Understanding Defendant Bankruptcy in Mass Tort Litigation: What You Need to Know

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Posted on Tuesday, December 19th, 2023 at 8:09 pm    

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    The purpose of bankruptcy is to give individuals and businesses in debt a “fresh start” while protecting the rights of the people to whom they owe money. However, some companies use the bankruptcy courts to avoid taking full responsibility for litigations. 

    The bankruptcy code (set out by title 11 of the United States Code) is incredibly complicated and some aspects of the process are controversial. If you are a plaintiff in a case and the defendant has just declared bankruptcy, we’ll help you understand what it means for your case. 

    Bankruptcy code basics

    What is bankruptcy?

    Bankruptcy is a legal process that may take place when a person or business can’t pay off their debts. Through filing in a bankruptcy court, the debtor (the person in debt) either liquidates their assets or creates a repayment plan. 

    While there are many types of bankruptcy, businesses have the option to file through either Chapter 7 or Chapter 11 of the U.S. Bankruptcy Code. In a Chapter 7 bankruptcy, also called a liquidation bankruptcy, the debtor’s property is sold in order to pay off their debts. In a Chapter 11 or reorganization bankruptcy, the debtor proposes a plan to the bankruptcy court to reorganize the business, often through a partnership or acquisition, and repay debts over time. 

    All bankruptcy cases must be filed in federal court. Across the U.S., there are 90 bankruptcy courts—one per federal judicial district, with a few exceptions. Each court is state-run and has its own local rules in addition to federal laws. 

    What are the requirements to file bankruptcy?

    Bankruptcy is generally filed by those unable to pay their debts, whether individuals, businesses, or other debtors. Specifically, Chapter 11 (the most common bankruptcy filed by defendants in mass tort cases) is usually filed by companies who need time to restructure their debt with the goal of eventually becoming financially secure. 

    The bankruptcy process itself is expensive, and generally comes with consequences including lowered credit and damage to a business’s reputation. That said, under both Chapter 7 and Chapter 11, almost any business or individual in the U.S. is allowed to file for bankruptcy—regardless of their income or debt amounts. This means that theoretically any corporation can file a bankruptcy petition, even if they are not in financial difficulty. 

    What happens after a company files bankruptcy?

    As soon as a bankruptcy petition is filed, an automatic stay goes into effect for the debtor. This injunction immediately stops all lawsuits against them, effectively protecting them from litigation until the process is resolved. 

    The case will go to bankruptcy court, which will manage the process and determine the validity of the debtors’ claim. If the petition is allowed to go forward, lawsuits against the debtor won’t be heard by juries—instead, they will be handled by the bankruptcy judge. 

    Litigation is already a time-consuming process, and whether or not the bankruptcy goes forward, the petition and subsequent court process can extend the timeline by a year or more. The more corporations are able to delay, the more likely it is that plaintiffs will give up on their cases or that relevant evidence will no longer be available. While these delays can be frustrating to plaintiffs, lawyers, and courts, we are committed to seeing your case through regardless of how long the bankruptcy process takes.  

    Key terms in the bankruptcy process

    Automatic stay: An injunction that goes into effect the moment bankruptcy is filed. It pauses any lawsuits and collection activity against the debtor. 

    Bankruptcy petition: The document filed that opens the bankruptcy case. 

    Chapter 7 Bankruptcy: Also called a “liquidation” bankruptcy, this type of bankruptcy can be filed by individuals, partnerships, and businesses and involves selling off the debtor’s property to pay off debts. After a business declares Chapter 7, it will cease to exist. 

    Chapter 11 Bankruptcy: Also called a “reorganization” bankruptcy, Chapter 11 usually involves a corporation or partnership. In this type of bankruptcy, the debtor proposes and executes a plan to reorganize their business and repay debts over time. As a result, the business can continue to exist and work towards becoming financially successful again. 

    Creditor: The individual or business to whom money is owed. 

    Debtor: The individual or business who has declared bankruptcy. In cases where a defendant in a litigation files for bankruptcy, the defendant is the debtor. 

    Image by Pixabay.

    Understanding defendant bankruptcy

    Why would mass tort defendants declare bankruptcy?

    In multidistrict litigation (MDL), the cases of many plaintiffs against the same defendant or group of defendants are consolidated in one court. This enables plaintiffs, defendants, and courts to gather information that applies to all cases, rather than conducting hundreds or hundreds of thousands of cases individually. 

    Generally speaking, if a defendant in an MDL is allowed to declare bankruptcy, a trust is set up to pay out any outstanding mass tort claims. Going through bankruptcy trusts almost universally result in much lower compensation amounts for plaintiffs in the litigation. “These bankruptcies are described as a ‘maneuver’ for a reason,” says Arielis Reyes, a paralegal at Wallace Miller. “Big businesses use them to seek resolution in another court, because the settlement amount might be reduced or eliminated.” 

    In short, if a company can successfully file bankruptcy while maintaining company operations, it can offload the burden of paying for litigations and preserve its bottom line—at the expense of the plaintiffs who have brought cases against it. Bankruptcy procedures also prevent the lawsuits from being heard by juries, instead resolving them through bankruptcy courts, in which plaintiffs have no choice but to abide by the plan worked out by the committee. Finally, depending on the reorganization plan, declaring bankruptcy may shield the defendant from future legal liability. 

    The history of bankruptcy court and MDLs

    The case generally regarded as the first to involve a bankruptcy in an MDL process is the 1982 Johns-Manville bankruptcy. The company, which manufactured and distributed asbestos products, was sued by thousands of individuals in the early 80s. In 1982, they filed bankruptcy, which automatically suspended all lawsuits. Contemporary scholarship published by the Notre Dame Law School found that the reorganization plan was “an attempt by a healthy and solvent corporation to declare bankruptcy” in bad faith and called for its dismissal. However, the bankruptcy was allowed to go forward, and a trust fund was created in 1988 to settle current and future asbestos-related claims. 

    The trust began with $2.5 billion—not nearly enough money to pay all claimants what they would be owed under a non-bankruptcy settlement. As a result, the trust does not pay claimants the full settlement value, but rather 5.1% of the value at each compensation level. 

    Drug maker Purdue Pharma and its owners, the Sackler family, have become notorious in recent years for their links to the ongoing opioid epidemic. Their medication OxyContin has been blamed by experts in public health for helping to start the opioid crisis. More than a thousand lawsuits had been filed against the company by 2019. 

    In 2019, the company filed for Chapter 11 to address the claims against them and an automatic stay was placed on litigation. In 2021, a federal bankruptcy court in New York approved a global settlement that included wealthy members of the Sackler family. Through the $6 billion settlement trust, to which the Sacklers pledged to contribute (although not before withdrawing $11 billion from the company), Purdue Pharma and the Sackler family would have been able to resolve current lawsuits and walk away free from future civil claims. In addition, although Purdue Pharma twice pleaded guilty to federal criminal charges, the Sacklers were never charged with any crimes. 

    The case drew significant attention both to Purdue Pharma and the practice of using bankruptcy court to resolve mass torts. Experts pointed to the case as evidence of a trend that wealthy individuals and corporations are using loopholes in bankruptcy law to get out of liability. 

    After years of contradictory court decisions, the plan was blocked by Supreme Court in August 2023. The petition was deemed to be an abuse of the bankruptcy system, as it could not be used to shield the Sackler family from all future lawsuits. 

    In another recent case, the Boy Scouts of America have recently faced thousands of lawsuits by former scouts alleging sexual abuse during their time with the organization. In February 2020, the Boy Scouts filed for bankruptcy protection, claiming that they would not survive as an organization without bankruptcy resolution of the lawsuits, and the U.S. District Court of Delaware approved a $2.46 billion reorganization plan. This plan allowed the organization to keep operating while compensating those who submit claims to the trust. After multiple appeals, the 3rd U.S. Circuit Court of Appeals declined to put the settlement on hold, allowing the resolution through bankruptcy court to continue. The settlement was supported by 86% of claimants, and the BSA successfully exited bankruptcy in April 2023. 

    What is the “Texas two-step”?

    The “Texas two-step” refers to a legal but controversial method for shifting mass tort liability into the bankruptcy system. Under a divisive merger statute in Texas, a company can create a new subsidiary, then split present and future liabilities from the solvent parent company’s assets and assign them to this company. 

    This effectively creates a new business entity which holds all legal liability, while the original parent company (or the other new company created by the division) keeps all its assets. Then, despite the fact that the parent company is still financially stable, the company holding the liabilities declares bankruptcy. This results in an automatic stay of litigation against the subsidiary and the parent corporation, and limits the amount the company will need to pay in compensation to the plaintiffs. It also means that the original company faces none of the consequences of bankruptcy, including damage to their credit rating or reputation. 

    The use of bankruptcy court by wealthy corporations to avoid paying out their legal damages to people harmed by their products is highly controversial. Politicians, legal experts, lawyers, judges, and other advocates have been critical of the tactic and several high-profile petitions have recently been rejected. However, the maneuver remains legal and commonly utilized as an “escape hatch” in mass tort litigation. 

    Case: 3M combat earplugs

    3M is a Fortune 500 company that made $34.2 billion in net sales in 2022. Since 2018, hundreds of thousands of veterans have brought claims against the company alleging that the combat earplugs they produced with their subsidiary Aearo Technologies were defective, leading to hearing damage and tinnitus. 

    After nearly four years of litigation, 3M abruptly declared bankruptcy on behalf of Aearo in 2022 and attempted to shift all liability to the subsidiary company. 3M has claimed it did so in response to a multidistrict litigation system “broken beyond repair,” alleging that many of the plaintiff claims hadn’t been vetted for legitimacy. However, plaintiffs’ lawyers have pointed out that 3M had no issue with the process until a majority of the initial jury trials were decided in favor of the plaintiffs, with more than $260 million awarded in damages. 

    In June 2023, federal judge Jeffrey J. Graham of the U.S. Bankruptcy Court for the Southern District of Indiana denied the company’s request for bankruptcy and ruled that plaintiffs’ cases should be allowed to proceed. Two months later, in late August 2023, 3M announced that they had agreed to a settlement of just over $6 billion, pending acceptance by plaintiffs. “It’s good news,” says Wallace Miller partner Timothy Jackson. “This was a case with a bankruptcy, and now it’s settling. So bankruptcy doesn’t mean the end of the road by any stretch.” 

    “It’s been a beautiful result in the 3M case,” Jessica Wieczorkiewicz, the litigation lead attorney at Wallace Miller, adds. “But we still lost that whole year.” 

    The 3M corporate headquarters in Minnesota. Photograph by Tony Webster from Minneapolis, Minnesota, United States, CC BY 2.0, via Wikimedia Commons.

    The 3M corporate headquarters in Minnesota. Photograph by Tony Webster from Minneapolis, Minnesota, United States, CC BY 2.0, via Wikimedia Commons.

    Real-world impact: How 3M’s attempted bankruptcy impacts veterans

    When Daniel, a veteran who served from 1988 to 2018, first heard about the lawsuit against 3M, he initially thought it was a scam. But as he read more about the case’s details, he realized how similar the allegations were to his situation. During his fourth deployment in 2008-2009, he says, “I remember using the 3M earplugs, I remember them being issued to us. We were given a tutorial on how to use them.” During that deployment, he was consistently exposed to loud noise, including machine gun fire—and after he returned home, he noticed his tinnitus for the first time. “And then I noticed how it got worse,” he says, “how my hearing loss actually seemed to increase.” 

    There’s a trend in the military, Daniel says, of soldiers not always seeking the medical care they need when they need it. “I was worried that was going to be me as well,” he says. “Did I go to the doctor when I started noticing my tinnitus? Did I go when I started getting more significant hearing loss, or was I just being a soldier? We always suck it up—we think, ‘This is going to get better, this is just part of the job.’ At the end of the day it hurts a lot of people.” 

    While it was initially challenging to track down his medical records, the military’s thorough documentation ended up paying off. Daniel was able to find the records of his doctor visits and provide the information needed to support his case. After that, the lawsuit was successfully filed and proceeded along the usual timeline. According to our attorneys, Daniel and plaintiffs like him would have typically already had a trial if not for 3M’s bid for bankruptcy. Instead, the process stalled. In the end, it caused almost a year of delay in the case. 

    Daniel is prepared to be patient. “If the process takes a while, as long as it’s done right and 3M is held accountable, I’m okay with it,” he says. But that doesn’t mean the corporation’s bankruptcy gambit doesn’t bother him. The most frustrating part, he says, is “the fact that they’re trying not to take responsibility for the flawed product that they put out there. If they know that they caused these damages to a lot of people’s hearing, they need to take accountability and do what needs to be done.” 

    A potential financial award in his case could help with quality of life and medical bills. But ultimately that isn’t what matters most to Daniel. “The hearing loss I suffer and the tinnitus I deal with… It’s 24/7. It doesn’t go away. And of course it bothers me some, but I’m not doing this for the financial gain,” he says. “You can’t really compensate me, unless you can take my tinnitus away. I’m going through this more out of trying to get justice or do what’s right.” 

    “I’m going to deal with this for the rest of my life,” Daniel adds. “But to try to file bankruptcy just to get out of taking responsibility for the damages your product caused… It’s discouraging.” 

    With the rejection of 3M’s tactics in this case, and in several other recent high-profile cases, some legal professionals hope that judges will crack down on these strategies. Big cases like these set a legal precedent. And, in the end, one of the goals of these lawsuits is to incentivize corporations to create safer products, products that consumers can trust. “When I was using the earplugs, I was doing the right thing to protect my ears,” Daniel says. “You want to continue to use products that are put out for their intended purposes. And hopefully they do what they’re supposed to, and they protect us in the right way—but we just don’t know what we don’t know.” 

    The veteran is also familiar with the harm caused by opioid painkillers and the lawsuits that have been filed as a result. Doctors in the military would often prescribe opioids for pain management before it was proven how addictive they could be. Opioid addiction has become a widespread problem among veterans, and the role of opioid manufacturers and distributors in the epidemic has been the subject of multiple lawsuits. 

    In cases like these, Daniel says, the money that he or others receive matters less than preventing it from happening again. “Maybe other companies in the future, they see these cases and realize, ‘You know what? We could cut corners this year. But if we do that, how are we impacting the lives of the people that are using their products?'” he says. “And hopefully these companies say, ‘Hey, it’s not worth the risk. Because we don’t want a lawsuit, so let’s do the right thing and let’s make a quality product for our consumers.'” 

    3M’s initial settlement offer—presented after their request for bankruptcy was rejected by a federal judge—is currently under negotiation. While he’s looking forward to the end of the process, Daniel says, “one of the biggest things for me is that I hope it’ll be publicized across all media. Just to let everyone know that they—it’s hard to say took accountability for it, since they’ve been trying to dodge it left and right—but that at least the soldiers who suffered from using the earplugs, at least they got compensated in some way.” 

    Daniel urges other veterans and service members impacted by the earplugs to do their own due diligence in terms of finding the records they need for a case. “Work with a good law firm that’s going to do their part,” he says, “and it’ll be worth it in the end, even if it’s just to keep the company accountable.” 

    Case: Johnson & Johnson baby powder

    Pharmaceutical company Johnson & Johnson (J&J) is the defendant in more than ten thousand claims consolidated in the U.S. District Court for the District of New Jersey. Plaintiffs claim that the company’s talc products, including their baby powder, contained asbestos and may have caused cancer. 

    In October 2021, J&J established a subsidiary called LTL Management LLC to hold the liability for the talc lawsuits. Two days later, the company filed for protection from litigation under Chapter 11 bankruptcy in a classic Texas two-step. In January 2023, the Second Circuit court dismissed the bankruptcy filing, finding that LTL was not in legitimate financial distress. The case was formally dismissed in April 2023; hours later, J&J refiled for bankruptcy with a higher trust amount. 

    The Chapter 11 case was again dismissed as of July 2023, with New Jersey bankruptcy judge Michael B. Kaplan once again arguing that it did not meet the standards for financial distress. The judge wrote: “Simply put, the debtor does not meet the more exacting gateway requirement implemented by the Circuit with respect to ‘good faith’ under 11 U.S.C. §1112(b), which would allow LTL to take advantage of the tools available under the Bankruptcy Code to resolve its present and future talc liabilities.” While these bankruptcy attempts have failed, they have delayed the litigation process by more than two years. 

    The J&J bankruptcy attempts are a particularly egregious example of corporations attempting to avoid mass tort liability through bankruptcy court. The company is one of the wealthiest in the world, with more than $25 billion in cash reserves; in the first quarter of 2023, it paid out $2.9 billion in dividends to shareholders.  

    Their bankruptcy petitions have attracted widespread attention, with politicians including Senators Dick Durbin and Elizabeth Warren speaking out against the company’s maneuvers and calling on Congress to close the Texas two-step loophole. 

    Johnson & Johnson’s talc baby powder is one of the products in question in the talc lawsuits. Photograph by Austin Kirk, Public domain, via Wikimedia Commons.

    Hear from our attorneys

    The attorneys at Wallace Miller have dedicated their careers to representing plaintiffs against large corporations like 3M and Johnson & Johnson. Through mass tort and class action litigation, individuals who otherwise would not be able to stand against these companies have a shot at receiving compensation. 

    The bankruptcy attempts by wildly profitable companies break that system. “The deck is already stacked against individual folks,” says Wieczorkiewicz. “This is just another example of big corporations finding loopholes to help themselves.” 

    “It’s a really disappointing thing, any time you see the defendant pull this maneuver, because they’re trying to get away from being accountable for what they did,” she adds. “I can’t believe the law allows for it—it’s ridiculous that the tax code has this loophole that allows the defendants to do this when we all know it’s a sham.” 

    Even if the bankruptcy bids are rejected, slowing the process is to the defendants’ advantage. “It’s part of their delay, delay, delay strategy, which causes the longest timelines,” Wieczorkiewicz says. “More time before payout is helpful for them. The more you delay, the less salient details are. People forget, or people aren’t able to get their medical records in time, or the statute of limitations passes. It makes people’s cases weaker. The more the defendants delay, the less evidence there is.” 

    And if the bankruptcy petition is accepted, the entire litigation will be shifted to the bankruptcy courts and begin a new legal process. Under bankruptcy procedures, the courts determine how best to pay all of the debtor’s creditors from a set pool of money. Depending on where claimants fall in the line of creditors, they often receive a much smaller amount than they would be entitled to under non-bankruptcy courts. 

    Still, these defendant bankruptcies are not a get-out-of-jail-free card. “We’re making sure everything that can be done is being done to protect your case,” Jackson says. “We won’t forget about you. The bankruptcy doesn’t mean your case automatically goes away.” And it isn’t only plaintiffs’ lawyers who are opposing the Texas two-step and unethical bankruptcy practices: federal and state judges are increasingly on the plaintiffs’ side, as more and more wealthy companies try to take advantage of the system. 

    The most difficult thing to deal with in the litigation process can be the waiting, especially when bankruptcy stretches the timelines even further. But throughout this process, your lawyers are working tirelessly to make sure your case is heard. Ultimately, the wealthy corporations declaring bankruptcy are doing so in order to make the lawsuits against them go away. But Wallace Miller, plaintiffs’ lawyers across the U.S., and the growing number of judges and politicians opposing this tactic aren’t going anywhere. “We’re doing everything under the law to continue to fight for you,” says Jackson. 

    What does a defendant bankruptcy mean for me?

    How can a company claim bankruptcy when they are financially successful?

    As law professor Melissa B. Jacoby writes in the Texas Law Review, there is an attitude in some legal professionals that “injured people might be better off if a financially struggling enterprise survived.” According to this argument, if a company goes under, no one will be paid anything, so it’s better to go into bankruptcy proceedings and receive less. 

    While this may be true in situations where defendants are in genuine financial distress, in lawsuit after lawsuit this has been proven not to be the case. In 1982, law experts at Notre Dame emphasized that Johns-Manville was solvent, and in the past few years, billion-dollar companies 3M and Johnson & Johnson have tried to claim bankruptcy on behalf of their subsidiaries for the sole purpose of paying plaintiffs less. These companies are exploiting a loophole in bankruptcy law and effectively taking advantage of the system to avoid their liabilities. 

    Writing in the Yale Law Journal, University of Georgia professor Lindsey D. Simon talks about companies that are solvent non-debtors attempting to rig the system. “These ‘bankruptcy grifters’ act as parasites,” she says, “receiving many of the substantive and procedural benefits of a host bankruptcy, but incurring only a fraction of the associated burdens.” 

    What does a defendant bankruptcy mean for my lawsuit timeline?

    In general, if a defendant in a mass tort litigation files for bankruptcy, it will slow the entire process down. This is because when an entity initially files their petition, they will then also file for a stay. This stay will pause all lawsuits against them and transfer existing proceedings into the bankruptcy court. 

    As a result, the MDL judge will generally relinquish oversight of the case to the bankruptcy court. The cases that have been brought against the defendant will need to go through a completely new set of proceedings, as the bankruptcy court must re-review the cases against the defendant. 

    In several prominent cases represented by Wallace Miller, including the talc litigation against Johnson & Johnson and the combat earplugs lawsuit against 3M, the defendant tried multiple times to declare bankruptcy. In both cases, the courts ultimately rejected the petitions, but the complicated court proceedings extended the process by years. 

    As a plaintiff already involved in a time-consuming and stressful process, it can be frustrating to see further delays as a result of defendant bankruptcy claims. Our legal team does everything we can to battle these claims and hold successful companies accountable as quickly as possible. We believe that you deserve justice through a fair settlement or verdict. 

    Will the legal system continue to allow these bankruptcy attempts?

    With rulings against large corporations in cases like those regarding Johnson & Johnson and 3M, it seems as though opinion may be turning against the use of bankruptcy by these companies. “In general, courts have been skeptical of at least what Johnson & Johnson has done, the so-called Texas two-step,” says Jackson. But he adds that some states are always going to want to favor corporations legally in order to attract and keep business. 

    However, Johnson & Johnson’s petition for bankruptcy has now been dismissed twice. “Big cases set legal precedent,” says Reyes, and this is a precedent that judges will likely cite in the future. And the more judges who rule that the Texas two-step is invalid, the stronger the plaintiff position becomes.  

    Left to right: Nicholas P. Kelley, Edward A. Wallace, Molly Condon Wells, Mark R. Miller, Jessica Wieczorkiewicz, Timothy E. Jackson.

    As a plaintiff, what can I do about it?

    There is very little that plaintiffs can do directly if a defendant declares bankruptcy. Legally speaking, the company is within their rights to file a petition, and as long as the loophole in the law that enables the Texas two-step continues to exist, they will continue to do so. 

    However, rest assured that even when the defendants are trying to avoid their liability through bankruptcy courts, your lawyers are still fighting for you. The legal team at Wallace Miller works tirelessly to make sure that you receive the compensation you deserve. 

    The attempts of large, wealthy corporations like 3M and Johnson & Johnson have brought increased attention to the practice of defendant bankruptcy. Many judges in both the federal and bankruptcy courts have been increasingly opposed to the practice, and this has been reflected in the rejection of petitions from these large corporations. And with judges, politicians, lawyers, and plaintiffs speaking out against this practice, it is possible that legal change is on the way. 

    Questions about defendant bankruptcy and what it means for your litigation? Contact Wallace Miller at 312-261-6193 to discuss your case. 

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