Legislative Efforts to Curb ‘Texas Two-Step’ Bankruptcies: What Creditors Should Know

The ‘Texas Two-Step’ bankruptcy has become a controversial strategy for corporations facing mass tort liabilities, allowing them to separate assets from liabilities and funnel legal claims into bankruptcy court. This tactic, famously used by Johnson & Johnson, Georgia-Pacific, and other major corporations, has triggered congressional scrutiny and legislative proposals aimed at curbing its use.

For creditors, suppliers, investors, and plaintiffs, these proposed legal changes could dramatically alter how they recover debts and claims from financially distressed companies. Understanding the legislative landscape and its potential impact is crucial for creditors navigating corporate bankruptcy cases.

What Is the ‘Texas Two-Step’ Bankruptcy?

The ‘Texas Two-Step’ is a bankruptcy loophole enabled by Texas corporate law. Here’s how it works:

1. A company uses Texas law to split into two entities—one with valuable assets and another burdened with legal liabilities.
2. The liability-heavy entity (often underfunded) files for Chapter 11 bankruptcy, shielding the parent company from lawsuits.
3. Bankruptcy halts litigation against the new liability-holding entity, delaying or reducing payouts to claimants and creditors.
4. The company proposes a settlement with creditors and plaintiffs through bankruptcy court, often offering far less than what lawsuits might have yielded.

Corporations defend the strategy as a more efficient way to settle mass tort claims, while opponents argue that it abuses bankruptcy law to avoid full accountability.

Recent High-Profile Uses of the ‘Texas Two-Step’

Johnson & Johnson’s Talc Litigation

• J&J deployed the Texas Two-Step in October 2021, shifting thousands of asbestos-related talc lawsuits into a newly formed entity, LTL Management LLC, which then filed for Chapter 11 bankruptcy.
• Courts rejected J&J’s attempt twice, citing bad faith bankruptcy filing and concluding that J&J was not financially distressed.
• J&J’s case highlights the judicial pushback against the strategy and has intensified calls for legislative reform.

Georgia-Pacific & Bestwall LLC

• Georgia-Pacific used the Texas Two-Step in 2017, shifting asbestos claims into Bestwall LLC, which then filed for bankruptcy.
• The case has been tied up in litigation for years, demonstrating how companies use this strategy to delay settlements.

3M’s Aearo Technologies

• 3M attempted to use a similar strategy in 2022, moving earplug-related mass tort claims into Aearo Technologies LLC.
• The bankruptcy court dismissed the case, stating that 3M was financially stable and did not qualify for Chapter 11 protection.

The growing judicial skepticism toward this tactic has fueled calls for legislative action.

Legislative Efforts to Restrict the Texas Two-Step

The Bankruptcy Venue Reform Act

One of the biggest enablers of the Texas Two-Step is venue shopping, where companies file bankruptcy in jurisdictions favorable to corporate debtors. This proposed act aims to:

• Prevent companies from choosing bankruptcy venues based on pro-debtor judges.
• Require cases to be filed in jurisdictions where the company has substantial business operations.
• Reduce forum shopping by corporations seeking lenient rulings.

The SACKLER Act

• Originally designed to prevent Purdue Pharma’s owners from using bankruptcy to escape opioid liability, this law would apply to Texas Two-Step cases as well.
• It would bar non-debtor entities (such as parent companies) from benefiting from bankruptcy protections unless they also file for bankruptcy.
• If enacted, this would prevent solvent parent companies from offloading liabilities while keeping assets intact.

The Non-Debtor Release Prohibition Act

• Targets third-party releases, which allow corporate executives and parent companies to avoid liability while settling through bankruptcy.
• Would prevent companies from shielding themselves from lawsuits unless they also declare bankruptcy.
• This bill is a direct response to Johnson & Johnson’s and Purdue Pharma’s cases.

The Bankruptcy Fairness Act

• Designed to tighten eligibility for Chapter 11 protection to prevent corporations from abusing bankruptcy to delay litigation.
• Would increase scrutiny on divisional mergers, ensuring they are not used for bad faith purposes.

Potential Changes to the U.S. Bankruptcy Code

Lawmakers are also considering broader amendments to the Bankruptcy Code, which may include:

• A stricter “good faith” requirement for Chapter 11 filings.
• Limitations on divisional mergers to prevent their use as liability shields.
• Expedited procedures for challenging bad-faith bankruptcies.

If these reforms pass, they could fundamentally change corporate bankruptcy strategy, making the Texas Two-Step much harder to execute.

What These Changes Mean for Creditors

Increased Litigation Leverage for Creditors

• If the Texas Two-Step is restricted, companies may settle claims more quickly instead of delaying through bankruptcy.
• Creditors and tort claimants could recover more without waiting years for court rulings.

Greater Accountability for Parent Companies

• Parent companies would no longer be shielded from liability by offloading claims to shell entities.
• This could result in higher settlements and payments for creditors.

Less Forum Shopping and Fairer Outcomes

• Bankruptcy cases would be heard in appropriate jurisdictions, not just in corporate-friendly courts.
• Creditors could fight for fairer terms in a neutral legal environment.

Stronger Good-Faith Requirements for Bankruptcies

• Corporations will face higher legal hurdles when attempting to use bankruptcy purely as a delay tactic.
• Courts will be less likely to approve suspicious restructurings.

Challenges and Opposition to Legislative Reforms

While creditors and consumer advocates support these legislative efforts, corporate lobbyists and legal experts argue that:

• Restricting Chapter 11 filings could force more companies into liquidation, harming suppliers and creditors.
• The Texas Two-Step creates a structured settlement process rather than chaotic mass litigation.
• The reforms might increase litigation costs for creditors by forcing more lawsuits outside of bankruptcy court.

Business groups are likely to challenge these laws in court, arguing they violate corporate restructuring rights.

How Creditors Should Prepare for These Changes

1. Monitor Legislative Developments
   • Creditors should stay updated on proposed bankruptcy reforms.
   • Engage with trade groups and legal counsel to understand potential risks and opportunities.
2. Evaluate Corporate Credit Risk More Closely
   • If companies can no longer use the Texas Two-Step, mass tort liabilities could lead to faster liquidations.
   • Creditors should assess corporate solvency risk more aggressively.
3. Strengthen Contractual Protections
   • Include stronger bankruptcy clauses in contracts.
   • Ensure agreements do not allow liabilities to be easily offloaded.
4. Advocate for Fairer Bankruptcy Practices
   • Engage in industry lobbying to ensure creditor rights are protected in new laws.
   • Support transparency measures in corporate bankruptcy cases.

Conclusion: A New Era for Corporate Bankruptcy?

Legislative efforts to curb the Texas Two-Step bankruptcy strategy could fundamentally reshape corporate restructuring. If these laws pass, creditors could see faster recoveries, fewer delays, and greater accountability from corporations.

However, legal battles over these reforms are far from over. Creditors should be proactive, monitoring changes and adjusting their strategies to ensure they are positioned to maximize recoveries in the evolving bankruptcy landscape.

Tatman Legal specializes in protecting creditors’ rights in bankruptcy cases. If you need legal guidance on how these changes may impact your claims or corporate debt recovery strategies, contact us today for expert consultation and representation.