The Texas Two-Step Controversy and Bankruptcy Forum Shopping

Introduction

The Texas Two-Step is the most contested bankruptcy structuring technique of the past decade, and the legal and political fight over it has reshaped how mass tort liability flows through the bankruptcy system. The structure uses a Texas state-law divisional merger to split a company into two pieces, with mass tort liability assigned to one piece and operating assets and a funding agreement assigned to the other. The liability-bearing piece then files Chapter 11, hoping to use the bankruptcy system to resolve the tort claims while the operating business continues outside bankruptcy.

This article walks through the mechanics, Johnson & Johnson's three failed talc filings and the out-of-court settlement that followed, and the forum-shopping fight that still shapes where large cases file.

The structure relies on a specific feature of Texas state law: the divisive merger statute in Texas Business Organizations Code Section 10.008, which lets a Texas corporation split itself into two or more entities and allocate its assets and liabilities among them. The typical Texas Two-Step has several steps:

Divisive Merger

A transaction under Texas Business Organizations Code Section 10.008 in which one entity divides into two or more, each taking designated assets and liabilities. Unlike a traditional spin-off or asset sale, a divisive merger is treated as a continuation of the original entity and does not trigger the same fraudulent transfer analysis. Texas is the best-known of the few states that permit it, and its statute is the legal foundation of the Texas Two-Step.

The appeal is clear: the healthy operating company stays out of bankruptcy, keeping its operations and relationships intact, while a structured Chapter 11 process caps the parent's exposure at a contractually defined funding amount. Plaintiffs' counsel objects that the structure separates the wealth (in the healthy entity) from the claims (in the bankrupt entity), making meaningful recovery harder.

Johnson & Johnson initiated the highest-profile Texas Two-Step in October 2021 when it created LTL Management LLC to hold its asbestos-containing talc powder liabilities. Through a Texas divisional merger, J&J transferred approximately 38,000 pending talc-related lawsuits to LTL, which filed Chapter 11 on October 14, 2021 in the Western District of North Carolina; the case was later transferred to New Jersey.

Bankruptcy Judge Michael Kaplan initially refused to dismiss, rejecting claimants' arguments that the filing violated Chapter 11's good faith requirement. On January 30, 2023, the Third Circuit reversed and ordered the case dismissed, reasoning that J&J's funding agreement left LTL with no real financial distress.

LTL refiled in April 2023 with a revised, less generous funding agreement designed to show the distress the Third Circuit had found missing. Judge Kaplan dismissed LTL 2 on the same good-faith grounds in July 2023, and the Third Circuit affirmed that dismissal in July 2024. The third attempt moved to Texas: in September 2024 a new subsidiary, Red River Talc LLC, filed a prepackaged Chapter 11 in the Southern District of Texas, and J&J's announcement of the Red River filing valued the plan at approximately $8 billion in present value (about $10 billion nominal over 25 years), enough to resolve 99.75% of all pending talc lawsuits against the company.

Claimed supermajority support did not save it. On March 31, 2025, Judge Christopher Lopez denied confirmation and dismissed the case for cause. As Hogan Lovells Cadwalader's analysis of the ruling sets out, he found solicitation and voting defects that left the debtor short of the 75% claimant support Section 524(g) requires, rejected a claimed "full pay" exception to the Purdue ban on nonconsensual third-party releases, and faulted an overbroad channeling injunction. J&J returned to the tort system.

Good Faith Filing Requirement

The rule that a Chapter 11 petition must serve a valid bankruptcy purpose, such as preserving value for creditors, and must not be a litigation tactic. Courts can dismiss a bad-faith filing under Section 1112(b). In the Third Circuit, a debtor must show genuine financial distress, which is why both LTL cases failed: a funding agreement from a solvent parent removed any real distress.

That chapter closed on July 27, 2026, when J&J announced a proposed resolution of its remaining 76,000 ovarian talc claims: a $5.5 billion commitment, with no more than $3 billion paid in 2027 and nothing further due before 2028, conditioned on participation by at least 95% of the remaining claims. The deal, which sits entirely outside bankruptcy, came five days after the federal MDL court ordered plaintiffs to show why their claims should not be dismissed for failure to prove specific causation.

The Aearo Technologies/3M earplug case took the same road faster: the Southern District of Indiana bankruptcy court dismissed it as a bad-faith filing in June 2023 because Aearo was not in financial distress, and 3M settled the claims for approximately $6 billion outside bankruptcy in August 2023, six times the amount proposed when Aearo filed in July 2022. J&J needed three more years and two more dismissals to reach the same place: paying claimants directly.

The Texas Two-Step controversy connects to a broader debate over forum shopping. Under 28 U.S.C. § 1408, a Chapter 11 debtor can file in any district where it has its principal place of business or principal assets, or where an affiliate has filed. That flexibility historically drove most large filings to the District of Delaware (where most U.S. public companies are incorporated) or the Southern District of New York.

Beginning in 2020, the Southern District of Texas (SDTX) attracted an increasing share of large filings; by the first half of 2023, nearly 50% of all large commercial bankruptcy cases filed there. The court built a complex-case panel of experienced restructuring judges, and one of them (David R. Jones) handled approximately 17% of all complex bankruptcy cases with over $1 billion in liabilities since 2020.

It did not end Houston's pull. Cornerstone Research's midyear 2026 report found that SDTX handled 32% of large corporate bankruptcy filings in the 12 months ending June 30, 2026, against 20% for Delaware and a historical Texas average of 13%. Saks Global filed there on January 13, 2026 owing at least $3.4 billion, and Dish DBS and Dish Wireless followed with a prepackaged Chapter 11 on June 30, 2026. Debtors prize its perceived speed and predictability; tort claimants say the same dynamic favors debtors over smaller and local parties. The SDNY responded to forum-shopping concerns in 2021 by randomly assigning mega Chapter 11 cases among all nine of its bankruptcy judges, regardless of courthouse.

Several proposals would curb Texas Two-Step structures and forum shopping. The Bankruptcy Venue Reform Act, introduced in multiple Congresses and most recently as H.R. 8111 in March 2026, would limit Chapter 11 venue to the district where the debtor's principal place of business or principal assets sat for the prior 180 days. It drops state of incorporation as a basis, confines the affiliate route to cases where a parent owning at least 50% of the debtor has properly filed, and disregards moves made within a year of filing to establish venue.

The Nondebtor Release Prohibition Act, also introduced in multiple Congresses, would codify the Purdue ruling and explicitly prohibit nonconsensual third-party releases. It has not been enacted.

The Texas Two-Step has been curtailed but not eliminated. The Third Circuit's good-faith test makes a well-funded, manufactured debtor nearly impossible to keep in Chapter 11 there, and Red River showed that moving to Texas does not escape Purdue or the Section 524(g) voting rules. Elsewhere the structure survives: Bestwall, Georgia-Pacific's asbestos spin-off, has been in Chapter 11 in North Carolina since 2017, and the Supreme Court declined in June 2026 to review the Fourth Circuit's refusal to dismiss it.

For mass tort defendants, the landscape now points toward direct settlement. Purdue (no nonconsensual releases) and LTL (no manufactured distress) close most bankruptcy pathways to durable liability protection, and J&J's July 2026 deal shows the trade-off: its headline $5.5 billion sits below the $8 billion present value offered through Red River, but it buys peace only for claims already filed, where the plan would have bound future claimants too. Bankruptcy is left for defendants that are genuinely insolvent.

For interview prep, know the three dismissals (January 2023, July 2023 and March 2025), the July 2026 settlement of at least $5.5 billion, the $6 billion 3M settlement and the October 2023 Judge Jones resignation. Together they tell one story: courts rejected an aggressive bankruptcy structure, a scandal tarnished the busiest large-case venue without dimming its appeal, and the defendants ended up paying claimants directly. The next article in this section turns to the 2026 outlook for the broader restructuring market.