Bankruptcy judge tosses Chapter 11 case by 3M's Aearo Technologies

• The strategy: Isolate those liabilities in a lone subsidiary, and kick just that entity into bankruptcy.
• "Courts are pushing back on the notion of companies using bankruptcy to shield themselves against mass torts," Doug Mintz, co-chair of Schulte Roth & Zabel's business reorganization practice, tells Axios.

The background: Back in 2021, Johnson & Johnson put a newly created subsidiary dubbed LTL Management into Chapter 11, loaded with legal claims stemming from lawsuits alleging its baby powder and other talc products caused cancer.

• Separately, 3M had Aearo file for Chapter 11 last year, as hundreds of thousands of lawsuits piled up claiming faulty earplugs made by Aearo led to hearing damage, especially in members of the U.S. military.

What J&J and 3M have in common: Neither expected the legal liabilities to bankrupt the parent companies themselves.

• Rather, they wanted to use the efficiency of the bankruptcy process to settle the claims. No jury sympathetic to the alleged victims, just a numbers-crunching bankruptcy judge who knows how to allocate money among sprawling groups of claimants.
• The companies argued they weren't trying to skirt their legal responsibilities. They both funded the respective Chapter 11 debtors with $1 billion or more to go toward settlements and said they'd be on the hook if the settlements required more.

The other side: Critics say the gambit gives solvent companies the benefits of bankruptcy protection without the drawbacks, and helps them force plaintiffs into accepting a potentially low-ball deal.

• For context, usually, when companies facing mounting legal liabilities turn to bankruptcy protection, it's because the claims may actually bankrupt them. So the entire company files, not just a hived-off unit (for example, Purdue Pharma or PG&E).

The latest: Aearo's bankruptcy judge said that "allowing an otherwise financially healthy debtor with no impending solvency issues to remain in bankruptcy, much less one whose liability for most of its debts is supported by an even more financially healthy, Fortune 500 multinational conglomerate, exceeds the boundaries of the Court’s limited jurisdiction."

• In J&J's case, a bankruptcy judge allowed the filing — but creditors appealed their objection to a federal appellate court, which in January agreed with the creditors and tossed the case.

• "Because LTL was not in financial distress, it cannot show its petition served a valid bankruptcy purpose and was filed in good faith," a three-judge panel said.
• That makes two opinions in the last few months "in which the courts have held that there is a specific standard for filing a company for bankruptcy," Mintz says.

But, but, but: The judicial landscape is still murky.

• J&J turned around and filed a Chapter 11 petition for LTL again in April — this time making LTL "look more bankrupt,” as Bloomberg’s Matt Levine explains.
• J&J also quadrupled the amount of money it's offering litigants in a settlement — to $8.9 billion, compared with $2 billion at the first filing — which appears to have made some of the creditor opposition melt away. J&J says that about 70,000 claimants have indicated support for the plan.

The bottom line: Neither story is over just yet. J&J's case is still in flux, and 3M says it may appeal the Aearo dismissal.

• Either way, the recent rulings mean more uncertainty around the strategy: "It probably takes a tool out of [companies'] toolbox, or at least leaves them uncertain if the tool will work when they pick it up," Mintz says.