David Skeel, S. Samuel Arsht Professor of Corporate Law at the University of Pennsylvania Carey Law School, recently testified at a hearing of the U.S. Senate Judiciary Committee’s Subcommittee on Federal Courts, Oversight, Agency Action, and Federal Rights, “Abusing Chapter 11: Corporate Efforts to Side-Step Accountability Through Bankruptcy.”
The following is an excerpt from Skeel’s written testimony:
The issue we’re focusing on today — the potential abuse of so-called Texas Two-Step transactions and other divisive mergers — is one of the principal reasons for a growing backlash against perceived abuses in the Chapter 11 reorganization process….
The term “divisive” or “divisional” merger is an oxymoron. A merger ordinarily combines two firms, with one or the other emerging as the “surviving” firm. In a divisive merger, by contrast, a firm tears itself asunder, separating its assets and/or liabilities into two entities. In the controversial recent Johnson & Johnson divisive merger, for instance, Johnson & Johnson put its talc liabilities into a new entity called LTL. Shortly after this transaction, LTL filed for bankruptcy, seeking to resolve the talc liability in bankruptcy. This strategy — effecting a divisional merger under the Texas statute and then putting the new entity in bankruptcy, has become known as the “Texas Two-Step.”
Texas Two-Step transactions are part of a larger pattern of transferring assets or liabilities from one corporate entity to another in a way that potentially disadvantages creditors of the original entity. In Johnson & Johnson’s case, talc claimants were shunted off to a separate entity with essentially no assets of its own. The new entity, LTL, is the passive recipient of funds from Johnson & Johnson and the entity that retained the assets (now called Johnson & Johnson Consumer Inc., or New JJCI) as expenses are incurred or victims obtain judgments. Texas’s divisive merger statute was not created with bankruptcy in mind. Texas lawmakers introduced it in 1989, hoping to add flexibility to corporate transactions. Its potential use to shift liabilities to a separate entity and then address those liabilities in bankruptcy seems to have been discovered roughly five years ago by companies with mass tort liability. The opportunity for abuse — and for undercutting the rights of victims and other creditors — is obvious….
Skeel is the author of True Paradox: How Christianity Makes Sense of Our Complex World (InterVarsity, 2014); The New Financial Deal: Understanding the Dodd-Frank Act and Its (Unintended) Consequences (Wiley, 2011); Icarus in the Boardroom (Oxford, 2005); Debt’s Dominion: A History of Bankruptcy Law in America (Princeton, 2001); and numerous articles on bankruptcy, corporate law, financial regulation, Christianity and law, and other topics.
He has also written commentaries for the New York Times, Wall Street Journal, Books & Culture, The Weekly Standard, and other publications. He has received the Harvey Levin award three times for outstanding teaching, as selected by a vote of the graduating class, the Robert A. Gorman award for excellence in upper-level course teaching, and the University’s Lindback Award for distinguished teaching.