The background: Multiple Texas two steps and multiple reps by Jones Day

As explained in the objection, J&J and its affiliates were named in tens of thousands of lawsuits alleging personal injuries caused by talc in certain products the company manufactured or sold. In 2021, J&J, represented by Jones Day, pursued a “Texas Two-Step.” Step one is involves a company with significant tort liabilities creating an entity domiciled in Texas and then splitting that domiciled entity in two using the divisional merger statute. Typically all liabilities along with maybe a few good assets are assigned to one entity (the “BadCo”) and all or most good assets are assigned to the other entity (the “GoodCo) and GoodCo executes a contract where it agrees to indemnify BadCo for tort liability. In step two, BadCo files for bankruptcy and GoodCo agrees to pay the administrative costs and a fixed contribution to a trust that will be set up for BadCo’s tort claimants in exchange for a release and injunction from all tort liability.

For step one here, Jones Day, representing J&J, domiciled the consumer division of J&J known as J&J Consumer Inc. (JJCI) in Texas. Then Jones Day advised J&J to split the JJCI company, creating the two entities: New JJCI (GoodCo) and LTL Management (BadCo). LTL was assigned all of old JJCI’s talc and mesothelioma liabilities. J&J, still represented by Jones day, negotiated a funding agreement across from LTL, where J&J and New JJCI gave LTL the right to payment up to the value of New JJCI, which at the time was approximately $61.5bn.

For step two, which occurred just days after LTL was formed, Jones Day, now representing LTL, converted the entity into a North Carolina LLC and filed for bankruptcy in North Carolina with Jones Day as proposed debtor’s counsel. Ultimately the case was transferred to New Jersey and was dismissed by the Third Circuit for bad faith, specifically lacking a valid purpose since there was no showing of financial distress.

Two years later, in 2023, New JJCI would transfer a number of its assets to its parent entity, which would later spin those assets into a new company, devaluing New JJCI. After that, LTL, still represented by Jones Day “agreed to cancel the 2021 Funding Agreement and voluntarily relinquish its principal asset—its rights to more than $61.5 billion from its affiliates—which was to be replaced with a similar, but far less valuable, agreement,” according to the US Trustee. The US Trustee also notes that no business rationale was provided for these transactions, and the “only conceivable purpose of these transactions was to manufacture ‘financial distress’ for LTL in a future chapter 11 case.”

After this transaction LTL again filed for bankruptcy, which was again dismissed. LTL with Jones Day as its counsel pursued an appeal of the dismissal.

While this appeal was pending in December 2023, LTL renamed itself LLT Management and changed its state of formation to Texas. In 2024, more corporate mergers and splits occurred resulting in three entities: (1) the debtor, Red River Talc, which was assigned only certain LTL talc-related liabilities; (2) a different entity called Pecos River Talc, which received the asbestos exposure liabilities, and (3) a new holding company, which was allocated all other assets and executed a funding agreement to pay the administrative expenses of a bankruptcy and to fund the talc personal injury trust under a plan for up to $7.9bn over 25 years, or $6.5bn on a net present value basis, which the US Trustee notes is over $2bn less than was available under the 2023 funding agreement with LTL.

With that, Red River Talc filed for bankruptcy with Jones Day as debtor’s counsel.

UST says Jones Day cannot represent them all

According to the US Trustee’s objection, “Jones Day’s representations include the following:

1. J&J prepetition in the 2021 Divisional Merger;
2. Old JJCI pre-petition in the 2021 Divisional Merger;
3. Certain J&J affiliates pre-petition and post-petition in purportedly unrelated matters;
4. J&J post-petition in purportedly unrelated matters;
5. LTL in both of its dismissed bankruptcy cases, and
6. The Debtor.”

Given all these representations, the US Trustee argues that Jones Day is not disinterested and holds an adverse interest against the estate.

The legal analysis

Section 327(a) of the bankruptcy code allows the debtor in possession to employ professional persons that “do not hold or represent an interest adverse to the estate” and that are “disinterested persons.”

According to Section 101(14) of the bankruptcy code, the term “disinterested person” means a person that:

1. Is not a creditor, an equity security holder, or an insider;
2. Is not and was not, within 2 years before the date of the filing of the petition, a director, officer, or employee of the debtor; and
3. Does not have an interest materially adverse to the interest of the estate or of any class of creditors or equity security holders, by reason of any direct or indirect relationship to, connection with, or interest in, the debtor, or for any other reason.

Given the Jones Day was the “architect” of both the 2021 divisional merger (including the 2021 funding agreement) and 2024 divisional merger, the US Trustee argues that Jones Day is on “both sides of the deal and raises several questions for Jones Day concerning issues of fundamental, inherent, and structural conflicts, inter-company claims and other issues that may exist between and among the Debtor, LTL, J&J, Old JJCI, New JJCI and other related J&J affiliates and subsidiaries.” The US Trustee characterizes this as an inherent conflict of interest and believes Jones Day cannot be seen as disinterested.

The US Trustee does not provide further analysis in its objection. Although this fact pattern raises questions, the objection does not really dive into how Red River Talc’s current interests in bankruptcy differ from any of its parent companies or non-debtor affiliates.

Outside of bankruptcy, the fiduciary duty is owed to the company and its shareholders; once a company enters the zone of insolvency, it owes a fiduciary duty to its creditors as well. Here, 9fin would point out an argument that the UST could have made but did not: Jones Day’s previous representations might have created an adverse interest and have “(1) economic interest that would tend to lessen the value of the bankruptcy estate or create an actual or potential dispute with the estate as a rival claimant, or (2) a predisposition of bias against the estate,” since creditors would benefit from Red River Talc going after J&J and its affiliates for more money to fund the settlement trust. Said another way, given Jones Day structured the funding agreements and offloading of talc liabilities to the entity filing that is now in bankruptcy, it would be difficult for Jones Day to argue that the very funding agreements and corporate maneuvers they structured were unfair.

The US Trustee and the coalition’s similar objections over appointing Randi Ellis as Legal Representative for Future Talc Claimants due to concerns over her ability to remain neutral were denied on 12 November. Jones Day as the debtors representative has the burden of proving it meets the disinterestedness standard.

Jones Day has not responded to requests for comment.

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