Johnson & Johnson Loses Texas Two Step Legal Dance - What Are The Implications?
It has been awhile but we wanted to come back to one of our oldest topics and both provide an update and also highlight something new.
Over a year ago we introduced and discussed a legal maneuver widely known in financial circles as the "Texas Two Step."
This is a scheme where a company can split itself into two legal entities and ring fence their liabilities into one of the two companies to better manage the threat of mass litigation.
For years, the Texas shuffle has been a neat trick with serious benefits for many US companies. It allowed very large and very profitable US companies to use complex legal machinations that used and abused Chapter 11 bankruptcy to avoid and minimize legal liabilities.
It was bullshit, in other words.
Our argument about the Texas Two Step was pretty simple:
This might have be a slick piece of corporate ballet but it was morally and ethically dubious.
We hoped that US courts would no longer permit it and, regardless of how they adjudicated that question, our company was founded so you could neatly avoid companies that try this maneuver.
You can read our previous work right here.
In the far more important here and now, we are thrilled to report that there have been some rather significant developments in a legal case around Johnson & Johnson's attempt to use this notorious legal scheme to limit the damage owed to frequent users of their famous Talc-based Baby Powder that they claim causes cancer.
The long and short of it is that a US bankruptcy court ruled that a Johnson & Johnson subsidiary was “not sufficiently financially distressed to avail itself of bankruptcy.”
In doing so the court pointed out something that just about everybody but Johnson & Johnson's high paid executives and lawyers could see was self evident:
Johnson & Johnson is nowhere close to being bankrupt.
In actual fact, the pharma giant is a very rich company!
It seems self evident that a company with a market cap of nearly $400 BILLION dollars, is nowhere near bankruptcy and creating a wholly owned subsidiary in the state of Texas and then claiming it has limited funds to resolve a class action lawsuit doesn't change that fundamental fact.
This was oddly refreshing in a way: because you have some legal loophole to try and pretend you are poor doesn't make it so. This was obvious to everyone for years except the US legal system and those who have financially depended on perverting it.
What now?
There are a few points to make:
In general, this is a good development. Anytime an approach that is patently absurd to the vast majority of laypeople gets binned, it is pretty positive.
Equally and unsurprisingly, it was bad for J&J stock! The company's shares sold off 4% the day of and have continued to head lower since.
The reason for this continued poor performance is the fear, now possibly very founded, that the legal liabilities will both spiral upwards and take years and years to resolve.
This last point is, in many respects, the truly important one. What investors really want isn't a low or minimal settlement (though it would be nice!). Realistically, most know that a cheap settlement is very unlikely but that was also a somewhat secondary concern.
What shareholders really hoped for was the forcing mechanism of the Texas Two Step bankruptcy process to bring everyone together and resolve all the class action lawsuits from one, tightly defined sum of money.
At least if J&J can draw a legal line underneath the whole issue sooner rather than later the company can move on regardless of how much it costs. THAT is, in many respects, the real prize from the Texas ring fenced liability scheme.
Now, how should we think about this?!
In one sentence:
While an overall positive development there are are some concerns.
The big one is, as we mentioned above, is the fear around time. Having major US companies locked in endless costly legal court battles, even if they are most certainly at fault, is not ideal. The US has needed tort reform for the entire 21st century and this only underlines why:
While companies should be liable when at fault, an endlessly spiraling amount of expensive litigation really doesn't suit either.
It poses a huge distraction as well as financial risks to the company and it isn't clear that actual victims really benefit all that much. It is, of course, very good for high priced and skilled lawyers, on both sides of the issue.....
The other issue is that Johnson & Johnson isn't the only company trying this maneuver. In fact it raises real question marks for a host of other American firms facing mass litigation such as the US unit of French industrial company St Gobain, Koch Industries's Georgia Pacific, and also 3M.
All of these companies may now see both the time line and the cost of settlement greatly expanded. It also just leaves their share price in legal limbo which comes with a host of other issues.
The good news is:
You can do something about this now!
You can simply remove JNJ from any of your portfolios - and do so at no additional charge - and then go on about your life. You can sleep safely totally, blissfully uncaring about what the US government is doing, what the courts are doing and whether or not the pharma giant is on the hook for another couple dozen billion or not.
It won't matter. For the first time as a US investors, Johnson & Johnson's problems are no longer your problems. Even better, you will also send a small but real signal to Johnson & Johnson that their morally dubious approach to running a company shall not stand.
That is something to celebrate to go along with the excellent news from the New Jersey bankruptcy court.
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