[Senate Hearing 117-881]
[From the U.S. Government Publishing Office]
S. Hrg. 117-881
ABUSING CHAPTER 11: CORPORATE
EFFORTS TO SIDE-STEP
ACCOUNTABILITY THROUGH BANKRUPTCY
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HEARING
BEFORE THE
SUBCOMMITTEE ON FEDERAL COURTS,
OVERSIGHT, AGENCY ACTION AND
FEDERAL RIGHTS
OF THE
COMMITTEE ON THE JUDICIARY
UNITED STATES SENATE
ONE HUNDRED SEVENTEENTH CONGRESS
SECOND SESSION
__________
FEBRUARY 8, 2022
__________
Serial No. J-117-51
__________
Printed for the use of the Committee on the Judiciary
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
www.judiciary.senate.gov
www.govinfo.gov
__________
U.S. GOVERNMENT PUBLISHING OFFICE
56-422 PDF WASHINGTON : 2025
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COMMITTEE ON THE JUDICIARY
RICHARD J. DURBIN, Illinois, Chair
PATRICK J. LEAHY, Vermont CHARLES E. GRASSLEY, Iowa, Ranking
DIANNE FEINSTEIN, California Member
SHELDON WHITEHOUSE, Rhode Island LINDSEY O. GRAHAM, South Carolina
AMY KLOBUCHAR, Minnesota JOHN CORNYN, Texas
CHRISTOPHER A. COONS, Delaware MICHAEL S. LEE, Utah
RICHARD BLUMENTHAL, Connecticut TED CRUZ, Texas
MAZIE K. HIRONO, Hawaii BEN SASSE, Nebraska
CORY A. BOOKER, New Jersey JOSH HAWLEY, Missouri
ALEX PADILLA, California TOM COTTON, Arkansas
JON OSSOFF, Georgia JOHN KENNEDY, Louisiana
THOM TILLIS, North Carolina
MARSHA BLACKBURN, Tennessee
Joseph Zogby, Chief Counsel and Staff Director
Kolan L. Davis, Republican Chief Counsel and Staff Director
SUBCOMMITTEE ON FEDERAL COURTS, OVERSIGHT,
AGENCY ACTION AND FEDERAL RIGHTS
SHELDON WHITEHOUSE, Rhode Island, Chair
PATRICK J. LEAHY, Vermont JOHN KENNEDY, Louisiana, Ranking
MAZIE K. HIRONO, Hawaii Member
CORY A. BOOKER, New Jersey LINDSEY O. GRAHAM, South Carolina
ALEX PADILLA, California MICHAEL S. LEE, Utah
JON OSSOFF, Georgia TED CRUZ, Texas
BEN SASSE, Nebraska
THOM TILLIS, North Carolina
Annie Owens, Majority Staff Counsel
Nathan Williams, Minority Staff Counsel
C O N T E N T S
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OPENING STATEMENTS
Page
Whitehouse, Hon. Sheldon......................................... 1
Kennedy, Hon. John............................................... 3
WITNESSES
Fitzgerald, Hon. Judith K........................................ 4
Prepared statement........................................... 26
Responses to written questions............................... 74
Maclay, Kevin C.................................................. 10
Prepared statement........................................... 38
Responses to written questions............................... 79
Naranjo, Kimberly Ann............................................ 6
Prepared statement........................................... 56
Skeel, David A. Jr............................................... 5
Prepared statement........................................... 61
Responses to written questions............................... 96
Zumbro, Paul H................................................... 9
Prepared statement........................................... 70
Responses to written questions............................... 99
APPENDIX
Items submitted for the record................................... 25
ABUSING CHAPTER 11: CORPORATE
EFFORTS TO SIDE-STEP
ACCOUNTABILITY THROUGH BANKRUPTCY
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TUESDAY, FEBRUARY 8, 2022
United States Senate,
Subcommittee on Federal Courts, Oversight,
Agency Action, and Federal Rights,
Committee on the Judiciary,
Washington, DC.
The Subcommittee met, pursuant to notice at 3:06 p.m., in
Room 226, Dirksen Senate Office Building, Hon. Sheldon
Whitehouse, Chairman of the Subcommittee, presiding.
Present: Senators Whitehouse [presiding], Hirono, Ossoff,
Kennedy, and Tillis.
Also present: Senators Durbin and Blumenthal.
OPENING STATEMENT OF HON. SHELDON WHITEHOUSE,
A U.S. SENATOR FROM THE STATE OF RHODE ISLAND
Chair Whitehouse. The hearing will come to order. I thank
all of our witnesses for being here. We are in the middle of a
vote sequence over in the Senate, and so you'll see people
appear and disappear, as they have to come from and return for
votes. I thank Senator Kennedy for allowing us to get underway
as he is on his way over here, and I will take the time to do a
little bit of housekeeping, particularly with respect hearing
exhibits. With consent, I will ask for the Reuters article,
``Special Report: Inside J&J's secret plan to cap litigation
payouts to cancer victims'' to be made an exhibit in this
hearing.
I will, with consent, get this Wall Street Journal article
behind me also entered as an exhibit.
I have two constituent letters from John ``Jay'' Erickson,
Jr., of Newport, Rhode Island, whose late wife Geralyn passed
away after a difficult battle against ovarian cancer, and John
Tassone of Narragansett, Rhode Island, who has been diagnosed
with mesothelioma and has undergone a major lung surgery. I
will ask that both of those letters be made a part of the
record of this hearing.
We also have a letter of support from seven bankruptcy
professors submitted to our Subcommittee for this hearing. The
professors are Professors Ellias, Ayotte, Block-Lieb, Dick,
Markell, Rasmussen, and Yadav, and their letter will be made
part of the record.
Finally, there is a brief in the United States Bankruptcy
Court for the District of New Jersey filed by Dean Erwin
Chemerinsky of the University California Berkeley School of
Law, the dean of that school of law, and I will make his amicus
curiae brief a part of the record here.
I'll do some opening remarks. When he gets here, Senator
Kennedy will then provide opening remarks. If Senator Durbin
gets here first, he's the Chairman of the Full Committee and he
may seek to offer some opening remarks. We'll have three rounds
of opening remarks, with any luck, and then I'll introduce the
panel, and you proceed with your testimony. Then we'll go on to
questions. I will be pretty rigorous about the 5-minute rule. I
know you've all put a lot of work into your statements. They
can be made a part of the record so we have the full benefit of
your full statement, but Senators who come to a hearing are
eager to ask questions and engage with the panel, and moving to
that quickly is a good thing for a Chairman to do. I will be a
strict policeman of the 5-minute rule.
We are here to address a novel and rather troubling
circumstance that is emerging in bankruptcy law.
Imagine that a big corporation wreaks serious harm on you
and your family. You sue for damages to cover hospital bills or
to care for a family member. When you do, you discover that
your claim against the company, a company that is out there
operating, apparently thriving, in the marketplace--your claim
is somehow in bankruptcy court that may not be heard for months
or years, and it may never be paid. Sadly, this situation is
not imaginary. The so-called ``Texas Two-Step'' has mired tens
of thousands of claims in bankruptcy proceedings.
It's bankruptcy's aim to grant honest but unfortunate
debtors a fresh start while doing the utmost to make creditors
whole. In recent years, large corporations on solid financial
footing have found a bankruptcy trick to shirk responsibility
for hurting Americans.
Here's how it works. First, a corporation with claims
against it from people that have been harmed transforms into a
Texas corporate entity. Second, that new entity exploits a
Texas law allowing something called a ``divisive merger,''
splitting the corporation into two corporations. Company one is
saddled with the claims; company two takes the corporate
assets.
The company saddled with the claims then files for
bankruptcy, perhaps in North Carolina where the Fourth Circuit
makes it nearly impossible for victims to have the company's
filing dismissed for bad faith. Victims harmed by the
corporation are left in bankruptcy proceedings that can take
years to resolve, condemned to receive only a fraction of what
they're owed.
Meanwhile, the company with the corporate assets continues
business as usual, shed of the claims. That's the Texas Two-
Step. Although, to be fair, the same thing can potentially be
done under Delaware law.
The originator of this move is perhaps the most prolific
industrial polluter in American history, Koch Industries. In
2017, it used the Texas Two-Step to dump its subsidiary's
asbestos liabilities. Victims are still tied up in the
bankruptcy process, as are asbestos claimants in ensuing
copycat cases.
Johnson & Johnson, one of the biggest and richest companies
in the world, last year faced over 38,000 lawsuits alleging
that its talc-based baby powder contained asbestos and caused
ovarian cancer and mesothelioma. Johnson & Johnson followed the
Koch Industries model and hatched a shell company that took on
the talc liability and filed for bankruptcy. Johnson & Johnson
now seeks a stay of all those claims, pending bankruptcy
proceedings.
This move presents four big concerns. First, it violates
the fundamental principle of bankruptcy that a company is
forgiven its debts, but it must offer up all its assets to
creditors. Then it gets a fresh start. The Texas Two-Step
separates the assets from the liabilities in violation of this
basic principle.
Second, it denies people their day in court. The civil jury
has been a bastion of individual rights throughout our history,
allowing people a vital check on the most powerful forces
arrayed against them. The Texas Two-Step denies victims a jury
of their peers, defeating the 7th Amendment in our Bill of
Rights.
Third, it encourages forum shopping. Johnson & Johnson had
no particular reason to file for bankruptcy in North Carolina;
in fact, Johnson & Johnson's Texan liability shell only existed
for 2 days before it filed bankruptcy. Outcomes in court should
not be determined by strategic forum shopping.
Finally, the Texas Two-Step mires victims in protracted
proceedings, robbing them of precious time. Asbestos victims
can die of mesothelioma and other types of cancers before their
claims are heard. That is a blot on our legal system.
So far, this trick has hit asbestos victims, but once the
Two-Step strategy catches on, it could deprive all sorts of
victims of the compensation they're due and undermine the
integrity of other creditor-debtor relationships. Hiding assets
in a bankruptcy is a serious wrong. The Texas Two-Step uses a
trick of corporate law to hide assets in plain view with
courts' connivance.
I thank Senator Kennedy for his bipartisan approach to this
hearing. I hope that we can continue to work in bipartisan
fashion to address this abuse of our bankruptcy process and to
make sure that injured victims get their day in court as our
Constitution entitles them to.
Senator Kennedy, you are recognized for your opening
remarks.
OPENING STATEMENT OF HON. JOHN KENNEDY,
A U.S. SENATOR FROM THE STATE OF LOUISIANA
Senator Kennedy. Mr. Chairman, thank you for calling this
hearing. Thanks to all of our witnesses for being here today. I
look forward to their testimony, and I plan to listen and to
learn. Thank you, Mr. Chairman.
Chair Whitehouse. All right. Let us begin then with Judge
Fitzgerald, a retired United States bankruptcy judge who served
in the Western District of Pennsylvania from 1987 to 2013,
including 5 years as the Chief Judge. While on the bench, she
presided over more asbestos mass tort bankruptcy cases than any
other bankruptcy judge. She's now a shareholder at the
Pittsburgh-based law firm of Tucker Arensberg and a professor
in the practice of law at the University of Pittsburgh School
of Law, where she teaches courses in bankruptcy and advanced
bankruptcy. Your Honor, thank you for being here. Please
proceed with your statement.
STATEMENT OF HON. JUDITH K. FITZGERALD,
SHAREHOLDER, TUCKER ARENSBERG, P.C.,
PITTSBURGH, PENNSYLVANIA
Judge Fitzgerald. Thank you, Chairman Whitehouse, Ranking
Member Kennedy, and all of the Members of the Subcommittee. I
appreciate the opportunity to be here today to testify as you
continue to work on issues related to abuse of bankruptcy and
the impact of divisive mergers, and I appreciate the efforts
that you are putting forth.
I want to begin by noting that I see nothing improper with
the State of Texas enacting a law authorizing a particular form
of merger between companies or permitting the division of one
company into two or more. Implementation of corporate law in
policy customarily is a matter of State law. It is only when
the corporate division separates out all of the troublesome
liabilities into one company, that I refer to as BadCo, and
puts the vast majority of the valuable assets into another
company that I call GoodCo, and then BadCo files bankruptcy but
GoodCo does not, that the problems and possible abuse arise.
I want to emphasize three points today that deal the very
essence of bankruptcy law. They are: first, bankruptcy relies
on the good faith of the debtor to undergo a valid
reorganization and to maximize the value of its assets and pay
back value to creditors; two, bankruptcy relies on the debtor's
complete disclosure of all assets and liabilities; and three,
bankruptcy involves burdens and benefits which are intended to
compensate creditors for what the debtor owes, in exchange for
which the debtor can channel payments to a trust, discharge
unpaid claims, and go about its business.
First, the bankruptcy system relies on the good faith of
debtors and requires that they utilize bankruptcy for valid
reorganizational purposes and to maximize the returns they pay
to their creditors. There is considerable concern today about
the bona fides of solvent companies engaging in the Texas Two-
Step for the sole purpose of sheltering their assets by putting
BadCo into bankruptcy. It's important to note that a BadCo has
no business to reorganize, and it is vested with insufficient
assets to pay liabilities. Thus, the purposes of bankruptcy are
not well served and the good faith of a BadCo bankruptcy is
called into question.
Second, the bankruptcy system relies on full and complete
disclosure so that all transactions take place subject to court
and public scrutiny. Yet there is nothing in the bankruptcy
code that requires GoodCo to disclose the assets it acquired
through the divisive merger. Only BadCo, the debtor that
absorbed the troublesome liabilities with insufficient assets
to pay them, must disclose.
Nonetheless, when BadCo files bankruptcy, it invokes the
full panoply of benefits that it enjoys as a debtor and takes
every effort it can to extend those benefits to its entire
corporate chain and others, even though those non-debtors have
not subjected themselves to court oversight. This enables the
original tortfeasors to avoid accountability for the harms they
cause.
Third, there is another harmful impact, particularly on
tort victims, when, in the bankruptcy process, they are left
with recovering only from BadCo. This harm would not exist but
for the divisive merger because without the merger, if the
original company filed bankruptcy, all of those assets and
liabilities would be within the bankruptcy court's purview.
The only purpose for which a BadCo bankruptcy is filed is
to enable a solvent company allegedly responsible for injuring
thousands of people to avoid litigating and proving its
defenses in courts of law. The original solvent company uses
BadCo as a shield from disclosure and then uses BadCo's
bankruptcy as a sword against tort victims who are denied
billions of dollars in assets that otherwise would be available
to pay valid claims.
A BadCo bankruptcy is not like other mass tort cases where,
for example, the asbestos manufacturer itself goes into
bankruptcy, accepts responsibility, and negotiates a plan to
pay tort victims. BadCo bankruptcies are exactly the opposite.
For example, J&J denies that its talc products were dangerous
and caused thousands of women to develop ovarian cancer and
mesothelioma, yet it formed LTL to act as its shield.
In conclusion, I submit that Congress could find abuse of
the bankruptcy system when the full benefits of bankruptcy are
granted to a nondebtor, well-capitalized, solvent company
which, to avoid responsibility for its harmful conduct,
manufactures BadCo as a new company for the sole purpose of
transferring the troublesome liabilities into it and then hides
behind BadCo when it files bankruptcy.
I thank you for this opportunity.
[The prepared statement of Judge Fitzgerald appears as a
submission for the record.]
Chair Whitehouse. Thank you very much, Judge Fitzgerald. I
appreciate it, and well done on the 5-minutes. I'm grateful to
you.
Our next witness is Professor David Skeel, the Samuel Arsht
Professor of Corporate Law at the University of Pennsylvania
Carey Law School. We will get beyond Pennsylvania with other
witnesses, I promise you. He is the author of numerous articles
on bankruptcy and financial distress, corporate law,
Christianity and law, law and literature, and other topics.
Since August 2016, he has served on the Financial Oversight and
Management Board for Puerto Rico, which he currently chairs.
Professor Skeel.
STATEMENT OF DAVID A. SKEEL, JR.,
S. SAMUEL ARSHT PROFESSOR OF CORPORATE
LAW, UNIVERSITY OF PENNSYLVANIA SCHOOL
OF LAW, PHILADELPHIA, PENNSYLVANIA
Professor Skeel. Thank you very much. Thank you for the
opportunity to testify today in this very, very important
hearing that y'all are holding. It's needless to say a great
honor to appear before you.
The issue that we're focusing on today, the potential abuse
of so-called Texas Two-Step transactions and other divisive
mergers, is, in my view, 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.
Rather than combining firms, divisive merger divides a firm's
assets and/or its liabilities into two entities. In Texas Two-
Step transactions, as in the controversial Johnson & Johnson
case, the liabilities are shunted off into a new entity, and
that new entity then files for bankruptcy. What this strategy
is designed to do is to turn a company like Johnson & Johnson's
consumer products business that would otherwise be liable into
a third party, in a sense, and to obtain a giant third-party
release, or what's sometimes called a non-debtor release.
In a sense, what this is doing is manufacturing an
opportunity for a nondebtor release. The opportunity for abuse
and for undercutting the rights of victims and other creditors
is obvious. One response to this is to rely on bankruptcy
courts and bankruptcy judges to police abuses. Courts can
dismiss a case if it was filed in bad faith and, in fact, a
motion to do that is pending right now in the Johnson & Johnson
transaction. Victims or other creditors can challenge the
divisive merger as a fraudulent conveyance.
Legislation was recently introduced in the House that would
take a much more sweeping approach. The legislation would
essentially bar the doors to bankruptcy for any divisive
merger, whether or not it's abusive. I believe the better
approach is to rely on the bankruptcy remedies rather than
completely outlawing divisive mergers. Although the bankruptcy
remedies are far from perfect, and I talk about some of the
obstacles in my written testimony, in my view, they're adequate
to the task.
I could be wrong about this. Courts may fail to adequately
police divisive mergers. If they do, legislative intervention
can and would be warranted, but at this point, I don't think
legislation is currently warranted, and I worry that any
legislation might have unfortunate unintended consequences. I
guess my conclusion is divisive mergers really do create a
danger of abuse. They should be scrutinized carefully and, in
appropriate cases, kicked out of bankruptcy, but in the first
instance, I would rely on the courts to do that policing. Thank
you.
[The prepared statement of Professor Skeel appears as a
submission for the record.]
Chair Whitehouse. Thank you, Professor. Our next witness is
Ms. Kimberly Naranjo, who comes to us from Sandy, Utah. She is
a mom of seven--bravo--and prior to her mesothelioma diagnosis,
she was a substance use disorder counselor with the Salt Lake
County Sheriff's Department. Ms. Naranjo was also studying for
a bachelor of science in marriage and family studies from
Brigham Young University-Idaho prior to her diagnosis. She is a
plaintiff in a talc lawsuit against Johnson & Johnson, and her
claims have been stayed as part of Johnson & Johnson's
bankruptcy filing. Ms. Naranjo, I'm very grateful that you took
the trouble to travel here for this hearing in the situation
which you find yourself, so thank you. Please proceed.
STATEMENT OF KIMBERLY ANN NARANJO,
SANDY, UTAH
Ms. Naranjo. Thank you, Chairman Whitehouse, Ranking Member
Kennedy, and Members of the Subcommittee. My name is Kimberly
Naranjo and I'm here to ask you for your help in preserving my
constitutional right and the rights of so many others to pursue
accountability in our courts.
I have been diagnosed with mesothelioma, which is a
terminal cancer that's caused by one thing and one thing only,
exposure to asbestos. I was given 12 to 16 months of life,
which puts my expiration date at March 2023, 1 month before my
50th birthday. I'm a single mother with two of my seven
children still under the age of 18: Angelica, who is 14 and
lives with a diagnosis of autism, and my son Jayce, who's only
9. I would like to share my story with you.
I was born into dysfunction. My biological mother was deep
in her disease of addiction, and I experienced horrific abuse.
I was in and out of foster care, passed around from family
members, and on my own since I was 15.
As a result of the trauma and abuse I experienced in my
early years, family, being a good mother, and having stability
was all I dreamed about. At the age of 19, I became pregnant
with my oldest daughter, Maria, and then gave birth to four
additional daughters, Adrianna, Monaliza, Faviola, and Karina,
within the next 6 years. I wanted to be a good mom, something
that I didn't have until my Aunt Cathy, who never gave up on
me, took me in, and later adopted me as an adult. She has
supported me my whole life and is right here behind me
supporting me now.
Although I did my best at being a good mother, the
unhealthy behavior patterns that I had been exposed to in my
early years started to manifest in my life. I needed to do
something to stop the cycle. My adopted mom permanently took
over caring for my five children, and I attended a residential
treatment program where I lived for 13 months. I'm proud to say
that next month I will celebrate 15 years of sobriety.
After completing treatment, I gained enough skills to
become a productive member of society. I decided that I wanted
to get an education and dedicate the rest of my life helping
others overcome their hardships. I graduated with highest
honors with my associate's degree in alcohol and drug
counseling and I started working as an addiction counselor.
I've dedicated the last 7 years of my life helping and
advocating for others. I didn't want to stop there; I continued
my education at BYU-Idaho working toward a bachelor's degree in
marriage and family studies. My goal was to get my master's
degree in social work.
I've worked very hard to break the cycle for my children,
who I am blessed to have a wonderful relationship with today.
Since my disease of addiction has been in remission, I have
been an active and supporting participant in all their lives.
Throughout my life, I have never lived in one residence
longer than 2 years, and I wanted that to change. Last year, I
purchased my first home, my forever home. I was also hired at
my dream job, working for the Salt Lake County Sheriff's Office
as an addiction counselor.
Three days into working at the sheriff's department, I felt
a pain in my side. The next week, I was diagnosed with
mesothelioma. It all happened so fast. One week, I was enjoying
my forever home, surrounded and celebrating life with my
family. The next week, I was given an aggressive treatment plan
in hopes to extend my life by a few months.
Unfortunately, I was no longer able to work. With no
income, I was unable to pay my mortgage and forced to sell my
forever home. I then had to sit down with my children and
grandchildren to let them know that I'm going to be leaving my
body. It was a really hard day. My oldest daughter, Maria, is
only 28 and a single mother, and she is going to raise my two
children after my death.
After spending hours going over every place I've ever lived
or worked, it was determined that the only way I was exposed to
asbestos was from Johnson & Johnson's baby powder. Instead of
protecting my children as advertised by Johnson & Johnson, I
had no idea I was exposing them and myself to the deadly
asbestos in that white plastic bottle I associated with
motherly love.
When I learned that I could file a lawsuit and have it
decided by a jury, I saw a path forward for my family. There
was a way that my children could be taken care of monetarily as
if I had lived. I was less scared knowing that even though I
can't control the fact that I'm dying, I could use my
constitutional right and be heard in a court of law. I knew
that justice would take care of my family. I was filled with
hope.
That hope was also taken from me. I learned that Johnson &
Johnson filed for bankruptcy and that I would not receive a
court date. I didn't understand. Johnson & Johnson is a really
big and thriving company. How can they be bankrupt? I learned
that they took advantage of a loophole where they made a new
company and put all their responsibilities related to Johnson &
Johnson's baby powder into that company, then filed bankruptcy,
and now everything's stopped except for the progression of my
cancer.
I have accepted the fact that I do not have much time left.
I even held a living memorial where I gave all my friends an
opportunity to say goodbye. I made parting gifts. When I
graduated from residential treatment, I was given a poem that
you can see right there--it's framed--don't quit. That's my
motto. I made copies of that picture, little wallet-sized, and
handed them out to all of my friends and everybody who came and
celebrated my life with me.
I don't have much time left, but I will not quit. Even
though I'm in pain every day, I get up and do my best to make a
difference in the world. I've even made myself a stickers chore
chart, and I give myself a star for getting up, taking a
shower, walking my son to the bus stop, and cooking. I will not
quit, no matter how tough this gets. It took every ounce of
strength for me to be here before you today, but I am here
today because I am a voice for the thousands of people that
Johnson & Johnson has harmed, and we have a right to be heard.
I'm so grateful that you've listened to me. I wish that
Johnson & Johnson would listen too, but they took away that
right from me and thousands of other people who have their own
stories, families, and lives that also deserve a right to be
heard by a jury.
Thank you again for your time and attention. I'm truly
grateful.
[The prepared statement of Ms. Naranjo appears as a
submission for the record.]
Chair Whitehouse. Thank you, Ms. Naranjo. We do hear you,
and we will remember.
Paul Zumbro is a partner at Cravath, Swaine, & Moore, and
the head of Cravath's financial restricting and reorganization
practice. Mr. Zumbro's practice focuses on restructuring
transactions and related financings, both in and out of court,
as well as bankruptcy, merger, and acquisition transaction. His
restructuring experiences includes both debtor and creditor
side representations and includes work in the field of
municipal and sovereign debt restructuring as well as
insolvency-related litigation matters. Mr. Zumbro.
STATEMENT OF PAUL H. ZUMBRO, CRAVATH,
SWAINE & MOORE LLP, NEW YORK, NEW YORK
Mr. Zumbro. Good afternoon, Chairman Whitehouse, Ranking
Member Kennedy, and Subcommittee Members. I'm honored to appear
before you today to discuss divisional merger bankruptcies,
known more colloquially and colorfully as the Texas Two-Step.
I'm testifying today solely as an expert in the field and not
on behalf of any person or party.
Texas Two-Step has a lighthearted ring to it, but the
underlying issues are serious and important, and I commend the
Committee for examining the topic. My perspective as a
bankruptcy practitioner is this: divisional merger bankruptcies
of the type that have been filed are an appropriate use of
bankruptcy.
Before discussing the reasons for that conclusion, let me
first briefly describe what a divisional merger is. Two States
have enacted divisional merger statutes, Delaware and Texas.
Unlike a traditional merger, where two entities merge together
to form a new entity, a divisional merger involves one entity
dividing into two. In a divisional merger bankruptcy, the
original company is divided into two parts, one new company
that attempts to resolve the asbestos-related claims globally
through a Chapter 11 bankruptcy process and one new company
that continues to operate the business.
Here is where a critical misunderstanding may arise. While
the transaction involves two steps, the separation of entities
and a bankruptcy filing, it does not involve the side-stepping
of accountability or financial responsibility for the asbestos-
related claims. The law should not and would not allow that.
Going all the way back to the Fraudulent Conveyances Act of
1571, also known as the ``Statute of 13 Elizabeth'', it has
been illegal to take actions with the purpose and intent to
delay, hinder, or defraud creditors. Those same words appear in
our Federal bankruptcy code and in the laws of all 50 U.S.
States. Importantly, the Delaware and Texas divisional merger
statutes do not attempt to override this longstanding body of
law. Rather, both provide that any division of assets and
liabilities is subject to existing creditors' rights laws.
The reason these transactions should not constitute a
violation of creditors' rights laws is the funding agreement,
and agreement from the operating company to fund the trust to
be established under section 524(g) of the bankruptcy code to
pay the claims. There is a funding agreement in each of the
divisional merger bankruptcies filed to date. At the core, the
funding agreement evidences an affirmative acceptance of
financial responsibility and access to the value of the company
that existed pre-separation, not a corporate effort to sidestep
accountability.
Why split the company before bankruptcy? Because it allows
the company to use the tools contained in the bankruptcy code,
such as 524(g) trust, to address mass tort liabilities and
compensate claimants while preserving as much value as possible
for all constituents. By separating the company into two,
productive assets and businesses, which often have operations
separate from the operations that resulted in the potential
liabilities, will be able to operate without the overhang of
bankruptcy which, among other things, affects employee
retention and relations and relationship with suppliers and
customers.
That value inures to the benefit of the claimholders
through the funding agreement so that the claimholders are no
worse off, and they may be better off. It also enables the
company to use the bankruptcy code to address tort liabilities
in a way that is more streamlined and is fair to the
claimholders--more fair to the claimholders as a whole than the
tort system through the use of provisions like the Section
524(g) of the bankruptcy code.
Claimant trusts have been an accepted method of addressing
asbestos claims since at least 1994, when Congress added
Section 524(g) to the bankruptcy code. They are fair. They can
only be established if 75 percent of the claimants themselves
approve it. They are efficient. Bankruptcy provides a single,
centralized forum to resolve and pay claims. They are
equitable, unlike the lottery-like results of a pot of gold for
some claimants and little or nothing to others. That is not
allowed in bankruptcy.
Both for these reasons and the strong Federal policy of
access to bankruptcy, I do not believe the legislation that has
been proposed to outlaw a bankruptcy filing within 10 years of
a divisional merger is necessary or appropriate. In my opinion,
congressional time and effort would be better spent on other
bankruptcy topics such as establishing uniform standards for
third-party releases in appropriate cases. Mr. Chairman, I
thank you again for the opportunity to share my thoughts on
these very important issues.
[The prepared statement of Mr. Zumbro appears as a
submission for the record.]
Chair Whitehouse. Thank you. Our final witness on the panel
is Mr. Kevin Maclay. He is the head of the bankruptcy and
complex litigation practice groups and a member of the board of
directors at Caplin & Drysdale. Mr. Maclay's practice focuses
on complex civil and commercial litigation and protecting
creditors' rights in Chapter 11 bankruptcy cases.
Mr. Maclay has extensive experience in such
representations, including serving as co-lead bankruptcy
counsel in the DBMP and Aldrich Pump divisive merger
bankruptcies. Mr. Maclay.
STATEMENT OF MR. KEVIN C. MACLAY,
CAPLIN & DRYSDALE, WASHINGTON, DC
Mr. Maclay. I would like to thank Chairman Whitehouse,
Ranking Member Kennedy, and Members of the Subcommittee for
inviting me to testify here today. My name is Kevin Maclay, and
I'm here to talk about the Texas Two-Step.
The Texas Two-Step is, at its core, extremely simple. A
company splits into two entities. One of those entities gets
nearly all of the assets and whatever liabilities the company
decides it wants to keep paying. The second company is a mere
shell. It gets almost none of the assets but gets whatever
liabilities the company chooses to stop paying.
To date, those disfavored liabilities have been those owed
to tort victims like Ms. Naranjo, sitting one chair over to my
right and from whom you've just heard. Then, the shell company
files for bankruptcy protection. This immediately cuts off Ms.
Naranjo's ability to get paid for her injuries, potentially for
an extended period of time, while other creditors of the
original entity continue getting paid in full and on time.
Indeed, from the perspective of the non-bankrupt company,
almost nothing has changed, because that entity carries out
business as usual under the same name as the original company,
making the same products as the original company, and selling
to the same customers as the original company. Yet, because of
its artificial creation of a bankrupt shell company through the
Texas Two-Step, the non-bankrupt is both immune from suit in
the tort system and free from the bankruptcy court oversight
and transparency required of all debtors in the bankruptcy
system.
No one should be able to put themselves above the law this
way, and until 2017, no one had. But then, Georgia-Pacific
pioneered the Texas Two-Step. As a result, the tort creditors
consigned to its bankrupt shell company, Bestwall, have been
stuck in bankruptcy for more than 4 years now without being
paid a dime while all other creditors have been paid in full.
Since then, the dominoes have continued to fall as one
extremely wealthy corporate family after another, all of them
worth many billions of dollars, have used the Texas Two-Step:
CertainTeed and Saint-Gobain, Trane Technologies, and now even
Johnson & Johnson. Johnson & Johnson is worth more than $450
billion and its credit rating is higher than the U.S.
Government's.
Bankruptcy is intended to assist the honest but unfortunate
debtors seeking to reorganize. When the richest and most
powerful corporations in the country are using the Federal
bankruptcy system to avoid paying the most vulnerable people in
the country, something is wrong. The system needs to be fixed.
The Texas divisional merger law was never intended to be used
this way. It explicitly was intended to preserve all rights of
creditors under existing laws. Out-of-state companies have
misused that law to pervert the Federal bankruptcy system.
This is just the beginning. While the Texas Two-Step so far
has been used to disadvantage tort victims, the very same
mechanism can and inevitably will be used to permit
corporations to rid themselves of any unwanted creditors:
commercial and contract creditors, warranty claim creditors,
environmental creditors, or others. The Texas Two-Step is a
free pass for a corporation to disregard its obligations under
law at will, and I believe that Congress should act now to
close this loophole.
You've heard today about the so-called funding agreement.
Let's talk about funding agreements. First of all, they're
written by the same people who came up with the Texas Two-Step.
They're not a protection against the Texas Two-Step; they're
part of the scheme.
First of all, they don't prevent the non-bankrupt entities
from sending their cash, potentially all of their money, to
other entities. They don't prevent subsequent mergers or
acquisitions, and most importantly, the non-bankrupt entities
that control the bankrupt shell companies have the final say in
whether those bankrupt entities even asked for the funding
agreement to be complied with in the first place.
In other words, these are highly contingent and frankly
illusory agreements which are not a protection against
anything. We've heard about other existing remedies. Well,
look, the other existing remedies haven't stopped the Texas
Two-Step. More and more of the richest companies in our country
are doing it, and their victims are getting stuck in bankruptcy
indefinitely, which deprives them of their ability to seek
justice in this country, which allows all other creditors to be
paid. It's just not fair.
We've already heard about in the Bestwall bankruptcy, 4
years later, they're still stuck in bankruptcy. That's not
even-handed justice, and frankly, Members of this Subcommittee,
delay is the point. This mechanism is used to stick disfavored
creditors into bankruptcy where they're stuck in the hopes that
someday, they'll knuckle under and agree to just to accept
pennies on the daughters--pennies on the dollars for the values
of their claims.
The existing bankruptcy code has not been sufficient to
stop this scheme. It's only accelerating. Unless this
Subcommittee and Congress does something to stop it, I fear
it's only going to get worse. Thank you.
[The prepared statement of Mr. Maclay appears as a
submission for the record.]
Chair Whitehouse. Thank you very much. Judge Fitzgerald, to
go to your GoodCo, BadCo example, when the division takes
place, how does anyone know that all of the injured parties
have been found yet? How does one know the scope of the total
injury that has been inflicted?
Judge Fitzgerald. I don't think that they do know that,
Senator. What they know is the number of suits that have been
filed against them and/or complaints that have somehow come to
their attention, not necessarily formal complaints. In all of
these cases, there are huge numbers of future demands, which is
one of the reasons that Congress foresaw the need for Section
524(g). So, I don't think it's possible to know.
Chair Whitehouse. What happens to lawful claims for
punitive damages?
Judge Fitzgerald. That depends on the particular case. In
the bankruptcy code, punitive damages are generally
subordinated to other types of claims. It depends on the State
law what has happened in many of the mass tort bankruptcy
cases.
Chair Whitehouse. What happens if the total injury exceeds
the trust amount? Does BadCo have a continuing claim against
assets of GoodCo to fill in any gaps?
Judge Fitzgerald. That depends, Senator, again, on what the
relationship between the parties is. In the case of the funding
agreements, the assertions have been made that that's the case,
but in fact there are cross indemnities generally speaking such
that if BadCo pays out money, then GoodCo's supposed to
reimburse, but if GoodCo pays out money, BadCo's supposed to
reimburse. The net effect is not necessarily clear, first of
all. And second----
Chair Whitehouse. Is GoodCo a party in the bankruptcy
proceeding?
Judge Fitzgerald. I'm sorry?
Chair Whitehouse. Is GoodCo ordinarily a party in the
bankruptcy proceedings?
Judge Fitzgerald. No. It's not a party unless it has co-
liability with the debtor. To that extent, it is essentially a
party. It's a named party. The problem is that GoodCo usually
has independent--or the allegations are that GoodCo has
independent liability, which would not be part of the
bankruptcy estate.
Chair Whitehouse. How about evidence? Discovery? Corporate
documents? Things like that. When somebody's been injured by a
corporate entity, usually there's a very robust discovery. That
discovery can continue really until the eve of trial on some
occasions, and I'm familiar with times when documents have been
discovered that completely change the complexion of the
liability. When Ms. Naranjo is sent to BadCo, what rights does
she have and what rights do her lawyers have to continue
discovery and document production and so forth against GoodCo?
Judge Fitzgerald. They still have rights. The problem is
that the way the operation has worked in bankruptcy is that
those rights are stayed and generally temporarily if not
permanently enjoined. Although there may be rights to
discovery, they're not accessible. The system simply is not
sufficient in that respect to deal with those issues.
Chair Whitehouse. So, discovery effectively stops----
Judge Fitzgerald. Yes.
Chair Whitehouse [continuing]. At the--when the Texas Two-
Step begins.
Judge Fitzgerald. It stops as to GoodCo.
Chair Whitehouse. Yes.
Judge Fitzgerald. Yes.
Chair Whitehouse. There's no reason for GoodCo to turn over
all of its documents to BadCo, is there?
Judge Fitzgerald. Certainly not.
Chair Whitehouse. In fact, that would be counter to the
purpose of the operation, assuming the purpose of the operation
is to protect the assets of GoodCo.
Judge Fitzgerald. That would be my opinion, yes, sir.
Chair Whitehouse. Mr. Maclay, do you have any response to
any of those comments that I just made? I've got another minute
before I turn it over to Senator Kennedy.
Mr. Maclay. Yes, Mr. Chairman. I think you've made an
excellent point and suggest an excellent point, which is that
GoodCo isn't in bankruptcy. It's not supposed to get the
protections of the bankruptcy, but it gets to enjoy those
protections. At the same time, like a puppet on a string, it
controls BadCo, because BadCo has overlapping officers and
directors with GoodCo and the rest of the corporate family.
It's really just an illusion, Your Honor, to think of BadCo as
anything other than an empty shell, as even some of the courts
applying these bankruptcies have recognized.
Chair Whitehouse. Makes one think of the old doctrine of
piercing the corporate veil. Would that apply here?
Mr. Maclay. You're exactly right, Your Honor, that--not
Your Honor, excuse me, Mr. Chairman----
Chair Whitehouse. It's all right.
Mr. Maclay [continuing]. That--you can tell I'm a lawyer--
that there are supposedly remedies that will work, but we're
talking here about time. People don't have 10 years to wait for
all of this to play out. People are dying now. People need to
get paid now. Ultimately, this is all about delay. That's the
whole point. Justice delayed is justice denied, Mr. Chairman.
Chair Whitehouse. Senator Kennedy.
Senator Kennedy. Thank you, Mr. Chairman. Ms. Naranjo, did
I say your name right? I'm sorry for all your troubles.
Ms. Naranjo. Yes, you did. Thank you.
Senator Kennedy. I'm sorry for all your troubles.
Ms. Naranjo. Thank you.
Senator Kennedy. Mr. Zumbro, tell my old friend Phil
Gelston I said hi.
Mr. Zumbro. Yes, sir. I will.
Senator Kennedy. Very----
Mr. Zumbro. He had warm regards to send to you as well.
Senator Kennedy. Fine lawyer. Fine lawyer. Professor Skeel,
with respect to a divisional merger and then a bankruptcy, does
the bankruptcy judge--or does the bankruptcy court make a
distinction between a divisional merger bankruptcy in good
faith and one in bad faith?
Professor Skeel. Yes. I think a bankruptcy judge would. I
think they would look at the BadCo, to use the term that we've
adopted from Judge Fitzgerald--they'd look at BadCo and they'd
ask the question, ``Is that an entity that is in bankruptcy for
a proper bankruptcy purpose?'' If you set up a BadCo that had
real assets in it, and it had the liabilities as well, you
might say yes, that's a proper purpose for that--for that
entity. The judge looks at what went on in the particular
divisional merger and makes a decision.
Senator Kennedy. Let me explore that a minute. I've not
ever practiced in bankruptcy court. When a divisional merger is
done, and then there's a bankruptcy, and you have two
companies--I'll use the terms RichCo and PoorCo as opposed to
Good and Bad. Does the bankruptcy--I assume that counsel for
the creditors is raising up fresh hell and saying, ``This
divisional merger was in bad faith, and it was only done to
avoid liabilities.'' Assume that's one of the allegations. Does
the bankruptcy judge then hold a hearing and look to PoorCo and
its present and prior management and say, ``Tell me why you did
this divisional merger''? If they say, ``To avoid our
liabilities,'' does the bankruptcy judge then have authority to
say, ``No. Get out of my courtroom''?
Professor Skeel. The answer to that would be yes, and I'll
unpack it just a little bit if I can. You do the divisional
merger. There's nothing strange about a divisional merger in
concept. I mean, you can have perfectly appropriate divisional
mergers, and nobody thinks about it until we end up in
bankruptcy. If you do a divisional merger and then you put
BadCo or PoorCo into bankruptcy, and the creditors, the
victims, challenge the bankruptcy, say it was filed in bad
faith, then the bankruptcy judge assesses the divisional
merger, the Texas Two-Step, and determines whether it belongs
in bankruptcy or not.
The standards that courts use vary a little bit from court
to court, but the standard that will apply in Johnson &
Johnson, for instance, which is the third circuit standard, the
Court of Appeals for the Third Circuit--what the court will ask
is, ``Was there a valid bankruptcy purpose?'' That was the
first question. Then the second question is, ``Was this
bankruptcy filed simply to gain a tactical advantage in
litigation?'' If it's not a valid bankruptcy purpose or it was
solely for a tactical advantage, the court will kick the case
out. There is a hearing in Johnson & Johnson in its divisional
merger case next week to address that question.
Senator Kennedy. Let me ask Mr. Zumbro. It seems to me that
issue is do we have a prophylactic rule passed by Congress that
says you can't do a divisional merger and then a bankruptcy, or
do we rely on the bankruptcy judge to decide when a divisional
merger is in good faith and bad faith? Bad faith meaning to
avoid your creditors.
Mr. Zumbro. Senator, I think that's right. I think the
bankruptcy courts are in much better position to evaluate those
issues than Congress. I don't think a law that flatly prohibits
a bankruptcy filing after a divisional merger is appropriate or
necessary. I did a divisional merger recently for a media
company that needed to sell a content library. If that company
that bought the content library--library needs to seek
bankruptcy protection in 10 years, why should it be precluded
from doing so? I think the courts can make these determinations
on a case-by-case basis.
Senator Kennedy. I understand. Could I ask, Mr. Chairman,
for 30 more seconds? Could you weigh in on that, Mr. Maclay?
Mr. Maclay. Absolutely. First of all, what Mr. Skeel said--
what Professor Skeel said is not accurate in the fourth
circuit. In the fourth circuit, where these bankruptcies are
all originally filed, bad faith is not enough to dismiss the
bankruptcy. A judge could find it's in completely bad faith,
it's a scheme, it's a fraud, but yet if the defendant, if the
debtor, can argue there's a reasonable likelihood of successful
reorganization, a standard which is almost impossible to meet,
then the bankruptcy has to stay. So dismissal is not an
adequate remedy even for bad faith under the law of the fourth
circuit where they of course file.
Second, with respect to this prophylactic rule, think about
the implications of what I've just said. The court's hands are
bound. They're bound by this governing controlling precedent,
and it doesn't matter if it's bad faith. That's not enough.
Judges are, of course, faced with the cases in front of them
and they do their best faced with the cases in front of them,
but when there is such a widely used scheme where the
wealthiest corporations go into bankruptcy to disadvantage some
of their disfavored creditors, that is a universal problem
that, I would submit, calls for a universal answer.
Senator Kennedy. Okay. Thank you all. Mr. Chairman, I have
been asked by Professor Anthony Casey of the University of
Chicago Law School and Professor Parikh of the Lewis & Clark
Law School to offer statements on their behalf into the record.
I have----
Chair Whitehouse. Without objection, they will be made part
of the record.
[The information appears as a submission for the record.]
Senator Kennedy. Thank you. I'm sorry to go over, Mr.
Chair.
Chair Whitehouse. Not a problem. Senator Hirono.
Senator Hirono. Thank you. I do not know if these questions
have been asked, but it seems to me that, especially in the
fourth circuit, there is a giant, I don't know what, I would
call it a loophole--Mr. Maclay, you seem to referred to that--
for plaintiffs to get any kind of redress. This is pretty
elementary, I suppose, for people who practice in that area,
but I'm not familiar with bankruptcy practice. If there is this
kind of divisive restructuring and the assets are in GoodCo and
the BadCo is the one that files for bankruptcy, I don't
understand why the plaintiffs--why can't the plaintiffs just
turn around sue GoodCo? I think this must be a question for our
first witness. Professor.
Judge Fitzgerald. Senator, what happens here----
Senator Hirono. Or Judge Fitzgerald, I'm sorry.
Judge Fitzgerald. I'm sorry.
Senator Hirono. Go ahead. It's for you.
Judge Fitzgerald. What happens, Senator, thank you, is that
BadCo files bankruptcy and has the benefit of the automatic
stay, which stops all litigation against the debtor. In some
courts, including those in the fourth circuit that have been
looking into these divisional mergers, that automatic stay has
been extended to parties that are not the debtor. It's extended
to GoodCo, and it's extended in the third circuit right now to
Johnson & Johnson.
At the moment, as to Johnson & Johnson, it's on a temporary
basis. The court has not ruled yet on a permanent basis.
Nonetheless, in the other cases, some of which have been
pending for 4 years, tort victims have not been able to pursue
their claims against any other company in the corporation chain
because the courts have extended the automatic stay and/or
issued injunctions prohibiting that action from going forth.
Senator Hirono. See, that's the part that I don't
understand. Why should there be an automatic stay when using
this kind of a process? Basically, a company can hide its
assets, but literally in your face. I don't understand why, in
bankruptcy law, there is this automatic stay and the plaintiffs
cannot get to the company that actually did the harm, but they
are insulated. Why is there this automatic stay?
Judge Fitzgerald. The----
Senator Hirono. Anybody else can weigh in and----
Judge Fitzgerald. The stay is sometimes extended to parties
who are co-liable with the debtor because, for example, they
may share insurance. If the automatic stay is not extended to a
party that share insurance with the debtor and all of that
insurance is depleted for other claims that are directly
against that other estate but not against the debtor, then the
debtor's estate is diminished.
There are reasons why the stay may actually be validly
employed against other companies. The problem that these
companies are facing--that the tort victims are facing, is that
the stay is stopping all action. Johnson & Johnson, for
example, can go on its merry way without anybody suing it for
its direct liability that's totally unrelated to its co-
liability. There are different theories and causes of action
that can be brought by parties, and the----
Senator Hirono. Is this stay a result of judicial action,
or is there some law that says in bankruptcy filing, there will
be an automatic stay?
Judge Fitzgerald. No. The stay is extended to parties when
the debtor files a motion and/or an adversary proceeding and
asks the court to extend that stay. Except in Johnson &
Johnson's case, the debtor, LTL Management, notified all of the
tort cases in which it was involved before it went to court and
asked the judge to extend the stay that the stay applied to
JJCI and J&J.
Senator Hirono. That really sounds like an abuse of process
to basically stop plaintiffs at the courthouse door. What if we
consider legislation that will prevent in these kinds of--from
any kind of a stay that completely insulates GoodCo?
Judge Fitzgerald. You know, one of my colleagues used to
say that you don't kill a flea with an atom bomb, and so I
think the unintended consequences----
Senator Hirono. Yes.
Judge Fitzgerald [continuing]. May be something that
Congress might want to look at because certainly----
Senator Hirono. Okay. I'm sorry. I understand about
unintended consequences. Do you have any suggestions? Do any of
you have suggestions to close some of these--to prevent these
kinds of, what I would call, abuse? Also, if it's relatively
easy to engage in these kinds of divisive mergers, what is to
prevent a company from just creating those kinds of entities at
the very beginning and just hold BadCo in abeyance until
there's time when BadCo should file for bankruptcy? Why don't
all companies engage in these kinds of mergers----
Professor Skeel. Well----
Senator Hirono [continuing]. To insulate itself?
Professor Skeel. Well, if I can----
Senator Hirono. Yes, please.
Professor Skeel [continuing]. Say a few words. You don't
need to, in a way. I mean, you don't need to set this up today
because, as Johnson & Johnson did, you can do it at last
minute. I mean, you can do it, and it takes a day to do this,
so there's no need to do it in advance.
Senator Hirono. Okay. That's the answer to that question.
Mr. Chairman, I'm glad you're having this hearing because I'm
learning something about bankruptcy law. I think we need to do
something, but we will--I hope that you come up with----
Chair Whitehouse. We will pursue.
Senator Hirono. I hope you can come up with something.
Chair Whitehouse. We will pursue.
Senator Hirono. Okay. Thank you very much.
Chair Whitehouse. We are very honored to be joined by the
Chairman of the Full Judiciary Committee, Senator Durbin of
Illinois, and I recognize him now.
Chair Durbin. Thanks, Senator Whitehouse. Twenty-six years
ago, I walked into this very room to become a brand-new Member
of the Senate Judiciary Committee. I was appointed to this
Subcommittee, and the Chair was a man named Chuck Grassley. We
were doing something that was interesting. We were rewriting
the bankruptcy code. You may remember that, 26 years ago. It
turned out I was the resident expert on the bankruptcy code by
virtue of taking a course in bankruptcy at Georgetown Law
School and having been appointed a trustee in bankruptcy for a
gas station in Springfield, Illinois by Judge Basil Coutrakon.
I had more experience with bankruptcy than anyone on the
Committee by virtue of these two things. We set about writing
the code, and Chuck Grassley taught me a lot about bankruptcy.
He's a pretty smart fellow.
I've tried to understand it going forward and tried to put
aside all the wording of bankruptcy, which can be dry as dust,
to get down to the human side. Ms. Naranjo, you helped us
understand the human side in a very personal way, and I know it
took its toll on you emotionally, but thank you for being here.
It makes a difference.
I listened to your explanation, Mr. Zumbro, rationalization
of divisional merger. There was one sentence you used that I
went back to make sure I caught it. You said, ``Why would a
company do this?'' You said, ``By separating the company into
two, productive--it's two assets and businesses will be able to
operate without the overhang bankruptcy which, among other
things, affects employees' retention and relations and
relationships with suppliers and customers.''
I think it might also be about money. Just going out on a
limb here. It isn't just a matter of getting along with people.
There's a lot of money on the table. For instance, LTL
Management has $2 billion in its settlement fund; that's the
PoorCo or BadCo, depending on how you want to characterize it.
Two billion. Huge, right? Not really. In one talc case against
Johnson & Johnson involving 22 cancer victims, plaintiffs were
awarded a judgment of more than $2 billion. How would you
evaluate the legitimacy of Johnson & Johnson's claims that
their actions would actually benefit the 38,000 plaintiffs like
Ms. Naranjo who are seeking restitution?
Mr. Zumbro. Well, sir, I think that the bankruptcy system
is supposed to be fair and equitable to everybody. As I
mentioned in my testimony, the pot of gold for that $2 billion
verdict might mean someone else gets zero in a verdict and gets
nothing. What the bankruptcy process is meant to do--you can't
do that. You can't have one person getting $2 billion and one
person getting nothing in the bankruptcy process because that's
not permitted. It's fair and equitable to everybody because
everybody has to get treated the same in bankruptcy.
Chair Durbin. No, you missed something very critical. The
GoodCo, if you can call Johnson & Johnson that, is worth $430
billion. The BadCo, LTL, ends up with $2 billion for 38,000
claims, and you're saying that is a fair apportionment by
Johnson & Johnson? Get real. The idea was to project $430
billion worth of corporate assets by creating a $2 billion
entity. That, you think, is fair because it's so small, but I
think most people want----
Mr. Zumbro. Sir, what I'm saying is I don't even know if I
could do the math, but whatever $2 billion is times 38,000,
that's bigger than even Johnson & Johnson could pay, right?
Johnson & Johnson is a lot more than--and I'm not representing
Johnson & Johnson, but they're a lot more than just the talc.
They've done COVID vaccines. They do a lot of other medical
things that are very valuable.
Johnson & Johnson is not a monolithic corporate entity.
It's owned by pension funds; it's owned by regular Americans in
401(k)'s. This is a more nuanced issue. Yes, it's about saving
money because the tort system is broken and you can't resolve
38,000 claims in the tort system. The bankruptcy system----
Chair Durbin. Mr. Zumbro----
Mr. Zumbro [continuing]. Allows it to be done more
efficiently.
Chair Durbin. Mr. Zumbro, if you're looking for----
Mr. Zumbro. It's a win-win for both the companies and the
victims.
Chair Durbin. Our legal system is supposed to be looking
for justice, not efficiency. If you think efficiency says a
$430 billion corporation can walk away from any wrongdoing--I
don't know when or if they ever discovered asbestos in talc,
which may have led to the mesothelioma suffered by the
gentlelady sitting to your right, but at some point, they're
going to be asked that in court and held responsible for their
answer. Apparently, they're losing these cases. There could
have easily been some knowledge, or there should have been some
knowledge, that they were in fact selling a dangerous product
which endangered the life of their innocent customers.
Go to Johnson & Johnson's website and take a look at all
the pictures of those beautiful babies and all the products
they sold for those babies. Our family bought some. Bet you
everybody in the room did too, never thinking for a moment they
might be dangerous. It turns out it was dangerous, and people
are suffering injuries. They're trying to dance around the
bankruptcy system to avoid paying these innocent victims. That
is not good corporate responsibility. I yield.
Chair Whitehouse. Senator Blumenthal.
Senator Blumenthal. Thanks, Chairman. I apologize that I
was absent for part of the testimony because I had to go vote,
so forgive me if I'm repeating any of the ground that's
covered, but I first want to just second what Chairman Durbin
has just said about the purpose of the whole justice system. It
is to enable the survivors and victims of harms to have a fair
day in court and to have fair access to compensation that
they're entitled to receive. I want to focus on one aspect of
the bankruptcy system that so deeply troubles me. What we're
hearing about the use of the Texas Two-Step rule, as it's
known, to borrow your phrase, Mr. Zumbro, colloquially and
colorfully, is very, very serious, which is the choice of
venues.
I recognize that some districts like the Southern District
of New York and the Eastern District of Virginia which, until
recently, saw a lot of venue and judge shopping, have taken
some steps toward self-correction by requiring random judge
assignment in bankruptcy cases. Some individual judges have
stepped up as well, like Judge Whitley, who transferred the
Johnson & Johnson bankruptcy from North Carolina to New Jersey,
where Johnson & Johnson is actually headquartered, but we've
seen companies move their headquarters to take advantage of
supposedly favorable forums and judges. There's a whole cottage
industry that is favorable to one side or another side. A lot
of the parties are not only skeptical, they are utterly cynical
about how this system works, non-lawyers as well as lawyers.
I've been very proud to work with Chairman Durbin and
Senator Warren on our Nondebtor Release Prohibition Act to
close some of the loopholes that enable these kinds of judge-
shopping problems. I'd like to ask all of you, aren't you
troubled by it, and what should we do about it?
Mr. Maclay. Thank you, Senator. Kevin Maclay. I think,
really, the venue issue is part of the broader problem that
we're here talking about today, which is corporations planning
out how to disadvantage their victims, essentially, their
creditors, and the fact that they have filed in the fourth
circuit and in the Western District of North Carolina. Only
they could tell you for sure their subjective reasons for doing
so, but of course the effective of it is that bad faith
bankruptcy filings can stay around and be used to disadvantage
their victims.
It's just one example, Senator, of a facet of the problem
that hopefully Congress will be able to fix because it's a very
real problem. I don't know--one of the questions was asked
earlier, why doesn't everyone do this? Given the way the law is
currently being applied, I don't know why everyone doesn't do
it. You get to stick all your liabilities into bankruptcy and
keep all your operating companies out. Not even the
inconvenience associated with the bankruptcy. It's really a
major, major problem. It's a loophole that could swallow the
entire bankruptcy code. I view it as a problem that needs an
urgent and immediate solution.
Senator Blumenthal. No matter how good the rule--and I'm
probably one of the few United States Senators, at least in
office today, who has actually tried a bankruptcy case, which I
did as State Attorney General. I tried a bunch of cases, as did
some of my colleagues. I'm no bankruptcy expert, and that's my
point, that the bankruptcy system is a set of seemingly
abstruse, arcane rules. It has a separate set of practitioners
and a separate judicial system.
If you're Purdue Pharma and you go to White Plains, you got
a judge that, and I'm not drawing any conclusions here, but
according to the plaintiffs in separate actions, the State
attorneys general, and some of the victims and survivors, was
very favorably inclined toward Purdue Pharma and the Sacklers.
Likewise, that pattern repeated. I guess I'm honing down on
reforming the rules, but making sure the rules are applied
evenhandedly and fairly. Mr. Zumbro.
Mr. Zumbro. Senator, first, thank you for the question. I
do think I would respectfully disagree on the Nondebtor
Prohibition Act. I think a blanket prohibition is not the right
way to do it, but I would encourage Congress to consider
adopting uniform--more uniform standards for when it is
appropriate because that issue, like the issue we discussed
today, I think, is more nuanced and less black and white than
it may seem because I think there can be appropriate
circumstances where the victims can actually recover more than
they would've otherwise recovered as a result of that.
I do understand your concerns about venue. I think having
the notion that third-party releases are illegal in California,
they're illegal in Texas, but they're permitted in Delaware,
maybe they're permitted in New York--I think they should be--is
probably not the right way because our Constitution requires
Congress to enact uniform laws on the subject of bankruptcy. I
would encourage the Congress consider uniform standards for
that, but as I've recently written on behalf of the New York
City Bar Association--we've written a letter to you and your
colleagues explaining the reasons why we don't think an
absolute prohibition is the right way to go, but rather more
standards that are uniformly applied across the judicial
circuits.
Senator Blumenthal. Anyone else? Ms. Naranjo, or----
Ms. Naranjo. Yes. Thank you so much, Senator. What I would
like to see is, I would like to have my and other 38,000
victims that are known as of right now--just mesothelioma takes
about 30 to 50 years to even show up. There's going to be more
victims. I want to have my constitutional right to be heard by
the people who harmed me, who harmed my children, who harmed my
family. I just want to be heard. That right was taken away from
me.
Senator Blumenthal. Thank you for being here today.
Ms. Naranjo. Thank you for listening.
Senator Blumenthal. Professor.
Professor Skeel. I would just say that I do think there's
some venue issues. I think the important thing is to address
the problems and not pass anything that fixes things that
aren't problems or changes things that aren't problems. In my
view, the two big problems we have now--one is judge shopping,
which you alluded to, in White Plains, and Houston, Texas, and
the Eastern District of Virginia. That seems to be in the
process of being solved, at least in the short run, but parties
should not be able to pick judges within a district, so that's
a problem.
The other problem, in my view, is the affiliate part of the
venue provision, which says any--any--if a connected entity, an
affiliate entity has filed in a courthouse, you can bring the
rest of the entity in, even if it's some tiny little entity
that just got formed for the purposes of the bankruptcy filing.
That's a problem, in my view. A venue reform that addressed
that, I think, could help.
What I don't think would help would be to take away the
domicile venue option, which is the Delaware venue option. I do
think that firms ought to be able to file in their State of
incorporation. In my view, it's very important to solve the
problems and not create problems by taking away options that
really aren't the problem. The real problem, in my view, is
judge shopping and that affiliate hook, which people have used
to do outrageous things.
Senator Blumenthal. Part of the problem is, as Mr. Zumbro
observed, that these rules can differ from one State, one
district to another.
Mr. Zumbro. Exactly. Bankruptcy lawyers will tell you quite
candidly that they have a conversation about that when they're
about to file a bankruptcy case. They feel like it would be
malpractice not to consider the fact that the third-party
release--nondebtor release law is very different in New York
than it is in Delaware than it is in Chicago or Texas.
Senator Blumenthal. A good argument for maybe a nondebtor
release national rule, which I proposed in the SACKLER Act.
Mr. Zumbro. Possibly, although I am of the view that it's
important that it be nuanced. That it--I think it would be a
mistake to completely outlaw third-party releases, but cracking
down on them I think makes sense. There is an argument for just
getting rid of them, you know? The basic argument is if you
don't file for bankruptcy, you don't get the benefits of
bankruptcy, you know? What third-party releases are doing is
giving the benefits of bankruptcy to folks who don't file.
Senator Blumenthal. Right.
Mr. Zumbro. There's a counterargument, which is in some
cases, bringing it into the bankruptcy context is better for
everybody, but that's not always true.
Senator Blumenthal. Judge Fitzgerald----
Chair Whitehouse. I'm going to take the Chairman's
prerogative here. I would like to ask Ms. Naranjo for a last
word here because one term that has come up repeatedly in this
hearing has been time, and there is no better witness on this
panel as to the matter of time than you.
In addition to what time you have remaining, you also have
decisions to make with regard to what you can leave to and how
you can provide for your children, and presumably without
knowing what is going to emerge from this black hole of a
bankruptcy that you are stuck in. Those decisions are hard to
make, and time is short for you to make those decisions. If you
could close us out with a few words about time?
Ms. Naranjo. Yes. Time is something that I think folks take
for granted. We sometimes feel, you know, we have time; we can
get to that; this will happen. Something that I've heard said
today was, you know, to make it fair and even. No bankruptcies
can do that. I won't be here. My kids will probably be 18 by
then because it takes a long time.
I'm scared for my family. Like I said in my testimony, my
daughter's only 28. She's a single mom. She doesn't own a home.
She's a hairdresser. She's going to raise my children. I don't
have a pension. I don't have a 401(k). I started late in life,
but when I started, I took off running.
I would like more time. I don't have time. Thirty-eight
thousand other people need more time, but we don't know how
much time we have in life. It needs to be heard. It needs to be
heard now, not later. I'm scared. I don't what's going to
happen, but I am so excited to be here today.
Chair Whitehouse. Would you do me one favor? Would you tell
your daughter, Monaliza, that my chief of staff is also named
Monalisa?
Ms. Naranjo. I heard that. Such a rare name. Such a rare
name. I'm so happy to be here. My family's so happy that I was
invited here. I'm so grateful that I got to be heard.
Chair Whitehouse. We're delighted to have you here. The
record of the hearing will stay open for 1 week so any further
comments can be included. I don't believe we had any questions
for the record, but if there were any, please answer within the
week.
We will undertake to try to figure out something fair here.
It does not make sense for a $450 billion corporation with
38,000 people with potentially lethal injuries to be able to
carve off $2 billion--I did the math, Mr. Zumbro; it's about
$52,000 per person--and walk away from the responsibility for
what it did.
With respect to the questions of fairness and efficiency,
there's a larger scope for fairness here in which it looks like
big companies are getting away with dodging real
responsibilities by using complicated trickery that ordinary
people don't have access to with the result that they create
delays that cause people like Ms. Naranjo to get actually no
recovery in her lifetime. That's neither efficient nor fair. I
hope we can find a sensible way to solve this.
Thank you all for your testimony. It has been very helpful.
[Whereupon, at 4:25 p.m., the hearing was adjourned.]
[Additional material submitted for the record follows.]
A P P E N D I X
Miscellaneous submissions:
Commercial Law League of America (CLLA).......................... 103
Erickson, Jr., John C............................................ 133
Erwin Chemerinskey Amici Curiae Brief............................ 108
Exhibit A........................................................ 140
LTL Management, LLC.............................................. 136
Reuters, "Special Report: Inside J&J's secret plan to cap
litigation payouts to cancer victims.......................... 167
Tassone, John A.................................................. 135
Wall Street Journal, "Profitable Companies Enlist Bankruptcy
Courts to Sidestep Cancer Trials.............................. 159
Commercial Law League of America, Appendix in support of
supplement to record
https://www.govinfo.gov/content/pkg/CHRG-117shrg56422/pdf/CHRG-
117shrg
56422-add1.pdf
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