the companies believed they would gain bargaining leverage by shutting down the tort system to obtain a final resolution with current and future claims at a price that otherwise might not be available. Second, and more importantly, bankruptcy offered the prospect of channeling future claims to a bankruptcy trust, thereby achieving finality by shielding the companies from future liabilities.

But there’s a highly effective—indeed superior—alternative to the second step that makes bankruptcy completely unnecessary.

Viable Alternative

Instead of having the structurally optimized entity—the entity with the liabilities—declare bankruptcy, this adequately capitalized and solvent optimized entity should be disaffiliated completely in a sale to an unrelated third party. As part of the disaffiliation, the outside auditors for the companies at issue must conclude that the optimized entities are funded adequately.

For the parent company and its shareholders, all current and future liabilities would be off the books—providing the much-desired “finality”—and given a clean slate, with the burden of the non-cash charge removed from the parent company’s financials. The capital markets would breathe a huge sigh of relief.

Plaintiffs’ claims would proceed in the tort system against the optimized, disaffiliated, entities where they would benefit from liquidation and payment of their claims all in the normal ordinary course of litigation. It’s a win-win.

The viability and integrity of this approach is proven. Entities such as Morse TEC and Intelco, former affiliates of larger public corporations, stand as testament to the efficacy and fairness of this strategy: structural optimization (step 1) followed by disaffiliation (step 2). The approach works for an array of current and future mass tort liabilities, from asbestos and per- and polyfluoroalkyl substances (PFAS) to talc and herbicides.

What’s Next?

Solvent public companies that have a substantial mass tort problem want and deserve finality, which requires removal of the specter of future claims.

Structural optimization and disaffiliation of the liable entities—with the outside auditors signing off on the removal of the contingent liability—is the right answer for everyone, including the capital markets, the claimants, boards of directors, and management teams. It’s time to change the narrative around solvent company mass tort, a narrative that was unnecessarily polluted by the Texas Two-Step.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

James Conlan is CEO of Legacy Liability Solutions. He spent 32 years at Sidley Austin, where he was chairman of the firmwide restructuring practice and a member of the firm’s executive committee.