A Debtor’s Lack of Immediate Financial Distress may be “Cause” for Dismissal

Blaise Muriel

St. John’s University School of Law

American Bankruptcy Institute Law Review Staff

Section 1112 of title 11 of the United States Code (the "Bankruptcy Code") provides that upon request from a party in interest, a bankruptcy court may dismiss a chapter 11 case for "cause."[1] In In re LTL Management, LLC, the U.S. Bankruptcy Court for the District of New Jersey held that dismissal of a chapter 11 reorganization proceeding was necessary under the Third Circuit’s recently articulated standards, because the debtor’s lack of immediate financial distress precluded the debtor from filing its bankruptcy petition in good faith.[2]

LTL Management, LLC ("LTL") is an indirect subsidiary of Johnson & Johnson ("J&J").[3] In 1979, J&J transferred all of its assets associated with the baby products division to J&J Baby Products Company and thereafter, Johnson & Johnson Consumer Inc. ("Old JJCI"), one of J&J’s corporate subsidiaries, assumed responsibility for all claims alleging that J&J’s talc-containing products caused cancer.[4] In October 2021, Old JJCI engaged in a series of merger transactions and ceased to exist, and two new companies were formed: LTL and Johnson & Johnson Consumer Inc. ("New JJCI").[5] As a result of the restructuring, LTL assumed responsibility for all of Old JJCI’s talc-related liabilities.[6] LTL also received rights under a funding agreement, which provided that J&J and New JJCI were obligated to pay talc related liabilities, as well as any and all costs and expenses LTL incurs during its bankruptcy case.[7] Two days after the restructuring, LTL filed its voluntary chapter 11 petition (the "LTL 2021 Chapter 11 Case") and a week after its voluntary filing, LTL initiated an adversary proceeding seeking an order declaring that the automatic stay applied to those actions against non-debtors, or to enjoin such actions and grant a temporary restraining order pending a final hearing.[8] The bankruptcy court denied motions to dismiss in the bankruptcy case and granted the preliminary injunction in the talc adversary proceeding.[9] Appeals were taken, and in January 2023, the Third Circuit issued an opinion directing the bankruptcy court to dismiss LTL’s 2021 Chapter 11 Case, holding that the case was not filed in good faith due to the debtor's lack of immediate financial distress.[10] In April 2023, the bankruptcy court dismissed LTL’s 2021 Chapter 11 Case.[11] Approximately 2 hours later, LTL initiated a second bankruptcy case, the case at issue.[12]

The bankruptcy court applied the Third Circuit’s decision resulting in dismissal of the LTL 2021 Chapter 11 Case and determined that “good faith necessarily requires some degree of financial distress on the part of a debtor.”[13] The bankruptcy court further explained that while the Third Circuit has not set out any specific test to evaluate financial distress, "the good-faith gateway asks whether the debtor faces the kinds of problems that justify [c]hapter 11 relief."[14] The bankruptcy court acknowledged that there is a fine line between a proper, early filing, and an abusive, premature filing and given the Third Circuit’s focus on immediacy and certainty of the financial distress, the bankruptcy court concluded that LTL fell on the wrong side of the line.[15] Noting that the threshold issue in a chapter 11 filing is not "insolvency" but rather, "financial distress" the bankruptcy court looked at LTL’s cash position and future revenues, and concluded that through a combination of held equity and royalty revenue streams, LTL was more than capable of meeting its debts.[16] The bankruptcy court dismissed LTL’s argument that future liability incurred as a result of the talc-related claims constitutes financial distress, and held that given LTL’s assets, it could satisfy any of the estimations that might be incurred as a result of talc-related litigation.[17] While recognizing that the tort landscape may change in the future and subject LTL to larger verdicts, the bankruptcy court found that LTL was not sufficiently financially distressed to avail itself of bankruptcy at this time.[18] The bankruptcy court concluded that while it could "smell the smoke," it could not "see the fire" and the emphasis on certainty and immediacy that is necessary for financial distress precluded a finding of a good faith chapter 11 filing for LTL.[19] Due to the lack of immediate financial distress, the bankruptcy court held that LTL’s second bankruptcy filing was not in good faith, and sufficient cause therefore existed for dismissal.[20]