By Jacquelynn Lin, J.D. candidate, Harvard Law School
STUDENT VOICES: The views expressed below are those of the student author and do not necessarily reflect the position of the Access to Justice Lab.
Johnson & Johnson (“J&J”) had a problem. Beginning in 2009, consumers across the country filed lawsuits alleging that asbestos contamination in the company’s talc-based baby powder products caused ovarian cancer and mesothelioma. In 2019, J&J recalled approximately 33,000 bottles of the product. Subsequent jury trials awarded plaintiffs billions in damages. In 2021, with over 38,000 ovarian cancer lawsuits still pending, J&J turned to the controversial corporate restructuring strategy known as the Texas Two-Step bankruptcy.
If successful, a Texas Two-Step would have deprived “hundreds of thousands of individual plaintiffs of their constitutional right to a jury trial” while allowing a “highly profitable company to reap…the benefits of the bankruptcy system without the attendant burdens.” For J&J, this maneuver paused tort litigation for years. Many tort victims never saw their day in court, and the company paid “less money, more slowly” to plaintiffs.
This post explains the Texas Two-Step, describes efforts to regulate its operation, and explores current reform efforts.
What is a Texas Two-Step Bankruptcy?
Pioneered in 2017, the Texas Two-Step is a contentious legal strategy companies use to manage mass tort liability while maintaining business operations. The maneuver leverages a “divisional merger” provision in the Texas Business Organizations Code, which permits a company to split into multiple entities and allocate its assets and liabilities among those entities.
To execute the maneuver, a liability-ridden company takes two steps:
- The Divisive Merger: The original company reincorporates in Texas to access the Texas Business Organizations Code and divides into two new entities – one with the lion’s share of the company’s assets (“AssetCo”) and the other with its tort liabilities and minimal assets (“LiabilityCo”). The two entities typically enter into a funding agreement under which AssetCo agrees to finance LiabilityCo’s tort liabilities up to a predetermined threshold and create a “settlement trust.” Afterward, AssetCo often reincorporates in Delaware to access favorable corporate law, while LiabilityCo usually reincorporates in North Carolina, where bankruptcy courts have historically been less likely to dismiss cases as filed in “bad faith.”
- The Bankruptcy Declaration: LiabilityCo files for Chapter 11 bankruptcy, triggering an automatic stay that halts its pending tort litigation. It may then seek an injunction extending protection to AssetCo and its subsidiaries, arguing that lawsuits against AssetCo could “adversely affect LiabilityCo’s bankruptcy estate and…hinder its reorganization.”
The Texas Two-Step is a fast dance. For example, in J&J’s case, the entire process occurred in three days. The company executed the divisive merger, assigned its liabilities to a newly created entity LTL Management LLC (“LTL”), and LTL filed for bankruptcy.
Through this process, the liability-laden company shields most of its assets from tort victims to whom it may owe billions, while the operating business continues its lucrative activities largely unaffected. Tort claimants are limited to recovering from the small pool of assets held by LiabilityCo and its settlement trust, potentially resulting in compensation amounting to only cents on the dollar. With tort litigation halted, plaintiffs lose a critical bargaining chip in settlement negotiations: the threat of jury verdicts and the accompanying reputational harm to the corporation.
More broadly, “gamification” of the bankruptcy system may erode public confidence in it. Successful use of the Texas Two-Step may also signal to other companies that they can shield themselves from product liability, thus weakening the deterrent effect of tort law against unsafe consumer products.
Why Involve Bankruptcy Courts in Mass Tort Litigation?
Despite this concerning legal innovation, resolving mass tort liabilities in bankruptcy courts is not new. In 1982, for example, the Johns-Manville Corporation filed for Chapter 11 bankruptcy, which resolved more than 16,000 lawsuits related to asbestos exposure and allowed claimants to recover substantial sums.
Bankruptcy offers several advantages in resolving mass tort litigation. First, bankruptcy promotes equitable treatment among claimants by preventing a “race to the courthouse” problem, in which early plaintiffs secure large judgments that deplete the defendant’s assets, leaving later claimants with little or no recovery. By centralizing claims, bankruptcy proceeding helps ensure that plaintiffs are treated consistently.
Second, bankruptcy reduces litigation costs and coordination challenges. Rather than litigating numerous cases across jurisdictions, one law firm may represent an entire class of tort victims, reducing aggregate legal fees.
Given these benefits, reform efforts have generally favored targeted rather than sweeping proposals. The goal is not to eliminate bankruptcy as a mechanism for resolving mass tort liabilities, but rather to prevent misuse and close loopholes, such as the Texas Two-Step. This blogpost next surveys ongoing regulatory efforts in response to the Texas Two-Step Bankruptcy maneuver.
Efforts to Regulate Texas Two-Step Bankruptcies
- Mixed Judicial Response
One potential constraint on Texas Two-Step Bankruptcies is the good-faith filing doctrine, which allows courts to dismiss bankruptcies filed in bad faith. However, circuit courts apply different dismissal standards, leading to mixed rulings.
Most Texas Two-Step bankruptcies have been filed in the Fourth Circuit, which demands that a litigant seeking dismissal of a bankruptcy show both (1) objective futility and (2) subjective bad faith. Under this standard, courts have been reluctant to dismiss bankruptcy filings. For example, last year, the Fourth Circuit allowed Bestwall LLC’s bankruptcy to proceed, enabling its parent company, Georgia-Pacific, to continue its Texas Two-Step maneuver. The majority concluded that the movants did not prove the bankruptcy was objectively futile, while the dissent warned that this precedent “opened the door to other companies that wish to avoid lawsuits.”
By contrast, the Third Circuit does not require movants to prove that a bankruptcy is objectively futile before dismissing a case. Instead, it asks (1) whether the bankruptcy was filed to obtain a tactical litigation advantage and (2) whether the bankruptcy serves a valid purpose. Applying this framework to the J&J facts described above, the Third Circuit dismissed LTL’s Chapter 11 bankruptcy filings in 2023 and 2024, The Third Circuit relied on LTL’s lack of financial distress as evidence of bad faith, which impeded J&J’s attempted use of the Texas Two-Step. As noted above, though, pro-consumer circuit law may be of little use because companies can forum shop the state in which they incorporate their LiabilityCos.
- Legislative Inaction: The Ending Corporate Bankruptcy Abuse Act
The primary proposed legislative response to Texas Two-Step bankruptcies is the Ending Corporate Bankruptcy Abuse Act (ECBA). Introduced in July 2024 by U.S. Senators Sheldon Whitehouse (D-RI) and Josh Hawley (R-MO), the ECBA aims to deter Texas Two-Step bankruptcies through two mechanisms.
First, the bill instructs courts to presume that Texas Two-Step bankruptcy filings are made in bad faith. The ECBA identifies indicators of a Texas Two-Step, such as recent divisive mergers and venue manipulation.
Second, the bill limits the ability of companies to extend bankruptcy protections to non-debtor affiliates. Specifically, the ECBA disallows halting litigation against parent companies that have engaged in a Texas Two-Step within the preceding four years, allowing claimants to continue pursuing claims against AssetCo.
Despite its bipartisan sponsorship, the ECBA’s prospects remain uncertain. No further action has occurred after its initial introduction in the House of Representatives and its referral to the House Committee on the Judiciary in 2024. In addition to competing for limited legislative attention, the bill has also drawn criticism from corporate and academic stakeholders. For example, Jessen urges the Senate to reject the ECBA for its “morally charged” and “incomprehensible” language, while Reisner et al. argue that the bad faith presumption may preclude companies from accessing bankruptcy as a legitimate tool for managing mass tort liabilities.
Looking Ahead: Reasons for Cautious Optimism
Although current regulatory frameworks do not adequately address Texas Two-Step Bankruptcies, recent legislative and judicial developments offer reasons for cautious optimism.
On the legislative front, House Representatives Zoe Lofgren (D-CA) and Ben Cline (R-VA) reintroduced the Bankruptcy Venue Reform Act (BVRA) on March 26, 2026. The bill signals renewed congressional interest in addressing forum shopping, which is central to Texas Two-Step maneuvers. Under the BVRA, Chapter 11 bankruptcies must be filed in jurisdictions tied to a company’s principal place of business or assets, thus limiting the ability of corporations to select favorable, pro-debtor jurisdictions. Although the BVRA did not pass in 2021 and 2023, its reintroduction may engender momentum for legislative reform.
For the judiciary, although the Supreme Court declined to review a Fourth Circuit ruling in favor of a Texas Two-Step Bankruptcy, it has demonstrated its willingness to scrutinize corporate misuses of bankruptcy law. In Harrington v. Purdue Pharma L.P., the Supreme Court rejected non-consensual third-party releases in bankruptcy settlements. The ruling hampers Texas Two-Step maneuvers by making it harder to release parent companies from liability and may encourage lower courts to regulate corporate gamesmanship in the bankruptcy system more strictly.
Finally, returning to the J&J case, after three failed Texas Two-Step Bankruptcy attempts, the company announced in 2025 that it would abandon bankruptcy proceedings, allowing plaintiffs to litigate their cases in the traditional tort system.
Overall, although current regulatory responses remain fragmented, these legislative and judicial developments suggest that the legal system may one day catch up to the corporations two steps ahead.
If you’re interested in more on this topic, listen to our podcast episode.