Don’t overhaul the U.S. bankruptcy system

Sen. Dick Durbin of Illinois is spearheading an effort to remake the U.S. bankruptcy system. He says his goal is to ban the “Texas two-step” — a way of reorganizing an insolvent business that a handful of companies have used to manage costly litigation. According to Durbin, this strategy represents a flagrant abuse of bankruptcy law.

But bankruptcy is hardly the national crisis he makes it out to be, and his proposed legislation to overhaul the entire bankruptcy process is an overreaction.

This “Texas two-step” procedure has been employed only a few times. In practice, it looks something like this: A group of individuals who claim to have been harmed in the same way, by the same company, sue that firm in what is known as a mass tort. In response, the company being sued moves its liabilities to a new, separate company — that’s step one. That new company then files for Chapter 11 bankruptcy, effectively pausing any tort suits that were already underway — that’s step two. From there, the bankrupt entity can establish a trust fund for compensating victims, without resorting to the more costly and time-consuming process of tort litigation.

Depending on who you ask, this strategy is either a misuse of Chapter 11 bankruptcy law, a reasonable way of managing a company’s legal liabilities, or something in between. Whichever it is, it’s definitely not frequently used.

In fact, companies have only used this procedure as an alternative to litigation a few times. In 2017, the paper company Georgia-Pacific used it in a case involving asbestos exposure. Last year, health-care company Johnson & Johnson adopted it in a case involving its talc products.

This latest example has drawn Sen. Durbin’s ire. Based on the senator’s rhetoric, one would assume that this two-step procedure happens all the time with companies and that its main purpose is to avoid compensating plaintiffs. But this isn’t true.

In fact, Johnson & Johnson has proposed a $2 billion settlement trust fund for claimants in that case. The tactic is completely legal under Texas law — hence its name — and in a number of other states.

And it avoids jackpot jury awards that could put a company out of business and its employees out of work.

All of which raises a question: If the Texas two-step is neither common, nor illegal, nor a major threat to the rights of tort claimants, why are some lawmakers determined to eliminate it? Because it poses a distinctive threat to an especially powerful constituency: trial lawyers.

These lawyers make their living by extracting massive payouts from companies in jury trials, then keeping a large percentage of those settlements for themselves. Typically, they pocket a third of the total award, but their fees can be much higher, depending on the case.

The “Texas two-step” avoids this kind of litigation, and diminishes the role — and potentially the payday — of plaintiffs’ lawyers as a result. It also allows bankruptcy judges to decide what kind of damages will fairly compensate everyone, rather than a jackpot jury award that may only compensate a few while putting a company out of business.

Threatened by this possible loss of windfall profits, the trial lawyers’ lobby is doing everything in its power to end this procedure, despite the fact that it’s infrequent, legal, and often a better alternative to litigation. Theirs is a powerful lobby, with many bought-and-paid-for allies on Capitol Hill: A new report by the Alliance for Consumers found that just eight top trial-focused law firms collectively gave $15 million in political donations to federal candidates from 2017 to 2020. Ninety-nine percent of that spending went to Democrats like Durbin.

In short, the campaign against this type of company restructuring isn’t about safeguarding our legal system from abuse. It’s about protecting trial lawyers’ bottom lines.

To be sure, there are plenty of ways our legal system could be fairer. But any effort to reform the tort process should benefit genuine victims of wrongdoing — not the trial lawyers who profit from the misfortune of others.

Jim Cawley served as the 32nd lieutenant governor of Pennsylvania from 2011 to 2015.