Designing Designer Bankruptcy

Today’s mass torts are headed to bankruptcy. Be it Purdue Pharma’s opioids, USA Gymnastics’ sexual abuse, PG&E’s wildfires, or Johnson & Johnson’s talc, mass-tort defendants have determined that bankruptcy—not class actions, multidistrict litigation, private claims resolution, or one-off state suits—is the way to manage their mass-tort liability.

But today’s mass-tort bankruptcy is not the mass-tort bankruptcy of yesteryear when the whole business filed for bankruptcy. Instead, these modern mass-tort bankruptcies are designer bankruptcies, where the defendant uses its corporate structure to choose which assets and which liabilities enter bankruptcy.

Take today’s marquee example, Johnson & Johnson. Facing tens of thousands of tort suits alleging that its talc caused cancer, Johnson & Johnson put those tort liabilities into a separate limited liability company and had that company file for bankruptcy. Meanwhile, the remainder of Johnson & Johnson, including the division responsible for producing talc, continued to operate normally, staying outside of bankruptcy.

My article takes stock of those designer bankruptcies. It begins by tracing their evolution from the original Manville Model, which emerged from asbestos litigation in the 1980s, to the contemporary Texas Two-Step, made famous by Johnson & Johnson. The article then situates these designer bankruptcies in a new theoretical framework, one drawn from organizational law, to understand the promise of designer bankruptcy (for tort victims and businesses alike) and the dangers to tort victims of being shortchanged by those designer bankruptcies. My article then translates that framework into recommendations for Congress, and for courts, to better design these designer bankruptcies to capture the value of sound design while protecting tort victims.

What the article reveals is a shift in design. Older designer bankruptcies focused on advanced planning to bankruptcy-proof an entity, create withdrawal rights from a bankruptcy, or minimize liability. Today’s design focuses on after-the-fact design, not advanced planning. And today’s design aims to put certain liabilities in bankruptcy rather than shield certain assets from it.

That shift in design also militates for a shift in our understanding of mass-tort bankruptcy. Indeed, the critical insight into these designer bankruptcies is that they are not primarily about bankruptcy law.

Rather, these designer bankruptcies are about organizational law—asset partitioning, regulatory partitioning, and governance across legal entities. Bankruptcy just happens to be a convenient, and perhaps the only, body of law to achieve the needed organizational law maneuvers.

In turn, understanding designer bankruptcy as primarily an exercise in organizational law sheds light on the benefits and perils of such bankruptcies. That understanding reveals the potential for designer bankruptcy to yield benefits to tort victims (in the form of higher payouts). It also reveals the perils of allowing defendants to maintain governance rights in such a bankruptcy (which risks fraudulent transfers that decrease victim payouts). More concretely, recognizing the benefits and perils of designer bankruptcy offers a way to better design such designer bankruptcies, harnessing the benefits and avoiding the perils. That translates into concrete recommendations for both legislators, as the ideal changes are statutory, and judges, who face such designer bankruptcies in their courtrooms.

A copy of the author’s full article is available here.

Michael Francus is an Associate Professor of Law at Notre Dame Law School.