ANALYSIS: Three mass bankruptcy maneuvers to watch in 2023

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Mass Chapter 11 bankruptcy cases have attracted considerable attention in recent years. High profile cases like LTL management, Aeroro Technologiesand Purdue Pharma have resulted in appeals at the federal circuit level that promise to shape the legal landscape for mass tort bankruptcy cases in the next year and beyond.

Through Chapter 11, companies facing mass crimes seek to centralize claims, achieve efficiency and finality, and avoid the unpredictability of litigation. Debtor strategies often involve providing non-debtor third parties with some level of protection in bankruptcy court. Three debtor strategies to watch in 2023 are the Texas Two-Step, the extension of automatic bankruptcy stays to third parties, and non-consensual releases of non-debtors.

Tort victims complain that these strategies bypass lawsuits, unfairly impose settlements on unwilling parties, and allow solvent businesses to obtain bankruptcy benefits without the charges.

Three key upcoming decisions will refine the law on these strategies in 2023.

Texas in two stages

The much-maligned Texas Two-Step—a divisive merger followed by bankruptcy—is one of the new mass tort bankruptcy strategies.

Under the Texas Business Organizations Code, an existing company can split into two or more entities. One entity retains the assets and business while the other assumes the liabilities and files for bankruptcy. The entity holding the assets usually funds the liable entity’s bankruptcy and a trust for tort claims.

Johnson & Johnson and a subsidiary followed this strategy in the LTL management case to face a massive lawsuit over J&J’s talc products. As part of the divisive merger, J&J and one of its subsidiaries are subject to a financing agreement regarding LTL Management’s bankruptcy and potential talc-related liabilities.

The LTL Management case is now pending in New Jersey District Bankruptcy Court as the Third Circuit considers the bankruptcy court’s denial of motions to dismiss the case for being filed in bad faith.

To ohactual argument, a committee representing the talc plaintiffs pointed out that the case was designed to provide bankruptcy benefits to non-debtors without the charges, while the debtor argued that the financing agreement offered protection and a better chance to the plaintiffs to recover their claims than the tort system. The panel was more inclined to the debtor’s arguments. A favorable decision may invite others to follow the same strategy, but the structure of the funding agreement may be essential for such cases to survive scrutiny.

Extension of automatic suspension to third parties

Affiliates of the debtor who have not filed for bankruptcy are generally not covered by the Bankruptcy Code automatic stay. But some courts have extended the automatic suspension to third parties.

In Chapter 11 mass tort cases, this step relieves third parties of litigation until the debtor can obtain a comprehensive settlement with releases that will cover third parties through a plan of reorganization. This strategy is also used in Texas-Two Step cases to protect the companies funding the bankrupt entity.

This question is at the forefront of the aearo case. Aearo and its affiliates are subsidiaries of 3Mwho have all been embroiled in gigantic multi-district litigation over earplugs used by the military who have been accused of causing hearing loss.

Alleging that the MDL process is broken, Aearo and its affiliates filed Chapter 11 with the Southern District of Indiana bankruptcy court, along with a proceeding to extend the automatic stay to 3M.

Bankruptcy Judge Jeffrey Graham declined to extend 3M’s automatic stay. Graham noted that the Seventh Circuit’s extended stay law was not as accommodating as the Fourth Circuit Legal Standard, which the debtor wanted the court to follow. Another notable factor was that 3M’s obligation to fund Aearo’s bankruptcy was not contingent on obtaining automatic stay protection.

The Seventh Circuit accepted a direct call of the decision of the bankruptcy court. A ruling in favor of 3M could make Seventh Circuit bankruptcy sites more attractive for mass liability cases. Alternatively, the panel could make it more difficult for third parties to benefit from automatic suspension.

This will be an important case to watch as this strategy is critical to the success of the other two strategies mentioned here. A decision likely won’t be made until at least the middle of 2023.

Non-consensual releases from non-debtors

Chapter 11 plans sometimes include provisions releasing non-debtor third parties from liability associated with the debtor. The federal circuits are currently split on whether nonconsensual releases of nondebtors can be approved, with the majority of circuits allowing them.

The legality of the non-debtors’ non-consensual releases is currently on appeal to the Second Circuit of the Purdue Pharma case. The court is reviewing the US District Court for the Southern District of New York’s ruling that the bankruptcy court did not have statutory authority to approve such releases in Purdue Pharma’s plan.

During the appeal arguments, the judges seemed open to the debtor’s arguments – including that there was overwhelming support for the plan and that its cancellation would result in little chance of recovery for the plaintiffs – and a little more skeptical of the others. arguments.

A decision could state more clearly approval standard non-consensual releases of non-debtors in the circuit. But a patchwork of standards across the circuits will remain unless the U.S. Supreme Court intervenes. A High Court showdown could be coming for Purdue Pharma.

Will Congress sink these strategies?

Previous legislative efforts in Congress have targeted these three strategies, but none of the efforts have gained momentum. With the realities of a divided government, Congress is unlikely to be able to rein in these maneuvers.

Instead, the parties will continue to argue these issues and the law will continue to evolve on a case-by-case basis. Since these cases often involve constitutional issues and circuit divisions, one or more of these issues may land in the Supreme Court.

Access additional analysis from our Bloomberg Law 2023 series here, covering trends in litigation, transactional, ESG and employment, technology and the future of the legal industry.

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