Texas Two-Step

Tstrack

Active Member
Premium Member
Sep 30, 2018
10
2
Hi Everyone

I've recently come across the below article on the FT which discusses Jones Day's involvement in a controversial use of Texas statute with Johnson & Johnson:


I've tried to do some research on the original basis for the statute and why Texas has provided a mechanism to split a company into two in the first place but am not getting any luck. Would be grateful for any insight!

Thanks
 

Abii

Legendary Member
Feb 1, 2021
233
676
I have really struggled trying to get to the why of this as well so will be following anyone else's input with interest.

From my reading around this is seems like it is a relatively new (in terms of law anyway) quirk. So it cannot be said that it is a historical issue that has carried over as it seems to have only been possible since 2006 and comes down to the definition of merger in texan law under the Texas Business Organizations Code, in which a merger also includes the "the division of a domestic entity into two or more new domestic entities or other organizations". Interestingly it seems something similar is also possible, albeit with more restrictions as to company types, in Delaware.

From my reading a couple of other companies have attempted the move, or are in the process with some limited success. Both asbestos cases and both held up in bankruptcy court and with injunctions etc. for several years now.
 

IRO

Distinguished Member
Junior Lawyer 5
Jan 21, 2021
54
88
TLDR: @Tstrack , you’ll want to research ‘divisive mergers’ if you want more information on why the statute was introduced in the first place/what the basis for the statute is. In essence, a divisive merger is used to provide a more straightforward way of restructuring companies based in Texas (and a few other locations). This restructuring can be for legitimate business reasons, but in general its used to shield a company from liabilities by transferring them to a separate company which then files for bankruptcy.

I’ve also included a Fact Profile for the J&J case for anyone who can’t access the FT article, which is behind a paywall.

Fact Profile:

  • There have been nearly 40,000 lawsuits alleging that Johnson & Johnson’s (J&J) talcum powder contained asbestos and caused cancer, which have resulted in $4.5bn in awards, settlements and litigation costs so far.
  • In response J&J has employed Jones Day to help the company through the process known as the ‘Texas two-step’, a divisive merger in which one company splits into two.
  • Jones Day has used this process to protect four clients facing asbestos-related litigation: Georgia-Pacific, a US unit of Saint-Gobain, Trane Technologies, and now J&J
  • J&J created a new subsidiary called LTL Management (LTL) and then split itself from this subsidiary. LTL holds all the liability for the talcum powder lawsuits, and has recently filed for Chapter 11 bankruptcy protection in North Carolina. North Carolina is the jurisdiction which makes it hardest for creditors to dismiss the filing. In November, the judge overseeing LTL’s bankruptcy case transferred it to New Jersey, where the majority of talcum powder lawsuits are based. A motion by talcum powder claimants to dismiss LTL’s bankruptcy is due to be heard on 14th February. Notably, Personal injury claims are halted during the bankruptcy process, so talcum powder claimants will see no progress on their lawsuits until the process is resolved unless they accept an out-of-court settlement.
  • Additionally, $2.3bn has been diverted from J&J to LTL Management to settle claims related to the talcum powder lawsuits. J&J denies it is trying to avoid its liabilities.

Questions​

  • What is the original basis for the statute which allows the Texas two-step?
  • Why has Texas provided a mechanism to split a company into two?

Divisive Mergers: The basis for the Texas two-step​

The process known as the Texas two-step was enabled by a revision of the Texas Business Organizations Code Title 1 (TBOC) in 2006. TBOC defines a “merger” as “the division of a domestic entity into two or more new domestic entities or other organizations”. This is known as a “divisive merger.” This is the original basis for the statue.

In term of why Texas has provided a mechanism to split a company in two it is essentially to allow the company a number of restructuring options. These benefit Texas by (a) making it a more attractive location to base your business, as divisive mergers are only available to “domestic” i.e. Texan companies, and (b) allowing Texan business to restructure to be more profitable, potentially raising higher taxes/boosting the Texan economy.

Obviously, these benefits do not apply if divisive mergers are simply used to protect companies from the liability of lawsuits. As @Abii mentions the process is usually used to protect against asbestos related cases.

However, there are many other reasons to pursue a divisive merger, and these could benefit Texas/Texan companies. For example:
  • The divisive merger allows for the transfer of assets without the need for numerous transfer agreements. Previously, companies were able to transfer these assets but the process was more arduous. The divisive merger simplifies the process.
  • A divisive merger also allows for the transfer of a contract which would otherwise be unassignable because of anti-assignment or anti-transfer clauses, provided that the contract did not have a change of control clause or similar provision.
  • A divisive merger can be used if the company wanted to sell a portion of the business. The entity could transfer the relevant assets/liabilities to a new entity and sell that company.
  • A divisive merger can be used to end a partnership which is no longer working, for example to dissolve a joint venture where the equity holders no longer want to pursue work together.
  • Divisive mergers can be used to isolate risk, as in the case of J&J, but this is not the only reason.
As you can see there are lots of legitimate reasons for divisive mergers to exist, which aren’t just to offer companies a way to protect themselves from lawsuits. Texas created the divisive merger to allow for these sorts of restructuring.

Additionally, if a company engages in a divisive merger and then has one of the resultant companies file for bankruptcy it is possible for the divisive merger to be characterised as a fraudulent transfer, which would then be void. These protections help to limit the extent the divisive merger can be used to help companies avoid their creditors/liabilities. Unfortunately, in the case of J&J these protections don’t seem to be sufficient which is why there are calls to end the Texas two-step.

I think that answers your questions. I’ve left out a lot of stuff so my answer didn’t get insanely long so if you want to know anything else/have any further questions I will be happy to answer!
 

Tstrack

Active Member
Premium Member
Sep 30, 2018
10
2
Hi All

Wanted to provide an update on the above - a new article has been published on the subject.


It largely confirms @IRO's commentary. I've briefly outlined recent developments in the article (not already covered by the above) for those interested:
  • The original lawmakers (Colin Huff, Steven Wolens) who wrote the bill allowing for divisive mergers have now commented on the recent use of the statute, stating that they did not intend for companies to use it to avoid liabilities.
  • The original intention of the statute was to create a more flexible business environment in Texas.
  • Ruling for the motion to dismiss LTL's bankruptcy, originally filed by the talcum powder lawsuit claimants, is expected by end of February. This is expected to either open floodgates for other companies to take advantage of the 'Texas Two-Step' or rule it out as a tactic.
 
  • Like
Reactions: IRO

James Carrabino

Legendary Member
Staff member
Future Trainee
TCLA Moderator
Gold Member
Premium Member
Forum Team
Junior Lawyer 11
Oct 12, 2021
661
1,417
TLDR: @Tstrack , you’ll want to research ‘divisive mergers’ if you want more information on why the statute was introduced in the first place/what the basis for the statute is. In essence, a divisive merger is used to provide a more straightforward way of restructuring companies based in Texas (and a few other locations). This restructuring can be for legitimate business reasons, but in general its used to shield a company from liabilities by transferring them to a separate company which then files for bankruptcy.

I’ve also included a Fact Profile for the J&J case for anyone who can’t access the FT article, which is behind a paywall.

Fact Profile:

  • There have been nearly 40,000 lawsuits alleging that Johnson & Johnson’s (J&J) talcum powder contained asbestos and caused cancer, which have resulted in $4.5bn in awards, settlements and litigation costs so far.
  • In response J&J has employed Jones Day to help the company through the process known as the ‘Texas two-step’, a divisive merger in which one company splits into two.
  • Jones Day has used this process to protect four clients facing asbestos-related litigation: Georgia-Pacific, a US unit of Saint-Gobain, Trane Technologies, and now J&J
  • J&J created a new subsidiary called LTL Management (LTL) and then split itself from this subsidiary. LTL holds all the liability for the talcum powder lawsuits, and has recently filed for Chapter 11 bankruptcy protection in North Carolina. North Carolina is the jurisdiction which makes it hardest for creditors to dismiss the filing. In November, the judge overseeing LTL’s bankruptcy case transferred it to New Jersey, where the majority of talcum powder lawsuits are based. A motion by talcum powder claimants to dismiss LTL’s bankruptcy is due to be heard on 14th February. Notably, Personal injury claims are halted during the bankruptcy process, so talcum powder claimants will see no progress on their lawsuits until the process is resolved unless they accept an out-of-court settlement.
  • Additionally, $2.3bn has been diverted from J&J to LTL Management to settle claims related to the talcum powder lawsuits. J&J denies it is trying to avoid its liabilities.

Questions​

  • What is the original basis for the statute which allows the Texas two-step?
  • Why has Texas provided a mechanism to split a company into two?

Divisive Mergers: The basis for the Texas two-step​

The process known as the Texas two-step was enabled by a revision of the Texas Business Organizations Code Title 1 (TBOC) in 2006. TBOC defines a “merger” as “the division of a domestic entity into two or more new domestic entities or other organizations”. This is known as a “divisive merger.” This is the original basis for the statue.

In term of why Texas has provided a mechanism to split a company in two it is essentially to allow the company a number of restructuring options. These benefit Texas by (a) making it a more attractive location to base your business, as divisive mergers are only available to “domestic” i.e. Texan companies, and (b) allowing Texan business to restructure to be more profitable, potentially raising higher taxes/boosting the Texan economy.

Obviously, these benefits do not apply if divisive mergers are simply used to protect companies from the liability of lawsuits. As @Abii mentions the process is usually used to protect against asbestos related cases.

However, there are many other reasons to pursue a divisive merger, and these could benefit Texas/Texan companies. For example:
  • The divisive merger allows for the transfer of assets without the need for numerous transfer agreements. Previously, companies were able to transfer these assets but the process was more arduous. The divisive merger simplifies the process.
  • A divisive merger also allows for the transfer of a contract which would otherwise be unassignable because of anti-assignment or anti-transfer clauses, provided that the contract did not have a change of control clause or similar provision.
  • A divisive merger can be used if the company wanted to sell a portion of the business. The entity could transfer the relevant assets/liabilities to a new entity and sell that company.
  • A divisive merger can be used to end a partnership which is no longer working, for example to dissolve a joint venture where the equity holders no longer want to pursue work together.
  • Divisive mergers can be used to isolate risk, as in the case of J&J, but this is not the only reason.
As you can see there are lots of legitimate reasons for divisive mergers to exist, which aren’t just to offer companies a way to protect themselves from lawsuits. Texas created the divisive merger to allow for these sorts of restructuring.

Additionally, if a company engages in a divisive merger and then has one of the resultant companies file for bankruptcy it is possible for the divisive merger to be characterised as a fraudulent transfer, which would then be void. These protections help to limit the extent the divisive merger can be used to help companies avoid their creditors/liabilities. Unfortunately, in the case of J&J these protections don’t seem to be sufficient which is why there are calls to end the Texas two-step.

I think that answers your questions. I’ve left out a lot of stuff so my answer didn’t get insanely long so if you want to know anything else/have any further questions I will be happy to answer!
Congratulations to @IRO for this excellent post, which has made you one of the first winners of our Starred Thread Awards! Thank you to @Abii and @Tstrack as well for your contributions :) This is a fascinating topic and I have learnt so much by reading what you all have to say!
 

About Us

The Corporate Law Academy (TCLA) was founded in 2018 because we wanted to improve the legal journey. We wanted more transparency and better training. We wanted to form a community of aspiring lawyers who care about becoming the best version of themselves.

Newsletter

Discover the most relevant business news, access our law firm analysis, and receive our best advice for aspiring lawyers.