A popular country dance, the “Texas two-step,” is being tried out in bankruptcy court. The trick is to convert a company into a Texas organization which is then split into two entities, one of which retains all liabilities and the other retains all assets. The purpose of this carefully choreographed maneuver is to avoid huge liability using the bankruptcy courts¹ when the entity holding the liability files for bankruptcy.²

“Texas Two-Step” was made possible by the enactment in 1989 of a provision in the Texas Business Organization Code as updated.³ While Texas recognizes typical mergers (combining two corporations into one), this provision recognizes “divisional mergers” when a corporation divides into two entities and then distributes assets and liabilities as it sees fit.⁴

Several large companies and organizations have attempted this strategy in the recent past with varying degrees of success. In D
Bestwall LLC,⁵ Debtor filed Chapter 11 to resolve massive asbestos claims through Section 524(g) after being created using divisive merger law. After the bankruptcy court appointed an official panel of asbestos plaintiffs, the panel filed a motion to dismiss the Chapter 11 petition as a bad faith filing.⁶ Alternatively, the committee requested that the venue be transferred for the convenience of the parties or in the interests of justice.^seven As the bankruptcy court explained, the former Georgia-Pacific LLC, which had a long history of asbestos litigation, restructured the business through a divisional merger in Texas. .⁸ As a result, Bestwall received certain assets and liabilities, including asbestos-related liabilities (64,000 asbestos-related claims were pending at the date of the petition).⁹

The bankruptcy court declined to dismiss the Chapter 11 proceeding for several reasons. First, the court noted that attempting to resolve asbestos-related claims through Section 524(g) of the Bankruptcy Code is a valid reorganization goal.^tenThe court also analyzed the debtor’s finances and concluded that Bestwall had the resources to reorganize.¹¹ Having found that the matter was not objectively trivial, the court did not find it necessary to review subjective bad faith.¹²

Bestwall Bankruptcy Court also rejected the location transfer request¹³ even though Bestwall formed as a Texas LLC (as part of a divisional merger) and then moved its domicile to North Carolina just 94 days before filing its Chapter 11 petition. However, the court found no compelling reason to transfer the place when the debtor was domiciled in North Carolina and had considerable assets in that state.¹⁴ It appears that while acknowledging the Texas divisional merger, the Bestwall bankruptcy court was not particularly troubled given that the debtor had $20 million in cash and also owned subsidiary stock worth of $145 million.¹⁵

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Footnotes

1. According to the Financial Times, Congress is considering legislation to ban “Texas Two-Step” to prevent big corporations from abusing Chapter 11. Senate Judiciary Committee Chairman Dick Durbin has reported that Negotiations were underway to scrap what he called a “free jail card” used by some of the wealthiest companies. “U.S. Lawmakers Plan Bill to Ban ‘Texas Two-Step’ Bankruptcy Scheme”, Jamie Smyth, February 28, 2022.

2. That entity then seeks an injunction against future liabilities under 11 USC § 524(g) after confirmation of a plan.

3.Texas Bus. Org. Ann.Code § 10.001 and following.

4. ID. in subsection 10.008(3).

5. 605 BR 43, 46 (Bankr. WDNC 2019).

6. ID.

seven. ID.

8. ID. at 47 years old.

9. ID.

ten. ID. at 49 years old.

11. ID. at 50 years old.

12. ID. at 50-51.

13. ID. at 51 years old.

14. ID. at 52 years old.

15. While NRA Chapter 11 was rejected in Texas (after a divisional merger), the grounds for rejection were a lack of broader good faith. See In re NRA of America628 BR 262, 285-86 (Bankr. ND Tex. 2021 (petition dismissed for lack of good faith because the case was not filed for a purpose intended to be sanctioned by the Bankruptcy Code).

Originally posted by Pratt’s Journal of Bankruptcy Law.

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.