Skip to main content
Gavel and scales in a judges office on a desk.

Litigation & the Business Bankruptcy Case

During a recent webinar, FORVIS examined a variety of litigation issues ranging from mass torts to small business bankruptcy cases. Read on for more.
banner background

During a recent webinar, FORVIS dove into litigation issues ranging from mass torts to small business bankruptcy cases under Subchapter V of Chapter 11. A discussion on avoidance actions also was held. View our insights on this issue below.

To kick things off, we began with the recent and active Johnson & Johnson case, which is challenging traditional thinking about when a company can or should use bankruptcy for protection.


Johnson & Johnson Consumer Inc. (Old Consumer) faces mass tort liability for ovarian cancer allegedly caused by talc (asbestos) in Johnson’s Baby Powder. Utilizing Texas’ divisional merger statute, “Old Consumer” with its parent—Johnson & Johnson (J&J)—does a corporate restructuring that reallocates assets and liabilities and results in the creation of LTL Management, LLC (LTL), effectively leaving LTL with claims and (new) J&J (New Consumer) with assets.

Purpose of the Chapter 11

New Consumer retains all the operating assets of the Old Consumer. LTL is allocated all the talc liability and receives nominal additional assets. LTL files Chapter 11 bankruptcy days after it is formed, and the divisional merger is completed.

Under a funding agreement, both entities agree to pay all bankruptcy and restructuring costs and all talc-related liabilities up to the value of J&J Old Consumer. It satisfies fraudulent transfer concerns related to the divisional merger and is the source of LTL’s Chapter 11 plan proposal to pay current and future talc claims through a trust under 11 U.S.C. Section 524.

In its simplest form, the perceived intent was to free the operations from the ongoing litigation and isolate claims to another company, creating an efficient forum (the bankruptcy court) for resolving such claims.

Creditors challenged the divisional merger and moved to dismiss the case under the assertion the case was not filed in “good faith.” The bankruptcy court denied the motion, but the Third Circuit Court of Appeals reversed, finding that LTL’s filing was not in good faith, and stated that the case should be dismissed. In support of its finding, the court found that “Financial Distress” is a requirement of “good faith”; without “financial distress,” there is no valid bankruptcy purpose to LTL’s filing. LTL does have significant talc-related liability, but it also has joint and several funding obligations from J&J and New Consumer up to $61 billion. The funding backstop means there is no present financial peril for LTL (total costs for talc-related litigation costs, settlements, and judgment in five preceding years are $4.5 billion).

As a result of the Third Circuit’s ruling, LTL’s case was dismissed, but it filed a second Chapter 11 case on April 4, 2023.1 The New Consumer Chapter 11 case is based on a Plan Support Agreement (PSA) with plaintiff law firms representing more than 60,000 talc claimants. The new funding agreement proposes $8.9 billion for a trust established to pay current and future talc claimants—more than three times J & J proposed in the first Chapter 11 filing.

While Johnson & Johnson is a “mega case” not qualifying for a small business reorganization, we then turned to one of the newer bankruptcy statutes that enacted laws affording debtors a more cost-effective and streamlined process for debt relief, as follows:

Small Business Reorganization Act

After years of study and debate, Congress enacted the Small Business Reorganization Act of 2019 (SBRA) with the purpose of providing a simpler, less expensive, and more effective restructuring option for eligible small businesses compared to “traditional” Chapter 11. An individual or business is eligible for SBRA if engaged in commercial or business activities, and liquidated debts are no more than $7,500,000.2 SBRA’s key differences from traditional Chapter 11s include:

  • Elimination of creditor sponsored plans
  • Elimination (with some exceptions) of the appointment of a creditors’ committee
  • Elimination of the “Absolute Priority Rule” as a condition to plan confirmation
  • Elimination of the requirement that at least one “impaired” class of creditors accept a debtor’s plan as a condition to confirmation
  • Elimination of U.S. Trustee fees
  • Addition of a statutory right to modify a non-purchase money mortgage secured by residential real estate if the mortgage debt was incurred in connection with the debtor’s business

The cumulative effect of these changes is the ability to confirm a plan absent creditor consent so long as: secured creditors receive value (cash or installment payments) equal to the present value of collateral, unsecured creditors receive at least the value they would receive in a Chapter 7 liquidation, and the debtor pays its projected net disposable income for a three-to-five-year period (as determined by the court) to fund plan obligations.

SBRA is a more powerful reorganization tool for the small business compared to traditional Chapter 11 with reduced costs, unincreased certainty of outcomes, and fewer distractions. SBRA filing also often compares favorably to state or federal court litigation to resolve claims.

In discussing SBRA, the presenters implied that SBRA can be an effective litigation tool for claims management, potentially including non-financial based litigation (such as product or contract liability) assuming the debtor otherwise qualifies, not only according to the statute, but now also potentially subject to the outcome of the Johnson & Johnson case concerning the need to be insolvent.

As we closed out the session, we next turned to Avoidance Actions and the Use of Financial Experts to assist in identifying or defending these actions.

Avoidance Actions

The primary purpose of avoidance actions is to allow debtors and bankruptcy trustees to avoid certain pre-bankruptcy transfers so that those transfers (or their value) can be recovered and redistributed to creditors in accordance with the “priority scheme.” These generally must be filed within two years of the petition date.

As for preference actions, the primary purpose is to equalize payments to creditors so that creditors who are paid before bankruptcy are not treated better than other creditors in the same class who were not paid, and to disincentivize creditors from picking apart a distressed company as it slides into bankruptcy. Requirements for a preference claim include:

  • The transfer was of the debtor’s interest in property;
  • The transfer benefits a creditor;
  • The transfer is on account of an antecedent debt;
  • The debtor is insolvent;
  • The transfer occurred within 90 days of the petition date (or one year for insiders); and
  • The creditor received more than it would in a Chapter 7 liquidation.

Key, Common Defenses in Preference Actions

Ordinary Course

A payment meets the definition of being made in ordinary course when the transfer was in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee, and such transfer was either made in the ordinary course of business or financial affairs of the debtor and the transferee; or made according to ordinary business terms.

  • Element #1 – Debt incurred in the ordinary course of business
  • Element #2 – Transfer made in the ordinary course of the parties’ respective businesses or financial affairs (subjective test)
  • Element #3 – Transfer made according to ordinary business terms (objective/industry standard test)

Subsequent Extensions of New Value

A creditor can reduce its liability to the extent the creditor gave “new value” to the debtor after the alleged preferential payment. Elements of the New Value Defense include:

  • The value was given to the debtor after the preferential transfer;
  • The new value was unsecured; and 
  • The new value remains unpaid—split in circuits on this element.

Contemporaneous Exchange for New Value

Required elements include:

  • The parties intended the transfer to be a contemporaneous exchange;
  • The exchange was actually contemporaneous; and
  • The exchange was for new value.

Fraudulent Transfers in Bankruptcy

Intentional Fraudulent Transfers – Badges of Fraud:

  • The transfer was to an insider.
  • The debtor retained control of the property after the transfer.
  • The transfer was concealed.
  • The debtor had been sued, or threatened with suit, before the transfer.
  • The transfer was not in the ordinary course of business.
  • The debtor transferred substantially all of its assets.
  • The consideration received was inadequate.
  • The debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred.
  • The transfer occurred shortly before or shortly after a substantial debt was incurred.
  • The debtor transferred the essential assets of the business to a lienor who transferred the assets to an insider of the debt.

Constructive Fraudulent Transfers

Under this test, the debtor must have “received less than a reasonably equivalent value in exchange for such transfer or obligation …” and the debtor also must be in one of three fragile financial conditions: (a) insolvency; (b) possessing an unreasonably small capital; or (c) believing that the debtor would incur debts beyond its ability to repay such debts after the transaction.

Utilization of Experts in Avoidance Actions

Experts, including CPAs, CFFs, CFEs, ABVs, ASA, and CIRAs, assist debtors and counsel in bringing or defending avoidance actions through a mix of objectivity, analytical skills, industry research, and tools and experience developed in prior cases to address patterns and industry “norms.” Consultants are often used to establish insolvency, a condition for avoidance actions, or alternatively, present findings that the debtor was solvent. Experts also can provide supportive and credible testimony in support of the defense or action brought to avoid such transfer.

If you have questions or need assistance, please reach out to a professional at FORVIS or submit the Contact Us form below.

Note: This article was prepared as a summary of a webinar on April 26, 2023. It should not be considered legal advice.

  • 1The motion to dismiss the second filing has been continued to June 27, 2023. The primary issue before the court is whether this second case also was a bad faith filing. Meanwhile, other courts appear divided on the issue of insolvency requirements for filing and/or use of the “Texas Two-Step” (see In re: Aearo Technologies [Case No. 22-02890] and In re: Bestwall LLC [Case No. 17-31795]).
  • 2Until June 21, 2024, at which time this limit sunsets back to lower limits.

Related FORsights

Like what you see?
Subscribe to receive tailored insights directly to your inbox.