Abusing Chapter 11: Corporate Efforts to Side-Step Accountability Through Bankruptcy (U.S. Senate Committee on the Judiciary, Subcommittee on Federal Courts, Oversight, Agency Action, and Federal Rights)

Hearing	Abusing Chapter 11: Corporate Efforts to Side-Step Accountability Through Bankruptcy
Committee	U.S. Senate Committee on the Judiciary, Subcommittee on Federal Courts, Oversight, Agency Action, and Federal Rights
Date	February 8, 2022

 

Hearing Takeaways:

• Divisive Merger Bankruptcies: The hearing focused on divisive merger bankruptcies, which are a multi-step strategy that allow for companies to offload their liabilities. The divisive merger bankruptcy strategy first involves a company engaging in a divisive merger, which is when a company splits their assets into separate entities. The company typically keeps their assets in one of the new entities and puts their liabilities in another of the new entities. The entity containing the assets is able to operate without the burden of the previous liabilities. Meanwhile, the entity holding the liabilities files for bankruptcy protection, which delays the ability of creditors to make claims against the liabilities. The entity holding the assets is protected during the bankruptcy process as a third-party.
  • Views of Critics of Divisive Merger Bankruptcies: Subcommittee Democrats, Ms. Fitzgerald, Mr. Skeel, Ms. Naranjo, and Mr. Maclay argued that companies employed the divisive merger bankruptcy strategy to unfairly reduce their liabilities and escape accountability for their wrongdoings. They stated that these companies that shed their liabilities through divisive mergers will be insulated from claims during the bankruptcy process, as they have transformed themselves into third-party entities for the purpose of the bankruptcy. They criticized this process for denying people of judicial avenues for remedying past wrongdoings and alleged that companies took advantage of the protracted nature of the bankruptcy process in order to obtain more favorable settlements from claimants. They stated that many claimants in divisive merger bankruptcy cases had health and/or financial challenges (often caused by the tortfeasor), which made them very eager to settle their claims promptly.
  • Venue Shopping Concerns: Several Subcommittee Members and the hearing’s witnesses expressed concerns that companies were seeking out favorable courts to make their bankruptcy filings. Mr. Zumbro recommended that Congress consider establishing uniform standards for third-party releases in order to reduce the problem of venue shopping.
  • Ability to Dismiss Abusive Divisive Merger Bankruptcies on Bad Faith Grounds: A key area of discussion during the hearing was the ability of bankruptcy judges to dismiss divisive merger bankruptcy cases that were filed in bad faith. While bad faith is typically grounds to dismiss a bankruptcy case, the witnesses highlighted how different courts across the U.S. were bound by different rulings and precedents on the topic. Mr. Maclay noted that bad faith alone did not constitute sufficient grounds for dismissing a bankruptcy filing in the U.S. Court of Appeals for the Fourth Circuit. He stated that debtors in the U.S. Court of Appeals for the Fourth Circuit just needed to prove that there existed a reasonable likelihood of successful reasonable organization in order to stay the bankruptcy filing.
  • Potential Future Applications of Divisive Merger Bankruptcies: Subcommittee Chairman Sheldon Whitehouse (D-RI) and Mr. Maclay noted how companies had mainly employed divisive merger bankruptcies within the torts context thus far. They raised concerns that companies would eventually expand their use of the practice to rid themselves of other types of creditors, including commercial and contract creditors, warranty claim creditors, and environmental creditors.
  • Views of Defenders of Divisive Merger Bankruptcies: Mr. Zumbro asserted that divisive merger bankruptcy transactions did not involve the sidestepping of accountability for claims against the original company. He remarked that divisional merger transactions were not violations of creditors’ rights laws because of the existence of funding agreements. He explained that funding agreements involved an agreement from the operating company to fund the trust to be established under Section 524(g) of the U.S. Bankruptcy Code to pay out claims. He testified that there existed a funding agreement in each of the divisional merger bankruptcies that had been filed to date. He remarked that divisive merger bankruptcies enabled productive assets and businesses to operate without the “overhang” of the bankruptcy process. He stated that this value inured to the benefit of claim holders through the funding agreement. Mr. Maclay contended however that funding agreements did not constitute a protection against improper conduct in divisive merger bankruptcies and asserted that funding agreements instead contributed to the problems associated with these transactions. He stated that funding agreements did not prevent the non-bankrupt entities from sending their money to other entities and did not prevent subsequent mergers and acquisitions. He further noted how the non-bankrupt entities that control the bankrupt entities holding all of the liabilities after a divisive merger could ultimately decide whether the bankrupt entities would request adherence to the funding agreements.
• Policy Approaches to Address Abusive Divisive Merger Bankruptcies: The hearing focused on two general approaches for addressing abusive divisive merger bankruptcies: prophylactic rules and judicial action.
  • Prophylactic Rules: One way to address abusive divisive merger bankruptcies would be to create a prophylactic rule that prevented companies that had engaged in a divisive merger from filing for bankruptcy protection. Sen. Richard Blumenthal (D-CT) and Mr. Macklay argued that such a blanket prohibition was necessary given the inability of courts to address the strategy. Mr. Skeel and Mr. Zumbro expressed concerns however that a blanket prohibition would unfairly harm companies that engaged in legitimate divisive mergers.
  • U.S. Bankruptcy Process Remedies: Mr. Skeel and Mr. Zumbro contended that bankruptcy courts and bankruptcy judges were better equipped to police abusive divisive merger bankruptcies. They noted how bankruptcy courts could dismiss cases if they were filed in bad faith and how victims and other creditors could challenge a divisive merger for being a fraudulent conveyance.

Hearing Witnesses:

1. The Hon. Judith K. Fitzgerald, Shareholder, Tucker Arensberg, P.C.
2. Mr. David A. Skeel, Jr., S. Samuel Arsht Professor of Corporate Law, University of Pennsylvania Law School
3. Ms. Kimberly Ann Naranjo
4. Mr. Paul H. Zumbro, Cravath, Swaine & Moore LLP
5. Mr. Kevin C. Maclay, Caplin & Drysdale

Member Opening Statements:

Subcommittee Chairman Sheldon Whitehouse (D-RI):

• He discussed how large corporations on solid financial footing were taking advantage of the U.S. bankruptcy process in order to shirk their responsibilities for hurting Americans.
• He noted how corporations with claims against them were transforming into Texas corporate entities and then exploiting a Texas law permitting divisive mergers.
  • He explained that divisive mergers involve splitting the corporation into multiple entities in which one entity is saddled with claims and the second entity takes the company’s assets.
  • He indicated that this strategy was popularly referred to as a “Texas Two-Step” transaction.
• He noted that the company saddled with claims could then file for bankruptcy protection and commented that these companies often sought out favorable jurisdictions that tended to not dismiss bankruptcy filings on bad faith grounds.
  • He identified North Carolina as a favorable jurisdiction given the tendencies of the U.S. Court of Appeals for the Fourth Circuit.
• He stated that the people with claims against the corporations in these instances were left in bankruptcy proceedings that could take years to resolve and could force them to accept a fraction of what they are owed.
  • He explained that the corporate entity holding the corporate assets could continue their normal business without the claims liability.
• He noted that while this bankruptcy strategy was commonly associated with Texas, he indicated that this strategy could also be pursued under Delaware law.
• He stated that Koch Industries originated this strategy and mentioned how the company had employed the strategy to dump the asbestos liabilities of its subsidiaries in 2017.
  • He indicated that the parties with asbestos claims against Koch Industries and its subsidiaries were still having their claims adjudicated through the bankruptcy process.
• He also mentioned how Johnson & Johnson was also pursuing this strategy in order to shed its asbestos liabilities.
• He remarked that this bankruptcy strategy presented four major concerns.
  • He indicated that the first concern was that it violated the fundamental principle of bankruptcy, which held that companies should only receive protection after they have offered up all of their assets to creditors.
  • He indicated that the second concern was that it denied people of judicial avenues for remedying past wrongdoings.
  • He indicated that the third concern was that it encouraged forum shopping, which he asserted undermined the concept of justice.
  • He indicated that the fourth concern was that it mired victims in protracted proceedings that robbed them of precious time.
• He noted that while this strategy had mainly been employed within the asbestos liabilities space, he stated that it could eventually be employed in other contexts.
  • He commented that the spread of this strategy undermined the integrity of other creditor-debtor relationships.

Subcommittee Ranking Member John Kennedy (R-LA):

• He expressed his interest in learning about the hearing’s topic from the witnesses.

Witness Opening Statements:

The Hon. Judith K. Fitzgerald (Tucker Arensberg, P.C.):

• She first stated that it was not improper for the state of Texas to enact a law that authorized a particular form of merger between companies or permitting the division of one company into two or more entities.
  • She commented that the implementation of corporate law and policy was customarily a matter of state law.
• She raised concerns however over how some companies spun off their troublesome liabilities into an entity that subsequently filed for bankruptcy protection.
• She remarked that the bankruptcy process relied upon the good faith of the debtor to undergo a valid reorganization and to maximize the value of their assets so that they could repay their creditors.
  • She also commented that the bankruptcy process relied upon a debtor’s complete disclosure of all of their assets and liabilities.
• She further stated that the bankruptcy process involved both burdens and benefits that were intended to compensate creditors for what the debtor owes 
  • She noted how the debtor in exchange could channel payments to a trust, discharge unpaid claims, and pursue their own endeavors.
• She then discussed how there existed “considerable concern” regarding the bona fides of solvent companies engaging in divisional merger bankruptcies for the sole purpose of sheltering their assets through spinning off their liabilities into a bankrupt entity.
  • She emphasized that the spun-off entity had no business to reorganize and asserted that the purposes of bankruptcy were not well-served in these instances.
• She also noted how the U.S. bankruptcy code did not require the new entity emerging from a divisive merger without liabilities to disclose the assets that it acquired from the divisive merger process.
  • She indicated that only the entity that absorbed all of the liabilities from the divisive merger and filed for bankruptcy protection must make disclosures of its assets and liabilities.
• She remarked that divisional merger bankruptcies enabled a new entity holding all of the liabilities to extend bankruptcy benefits to its entire corporate chain and noted that the nondebtor elements of the corporate chain were not subject to court oversight.
  • She commented that this dynamic enabled the original tortfeasors to avoid accountability for the harms that they caused.
• She then discussed how the tort victims of a company that engaged in a divisional merger bankruptcy process could only pursue recoveries from an entity saddled with liabilities, which would substantially limit their potential recovery amounts.
• She concluded that Congress could find abuse of the U.S. bankruptcy system when the full benefits of bankruptcy protection are granted to a nondebtor, well-capitalized, and solvent company that spins off their liabilities into a new entity for the purpose of shirking responsibility for the liabilities.

Mr. David A. Skeel, Jr. (University of Pennsylvania Law School):

• He remarked the potential abuse of “Texas Two-Step” transactions and other divisive mergers were largely responsible for the growing backlash against perceived abuses of the Chapter 11 bankruptcy reorganization process.
  • He commented that the terms “divisive merger” and “divisional merger” were oxymorons and explained that these mergers divided a firm’s assets and/or liabilities into multiple entities.
• He discussed how companies engaged in divisional merger bankruptcy strategies spun off their liabilities into a new entity that subsequently files for bankruptcy protection.
• He remarked that the divisional merger bankruptcy strategy was designed to turn liable companies into third parties in the bankruptcy process.
  • He explained that this strategy enabled the liable companies to obtain a nondebtor release in the bankruptcy process.
• He discussed how one response to divisional merger bankruptcies was to rely on bankruptcy courts and bankruptcy judges to police abuses.
  • He noted how bankruptcy courts could dismiss cases if they were filed in bad faith and how victims and other creditors could challenge a divisive merger for being a fraudulent conveyance.
• He mentioned how there was currently legislation under consideration in the U.S. House of Representatives that would prohibit companies that engaged in divisive mergers from filing for bankruptcy protection.
  • He indicated that this legislation’s prohibition of divisive mergers applied regardless of whether the mergers were abusive.
• He contended that the U.S. should rely on bankruptcy remedies to address “Texas Two-Step” transactions rather than completely outlaw divisive mergers.
  • He acknowledged that while bankruptcy remedies were “far from perfect,” he asserted that they would sufficiently address abuses of the bankruptcy process.
• He stated however that Congress should be prepared to pass legislation to address divisional merger bankruptcies if bankruptcy courts demonstrated that they were no longer adequate at policing divisive mergers.
• He expressed concerns that any legislation at the present time might have unintended consequences.

Ms. Kimberly Ann Naranjo:

• She mentioned how she had been diagnosed with mesothelioma and noted how exposure to asbestos caused mesothelioma.
  • She testified that she had been exposed to asbestos through Johnson & Johnson’s baby powder product.
• She recounted how she had intended to sue Johnson & Johnson for exposing her to asbestos and stated that such a lawsuit would provide her family with financial relief after she eventually succumbs to mesothelioma.
• She remarked however that Johnson & Johnson’s bankruptcy filing was preventing her from filing a lawsuit against the company for exposing her to asbestos.
• She stated that Johnson & Johnson was able to exploit a “loophole” that allowed them to form a new company that took possession of all of their asbestos-related liabilities.
  • He indicated that this new company then filed for bankruptcy protection, which delayed the asbestos claims filed against Johnson & Johnson.
• She remarked that her experience was not unique and testified that there were “thousands” of other people that had been exposed to asbestos through Johnson & Johnson products that could not pursue legal remedies against the company.

Mr. Paul H. Zumbro (Cravath, Swaine & Moore LLP):

• He remarked that divisional merger bankruptcies constituted an appropriate use of the bankruptcy process.
• He discussed how Delaware and Texas permitted divisional mergers, which involve one entity dividing into two entities.
  • He noted how one of these entities might attempt to address its liabilities through the bankruptcy process and how the other of these entities might attempt to continue operating the business.
• He indicated that while divisional merger bankruptcy transactions did involve two steps, he asserted that these transactions did not involve the sidestepping of accountability or financial responsibility for claims against the original company.
• He noted how it has long been illegal to take actions with the purpose and intent to delay, hinder, or defraud creditors.
  • He mentioned that this language appeared in the U.S. Bankruptcy Code, as well as the laws of all 50 U.S. states.
• He stated that the Delaware and Texas divisional merger statutes did not try to override this longstanding law and noted that both state statutes stipulated that any divisions of assets and liabilities were subject to existing creditors’ rights laws.
• He remarked that divisional merger transactions were not violations of creditors’ rights laws because of the existence of funding agreements.
  • He explained that this funding agreement involved an agreement from the operating company to fund the trust to be established under Section 524(g) of the U.S. Bankruptcy Code to pay out claims.
• He indicated that there existed a funding agreement in each of the divisional merger bankruptcies filed to date.
  • He stated that the funding agreement demonstrates an affirmative acceptance of financial responsibility and access to the value of the company that existed pre-separation.
• He explained that companies engaged in divisional merger transactions prior to filing for bankruptcy protection so that they could make use of U.S. Bankruptcy Code provisions to address mass tort liabilities and to compensate claimants while preserving as much value as possible for all constituents.
• He remarked that these transactions enabled productive assets and businesses to operate without the “overhang” of the bankruptcy process.
  • He elaborated that the bankruptcy process often impacted employee retention and relations and relationships with suppliers and customers.
• He stated that this value inured to the benefit of claim holders through the funding agreement.
• He also discussed how divisional merger transactions enabled companies to use the U.S. Bankruptcy Code to address tort liabilities in a more streamlined and fairer manner.
  • He remarked that claimant trusts have been an accepted method for addressing asbestos claims since 1994.
• He asserted that these trusts were fair and noted that they could only be established if 75 percent of the claimants themselves approve the trusts.
  • He also stated that these trusts were efficient and equitable.
• He expressed his opposition to legislative proposals that would outlaw bankruptcy filings within ten years of a divisional merger transaction.
  • He suggested that Congress instead focus on other bankruptcy topics, such as establishing uniform standards for third-party releases in bankruptcy cases.

Mr. Kevin C. Maclay (Caplin & Drysdale):

• He explained how a “Texas Two-Step” transaction involved a company splitting into two entities in which one entity receives only liabilities from the company and the other entity receives the remainder of the liabilities and assets from the company.
  • He mentioned how these disfavored liabilities included liabilities owed to tort victims.
• He noted how the new entity holding all of the original company’s liabilities then filed for bankruptcy protection in a “Texas Two-Step” transaction in order to delay the ability of tort victims to obtain what they are owed.
  • He indicated however that other creditors of the original company could continue to receive payments in full and on time.
• He highlighted how the new entity that emerged from the divisive merger without the liabilities could continue to operate under the name of the original company, make the same products as the original company, and sell to the same customers as the original company.
  • He also noted how this new entity was immune from lawsuits in the tort system and free from the oversight and transparency requirements of U.S. bankruptcy courts.
• He asserted that divisive merger bankruptcies enabled companies to put themselves “above the law.”
• He then discussed how divisive merger bankruptcies were a new practice and noted how Georgia-Pacific had pioneered the practice in 2017.
  • He mentioned how other companies had subsequently made use of divisive merger bankruptcies, including CertainTeed, Saint-Gobain, Trane Technologies, and Johnson & Johnson.
• He expressed concerns that the wealthiest corporations were using divisive merger bankruptcies in order to avoid paying restitution to the most vulnerable people in the country.
• He remarked that Texas’s divisional merger law was explicitly intended to preserve all rights of creditors under existing laws and asserted that out-of-state companies were misusing the law in order to pervert the federal bankruptcy system.
• He stated that while divisive merger bankruptcies thus far have only been used to disadvantage tort victims, he predicted that this practice would eventually be used by corporations to rid themselves of any unwanted creditors.
  • He suggested that these unwanted creditors could include commercial and contract creditors, warranty claim creditors, and environmental creditors.
• He called on Congress to swiftly act to close the divisive merger bankruptcy “loophole.”
• He then remarked that funding agreements did not constitute a protection against improper conduct in divisive merger bankruptcies and asserted that funding agreements instead contributed to the problems associated with these transactions.
  • He stated that funding agreements did not prevent the non-bankrupt entities from sending their money to other entities and did not prevent subsequent mergers and acquisitions.
• He further noted how the non-bankrupt entities that control the bankrupt entities holding all of the liabilities after a divisive merger could ultimately decide whether the bankrupt entities would request adherence to the funding agreements.
• He lastly stated that current remedies in existence had failed to stop “Texas Two-Step” transactions and called on Congress to address these transactions.

Congressional Question Period:

Subcommittee Chairman Sheldon Whitehouse (D-RI):

• Chairman Whitehouse asked Ms. Fitzgerald to indicate whether the extent of a company’s total responsibilities was known at the time when a company engages in a divisive merger bankruptcy.
  • Ms. Fitzgerald stated that the total extent of a company’s responsibilities was not known when the company engages in a divisive merger bankruptcy. She indicated that only the total number of lawsuits filed against the company and the total number of complaints (both formal and informal) lodged against the company were known at the time of the divisive merger bankruptcy. She discussed how divisive merger bankruptcy cases tended to have “huge numbers” of future demands, which had led Congress to establish Section 524(g) of the U.S. Bankruptcy Code.
• Chairman Whitehouse asked Ms. Fitzgerald to indicate what happened to lawful claims for punitive damages during divisive merger bankruptcies.
  • Ms. Fitzgerald stated that what would happen to lawful claims for punitive damages during a divisive merger bankruptcy would be very case dependent. She discussed how putative damages were generally subordinated to other types of claims in the U.S. Bankruptcy Code. She noted how state laws also played a key role in determining how punitive damages would be treated during bankruptcy proceedings.
• Chairman Whitehouse asked Ms. Fitzgerald to indicate what would happen in the event that the bankrupt entity in a divisive merger’s total injury exceeded the amount of the company’s trust. He asked Ms. Fitzgerald to indicate whether the entity saddled with the liabilities in a divisive merger bankruptcy maintained a continuing claim against the assets of the other entity that spun off its liabilities in the divisive merger for filling in any funding gaps for the trust.
  • Ms. Fitzgerald stated that the relationship between the entities following a divisive merger bankruptcy dictated whether one entity could maintain a continuing claim against the other entity. She noted that while there were assertions that such a continuing claim would exist due to funding agreements between the entities, she highlighted how there generally existed cross-indemnities between the entities that required the entities to reimburse each other for payouts. She commented that the canceling out of these payments undermined the assertion of a continuing claim.
• Chairman Whitehouse asked Ms. Fitzgerald to indicate whether the entity that shed its liabilities as part of a divisive merger was a party in the bankruptcy of the other entity that emerged from the divisive merger.
  • Ms. Fitzgerald stated that the entity that shed its liabilities as part of a divisive merger was usually not a party in the bankruptcy of the other entity that emerged from the divisive merger unless it had co-liability with the debtor. She noted however that the former types of entities tended to have independent liability, which would not be part of the bankruptcy estate.
• Chairman Whitehouse asked Ms. Fitzgerald to indicate whether claimants had rights to continue to pursue discovery and document production against the entity that shed its liabilities through a divisive merger.
  • Ms. Fitzgerald noted that while claimants did have rights to continue to pursue discovery and document production in these cases, she indicated that these rights were stayed during bankruptcy proceedings. She added that these rights could be temporarily or permanently enjoined during the bankruptcy proceedings. She commented that these discovery and document production rights were thus often not accessible to claimants.
• Chairman Whitehouse asked Ms. Fitzgerald to confirm that it was not in the interest of the entity that had shed its liabilities through a divisive merger to turn over its information and documents to the entity that had assumed the liabilities and had filed for bankruptcy protection.
  • Ms. Fitzgerald confirmed Chairman Whitehouse’s description of the situation.
• Chairman Whitehouse asked Mr. Maclay to comment on his exchange with Ms. Fitzgerald.
  • Mr. Macklay remarked that the entity that shed its liabilities through a divisive merger was able to both enjoy bankruptcy protections and control the new entity that assumed its liabilities as part of the divisive merger. He elaborated that the two entities tended to have overlapping officers and directors and asserted that the new entity holding the liabilities was a shell company. He stated that the claimants against a company often could not wait to resolve their claims due to their immediate financial and health needs and contended that divisive merger bankruptcies were merely a legal delay tactic.

Subcommittee Ranking Member John Kennedy (R-LA):

• Ranking Member Kennedy asked Mr. Skeel to indicate whether the bankruptcy judge in a divisive merger bankruptcy case would make a distinction between a divisive merger bankruptcy filed in good faith and a divisive merger bankruptcy filed in bad faith.
  • Mr. Skeel answered affirmatively.
• Ranking Member Kennedy stated that the counsel for the creditors in a bankruptcy filing involving an entity that emerged from a divisive merger would likely attempt to prove that the bankruptcy filing had been made in bad faith. He asked Mr. Skeel to indicate whether bankruptcy judges in these cases would hold hearings to assess how the new entity holding the liabilities had been formed. He also asked Mr. Skeel to indicate whether the pursuit of a divisional merger bankruptcy strategy in order to evade responsibility for a company’s liabilities would constitute an improper bankruptcy filing.
  • Mr. Skeel remarked that a bankruptcy judge could assess whether a divisive merger bankruptcy was filed in good faith, which would determine whether the entity emerging from a divisive merger deserved to receive bankruptcy protections. He stated that the standards for assessing good faith varied across courts. He noted how the U.S. Court of Appeals for the Third Circuit (which was hearing the Johnson & Johnson divisive merger bankruptcy case) would assess whether there existed a valid bankruptcy purpose and whether a bankruptcy was filed in order to gain a tactical advantage for litigation. He indicated that the U.S. Court of Appeals for the Third Circuit would dismiss divisive merger bankruptcy filings if the bankruptcies did not have valid purposes and were filed to gain tactical advantages. He mentioned that the U.S. Court of Appeals for the Third Circuit would be holding a hearing next week to assess the validity of Johnson & Johnson’s divisive merger bankruptcy filing.
• Ranking Member Kennedy remarked that Congress must determine whether it should establish a prophylactic rule to prohibit entities emerging from divisive mergers from filing for bankruptcy or rely upon bankruptcy judges to decide whether the divisive merger that preceded a bankruptcy filing had been made in bad faith.
  • Mr. Zumbro stated that U.S. bankruptcy courts were better positioned than Congress to evaluate the appropriateness of bankruptcy filings. He mentioned how he had recently worked on a divisional merger for a media company that had needed to sell a content library. He questioned the wisdom of precluding the company that bought this content library from filing for bankruptcy protection for a set period of time. He asserted that courts were equipped to determine the appropriateness of bankruptcy filings on a case-by-case basis.
• Ranking Member Kennedy provided Mr. Maclay with an opportunity to respond to the previous comments.
  • Mr. Maclay noted that Mr. Skeel’s previous comments did not apply to the U.S. Court of Appeals for the Fourth Circuit, which was a popular jurisdiction for divisive merger bankruptcy filings. He remarked that bad faith alone did not constitute sufficient grounds for dismissing a bankruptcy filing in the U.S. Court of Appeals for the Fourth Circuit. He stated that debtors in the U.S. Court of Appeals for the Fourth Circuit just needed to prove that there existed a reasonable likelihood of successful reasonable organization in order to stay the bankruptcy filing. He also stated that U.S. courts were bound by bad precedent in terms of their ability to dismiss bankruptcy filings on bad faith grounds. He called for a prophylactic rule in order to address the aforementioned challenges.

Sen. Mazie Hirono (D-HI):

• Sen. Hirono commented that there appeared to exist a “loophole” in the U.S. Court of Appeals for the Fourth Circuit that enabled parties to file for bankruptcy protection in bad faith. She then asked Ms. Fitzgerald to explain why parties could not pursue claims against an entity that had shed its liabilities as part of a divisive merge.
  • Ms. Fitzgerald noted that an entity that emerged from a divisive merger saddled with liabilities could file for bankruptcy protection and receive an automatic stay, which stopped all litigation against the debtor. She mentioned how some courts (including those falling under the U.S. Court of Appeals for the Fourth Circuit) had extended this automatic stay to parties that are not the debtor, including the entity that emerged from a divisive merger that had been able to spin off their liabilities. She stated that this extension of the automatic stay to non-debtor parties had prevented tort victims from pursuing their claims against companies within the corporate chain of the bankrupt entity.
• Sen. Hirono asked Ms. Fitzgerald to explain the justification for providing an automatic stay to non-debtor companies as part of a bankruptcy proceeding.
  • Ms. Fitzgerald explained that the stay was sometimes extended to parties that were co-liable with the debtor because the party and the debtor might share an insurance policy. She elaborated that the non-debtor might need to pay out claims through the shared insurance policy during the debtor’s bankruptcy proceedings and commented that this dynamic would undermine the debtor’s ability to repay their existing claims. She stated that the extension of the automatic stay to the non-debtor party would thus guard against this type of situation. She raised concerns however that the automatic stays were stopping all actions against the non-debtor entities that emerged from divisive merger transactions. She stated that this situation enabled companies like Johnson & Johnson to not face lawsuits for their direct liabilities (which were unrelated to their co-liabilities).
• Sen. Hirono asked Ms. Fitzgerald to indicate whether the automatic stays in bankruptcy filings were the result of judicial actions or laws.
  • Ms. Fitzgerald explained that the stays are extended to parties when a debtor files a motion and/or an adversary proceeding to request such an extension. She noted however that the debtor in the Johnson & Johnson divisive merger bankruptcy case (LTL Management) had notified all of the tort cases in which it was involved before it went to court and requested that the stay apply to both Johnson & Johnson Consumer Inc. and Johnson & Johnson.
• Sen. Hirono commented that LTL Management’s actions were seeking to improperly prevent plaintiffs from pursuing their claims in court. She expressed interest in legislation that would prevent entities that shed their liabilities through divisive mergers from being granted automatic stays.
  •  Ms. Fitzgerald raised concerns that such legislation might have significant unintended consequences.
• Sen. Hirono then asked the witnesses to provide suggestions for preventing abuses of the bankruptcy process so that companies could not evade responsibility for their liabilities. She also asked the witnesses to indicate the safeguards that were in place to prevent companies from preemptively pursuing divisive mergers in order to insulate themselves from future liabilities.
  • Mr. Skeel stated that companies could pursue divisive mergers very quickly, which meant that companies did not need to pursue such mergers in advance.
• Sen. Hirono concluded that Congress needed to take actions to address divisive merger bankruptcies.

Full Committee Chairman Dick Durbin (D-IL):

• Chairman Durbin mentioned how Mr. Zumbro had justified the practice of divisive merger bankruptcies on the basis that it would permit a productive company to operate without the “overhang” of bankruptcy. He further noted that Mr. Zumbro had elaborated that this “overhang” of bankruptcy could impact a company’s employee retention and relations and relationships with suppliers and customers. He speculated however that the primary reason that companies pursued divisive merger bankruptcies was financial in nature. He stated that divisive merger bankruptcies enabled companies to significantly limit their liabilities. He asked Mr. Zumbro to evaluate the legitimacy of Johnson & Johnson’s claim that their divisive merger bankruptcy would actually benefit the 38,000 plaintiffs seeking restitution against the company.
  • Mr. Zumbro discussed how the U.S. bankruptcy process sought to fairly and equitably distribute a debtor’s funds to creditors.
• Chairman Durbin interjected to note that Johnson & Johnson was worth significantly more than the new entity that it created through a divisive merger to hold its asbestos liabilities. He alleged that Johnson & Johnson was attempting to cap the amount of asbestos claims it would pay out through its use of a divisive merger.
  • Mr. Zumbro noted how Johnson & Johnson was a large corporation that engaged in multiple lines of business and was largely owned by pension funds and retail investors. He remarked that the U.S. tort system was broken and stated that the U.S. bankruptcy system allowed for a large number of claims against a company to obtain resolution more efficiently. He called the bankruptcy process a “win-win” for both the company and the victims.
• Chairman Durbin remarked that the U.S. legal system should be focused on justice and not on efficiency. He asserted that Johnson & Johnson was attempting to use the U.S. bankruptcy system to avoid consequences for its bad actions.

Sen. Richard Blumenthal (D-CT):

• Sen. Blumenthal expressed agreement with Full Committee Chairman Dick Durbin’s (D-IL) statement that the purpose of the U.S. legal system was to provide Americans with avenues for justice and recourse when they experience a tort. He then expressed concerns over how companies that engaged in venue shopping when pursuing divisive merger bankruptcies. He acknowledged that while some courts were taking actions to address this problem, he also noted that many companies were relocating their headquarters in order to obtain more favorable forums and judges for their bankruptcy cases. He mentioned his legislation, the Nondebtor Release Prohibition Act of 2021, which sought to address the problem of venue shopping. He asked the witnesses to indicate whether they were concerned about venue shopping and to provide recommendations for addressing the issue.
  • Mr. Maclay remarked that venue shopping was part of a broader problem of corporations planning to disadvantage their victims. He stated that companies that engaged in divisive merger bankruptcy strategies tended to file for bankruptcy in U.S. courts within the U.S. Court of Appeals for the Fourth Circuit’s footprint in order to ensure that their bad faith bankruptcy filings would not be dismissed. He expressed his hope that Congress would address this issue.
• Sen. Blumenthal remarked that the U.S. bankruptcy system contained a set of abstruse and arcane rules that operated separately from the traditional U.S. justice system. He expressed interest in addressing the problem of venue shopping so that U.S. bankruptcy rules would be fairly applied.
  • Mr. Zumbro expressed opposition to the Nondebtor Release Prohibition Act of 2021. He stated that Congress should instead consider adopting more uniform standards for nondebtor releases. He remarked that there existed appropriate circumstances in which victims could recover more than they would have otherwise recovered through nondebtor releases.
  • Ms. Naranjo noted how mesothelioma could take decades to manifest and stated that she wanted to be able to pursue her claims against Johnson & Johnson for exposing her to the disease. She asserted that her ability to pursue her claims against Johnson & Johnson had been taken away from her through legal maneuvering.
  • Mr. Skeel remarked that venue shopping was a problem and cautioned Congress against pursuing prophylactic rules. He stated that courts were working to address venue shopping on their own. He then discussed how an affiliate entity could file a bankruptcy case in a certain venue, which would permit their parent entity to pursue their case in that venue. He called this practice problematic and expressed support for policies that would address this practice. He cautioned against removing the domicile venue option and stated that firms ought to be permitted to file bankruptcy in their state of incorporation.
• Sen. Blumenthal called it problematic that bankruptcy rules could vary heavily across states.
  • Mr. Skeel noted how bankruptcy lawyers were keenly aware of these variations in bankruptcy rules across states and took these variations into account when they made their bankruptcy protection filings.
• Sen. Blumenthal reiterated his support for a national prohibition on nondebtor releases.
  • Mr. Skeel indicated that while he did not support a total prohibition on nondebtor releases, he expressed support for restricting the use of such releases. He noted that nondebtor releases provided the benefits of bankruptcy protection to parties that did not file for bankruptcy. He stated however that bringing some cases into the bankruptcy context was better for all parties.

Subcommittee Chairman Sheldon Whitehouse (D-RI):

• Chairman Whitehouse noted how Ms. Naranjo’s terminal cancer diagnosis provided her limited time to get her affairs in order. He stated however that the protracted nature of the Johnson & Johnson divisive merger bankruptcy was creating uncertainty for Ms. Naranjo during her final years of life. He provided Ms. Naranjo with an opportunity to comment on her current situation.
  • Ms. Naranjo predicted that she will be dead when the Johnson & Johnson divisive merger bankruptcy was fully resolved. She testified that she did not possess either a pension or a 401(k) plan, which meant that her family would experience financial challenges when she died. She remarked that the Johnson & Johnson divisive merger bankruptcy needed to be resolved immediately to ensure that claimants of Johnson & Johnson would receive recourse while they were still alive.
• Chairman Whitehouse called it unfair that Johnson & Johnson and other companies were able to drastically limit their liabilities and shirk their responsibilities through the bankruptcy process.