By Ralph Brubaker (University of Illinois College of Law)
This three-part article analyzes the innovative “Texas Two-Step” mass-tort bankruptcy phenomenon, in real time as the courts grapple with legal challenges to the fundamental legitimacy thereof. Through the Two-Step maneuver, an eminently solvent and thriving mass-tort defendant can isolate its mass-tort obligations in a newly created subsidiary that files bankruptcy. The legacy company provides a funding backstop that obligates it to pay the mass-tort liability, but the profitable business operations that must do so remain outside (and thus are not subjected to the substantial costs of) the bankruptcy process. The professed and only purpose of the bankruptcy filing, then, is to resolve the mass-tort litigation using the federal bankruptcy process rather than through the nonbankruptcy tort system.
Proponents argue that the Texas Two-Step bankruptcy merely provides a more efficacious means of determining and paying the mass-tort claimants what they are due. Looking “under the hood” of the complex bankruptcy process, however, reveals the multiple ways and means by which bankruptcy systematically prejudices the mass-tort claimants, particularly future claimants, and permits equity holders to capture value (and in some cases, potentially staggering amounts) at the expense of the mass-tort claimants. Most significantly, bankruptcy imposes a mandatory no-opt-outs settlement of (fixing a hard cap on) the defendant’s aggregate mass-tort liability that compromises individual tort claimants’ basic right to priority over (i.e., to be paid in full ahead of) equity interests.
When a mass-tort defendant poses no realistic prospect of inability to fully and timely pay all of the tort claimants, the good-faith filing doctrine of bankruptcy law provides a ready and proper means of dismissing the Two-Step bankruptcy case, which was the ultimate fate of the Johnson & Johnson/LTL Management cases in the Third Circuit. North Carolina bankruptcy courts, however, have refused to dismiss such cases on that basis, and thus the constitutional validity of those bankruptcy cases has been raised. While the issue is novel, Founding-era evidence, the Supreme Court’s consistent constructions of the meaning of the Bankruptcy Clause, and the structural relationship between the Bankruptcy Power and other constitutional rights and limitations, all strongly suggest that there must be a nonpaying-debtor limitation on the constitutional “subject of Bankruptcies.” Pursuant thereto, a putative bankruptcy debtor must pose a credible threat of inability or (in the case of an involuntary bankruptcy at the instance of creditors) unwillingness to fully and timely pay all creditors.
The structural importance of this nonpaying-debtor requirement flows from the ways in which bankruptcy comprehensively overrides multiple constitutional rights and limitations: Bankruptcy is a judicial process that forces all claimants into a mandatory federal-court process, that includes any and all state-law claims against a debtor-defendant, and that imposes an aggregate liability cap on those claimants, with no opt-out from that cap to pursue the debtor-defendant for full payment of the amount awarded by a jury in the available nonbankruptcy forums of claimants’ choice. Those fora are largely state courts because of states’ principal sovereignty over the development and administration of state-law claims, embedded in Article III’s limits on federal courts’ jurisdiction over state-law claims. In Ortiz v. Fibreboard, the Supreme court held that such a mandatory no-opt-outs federal-court process violates individual claimants’ due process and Seventh Amendment jury-trial rights if the defendant can fully pay all claimants. The nonpaying-debtor limitation on the Bankruptcy Power prevents such a defendant from broaching the Constitution’s Article III-Due Process-Seventh Amendment ring fence (protecting both individual claimants and state sovereignty) by simply choosing to file bankruptcy, e.g., via the Texas Two-Step stratagem.
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