The Johnson & Johnson “Two-Step” Bankruptcy

This hot new tactic by corporations has been dealt a significant blow.

The “two-step” is when a corporation creates a shell company to offload any balance sheet risk or liabilities. Once the balance liabilities are shifted to the shell, the shell files for Chapter 11 bankruptcy under the Federal Bankruptcy Code.

A major liability for US drug manufacturers is litigation expenses. Specifically, Johnson & Johnson has faced billions in lawsuit damages for the manufacturing of it’s Baby Powder.

A chapter 11 filing does result in a stay of all pending litigation, though attorneys can often get relief from the stay via motion. J & J had agreed to settle the lawsuit after washing it’s liabilities through this shell.

The plaintiffs, however, had different plans. The talcum lawsuit would have been severely curtailed by the two-step, having key legal issues decided through the Bankruptcy court, without the option of rejecting the settlement and seeking trial.

The 3rd Circuit US District Court in Philadelphia has now sided with the plaintiffs who opposed the two-step from the start.

This is great victory for plaintiffs and their counsel that will have lasting effects. Other companies who are currently thinking about this strategy may now reconsider.

Plaintiff lawyer Leigh O’Dell properly points out the US Bankruptcy process is not designed for companies as established as J & J.

In my opinion, had the District Court gone the other way, the result would be absurd, conspicuous liability laundering. Yet it was a close case and the outcome not guaranteed.

In the typical bankruptcy case, the District Court wouldn’t have decided any issues. Thankfully, this was not a typical bankruptcy case, and the Court blocked the absurd maneuvering by J & J.