Friday, March 3, 2023

LTL Management and the Third Circuit: Financial Distress Required for Good Faith Filings


By Candice L. Kline, Esq.


Chicago, Illinois

This post is an excerpt from the forthcoming fifth installment in the Mass
Third-Party Releases Series in the upcoming CLW magazine.


          The recent Third Circuit opinion in In re LTL Management, LLC [1] focuses on when debtors may qualify for bankruptcy protection.  The appeal came from the bankruptcy court’s denial of motions to dismiss the LTL bankruptcy case based on allegations the filing lacked good faith.[2]  

          The Third Circuit examines the parameters of good faith and avoids other key techniques to access bankruptcy, isolate liabilities, and cap the liabilities in mass tort cases such as the legality of nonconsensual third-party releases (not yet ripe in LTL) and the propriety of the “Texas Two-Step” divisive merger and other affiliated-filing practices used in the service of protecting a financially healthy parent company without the hassle of filing bankruptcy itself.

          If viewed narrowly, the precedential opinion merely requires debtors to show some “financial distress” to establish good faith and avoid dismissal.  That requirement could be satisfied by adding a new section to a first-day affidavit, or perhaps more keenly, not waiting until the last minute to hive off the liabilities or to create a new affiliate only for bankruptcy purposes.  If considered more broadly, the Third Circuit may have opened the door to major rethinking in this area of “creative” practice.[3]

          On direct appeal of consolidated appeals by many parties, the Third Circuit reversed the bankruptcy court’s order denying the motions to dismiss and remanded the case to the bankruptcy court with instructions to dismiss LTL’s chapter 11 case.[4]

          The dismissal lifts a litigation stay on talc liability lawsuits and permits plaintiffs to resume their litigation as if the bankruptcy had not occurred.[5]  Although J&J promised an appeal, and has filed a petition for en banc review discussed below, success seems unlikely.  Few arguments seem likely to challenge Judge Ambro’s common sense premise: only debtors experiencing actual financial distress may seek bankruptcy protection.

          Judge Ambro clarifies lofty goals and good intentions “do not suffice alone.”[6]  He emphasizes the intended purpose of bankruptcy protection and limits its access to debtors “in financial distress.”[7]  After concluding that LTL was not in financial distress, the Third Circuit dismissed LTL’s chapter 11 petition, ending the bankruptcy. A petition for rehearing is pending.

          Judge Ambro emphasized that Third Circuit precedent seems to require proof of financial distress to establish a valid bankruptcy purpose and defeat a good faith challenge.[8]  An impaired or deteriorating financial condition, actual and not speculative, is a critical prerequisite for a good faith filing.  Reading Third Circuit cases, the opinion states “the theme is clear: absent financial distress, there is no reason for Chapter 11 and no valid bankruptcy purpose.”[9]  Financial distress is determined case-by-case.[10]

          LTL fell short of proving good faith because it had the financial means through the Funding Agreement to deal with the liabilities.  The Third Circuit held that only LTL’s financial condition matters for this test because it alone is the debtor with its petition facing dismissal.[11]  The good-faith requirement applies to the debtor in bankruptcy, not the corporate family.[12]  Here, the test applied to LTL alone, and it had recourse to cover its liabilities under the Funding Agreement up to $61.5 billion.[13]

          The Funding Agreement was backed by gold-standard corporate resources, with the J&J parent holding a AAA-credit rating, worth over $400 billion in equity value, and $31 billion in cash and marketable securities.[14]  With such financials, the Third Circuit concluded, “It is hard to imagine a scenario where J&J and New Consumer would be unable to satisfy their joint obligations under the Funding Agreement.”[15]

          The Third Circuit has spoken on the first gating issue: good faith filing.  Other important issues, such as third-party releases, remain at issue in the Purdue Pharma appeal to the Secord Circuit (pending) and the Boy Scouts plan appeal in the District of Delaware.  With each decision, the practice of mass torts in bankruptcy will morph and adapt.  Potentially, more legislation may enter the fray.

          J&J promised, and filed on February 13, 2023, a petition for rehearing and rehearing en banc of the Third Circuit’s precedential opinion.[16]  This petition remains pending.

[1] LTL Management, LLC. v. Official Committee of Talc Claimants, et al. (In re LTL Management, LLC), -- F.3d ---, Case. No. 22-2003 (3d. Cir. Jan. 30, 2023) (precedential).

[2] 11 U.S.C. § 1112(b). Id. at 29 (describing the motions filed by multiple talc claimants seeking dismissal of LTL’s bankruptcy petition).

[3] “That said, we mean not to discourage lawyers from being inventive and management from experimenting with novel solutions. Creative crafting in the law can at times accrue to the benefit of all, or nearly all, stakeholders.” LTL Op. 56.

[4] Id.

[5] Id.

[6] LTL Op. at 18.

[7] Id.

[8] Id. at 35.

[9] Id. at 36. The court adds, “[f]inancial distress must not only be apparent, bit it must be immediate enough to justify a filing.” Id. at 38.

[10] Id. at 38.

[11] Id. at 43.

[12] Id. at 44. (citing Ralph Brubaker, Assessing the Legitimacy of the “Texas Two-Step” Mass-Tort Bankruptcy, 42 No. 8 Bankr. L. Letter NL 1 (Aug. 2022)).

[13] Id. at 46.

[14] Id. at 47.

[15] Id.

[16] In re LTL Management LLC, Petition for Rehearing and Rehearing En Banc, Case No. 22-2003 (3d Cir. Feb. 13. 2023).

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