Country Dancing In The Bankruptcy Court: The "Texas Two-Step"

• Published date: 02 June 2022
• Subject Matter: Corporate/Commercial Law, Insolvency/Bankruptcy/Re-structuring, M&A/Private Equity, Corporate and Company Law, Insolvency/Bankruptcy
• Law Firm: Shulman Rogers
• Author: Michael J. Lichtenstein

A popular country dance, the "Texas two-step," is now in the process of being experimented with in the bankruptcy courts. The trick is to convert a business into a Texas organization that is then split into two entities, one of which retains all the liabilities and the other retains all the assets. The purpose of this carefully choreographed maneuver is to avoid enormous liabilities through using the bankruptcy courts¹ when the entity that holds the liabilities files a bankruptcy petition.²

The "Texas two-step" was made possible by the 1989 enactment of a provision in the Texas Business Organization Code as updated.³ While Texas recognizes typical mergers (combining two companies into one), this provision recognizes "divisive mergers" where a company divides into two entities and then allocates assets and liabilities as it chooses.⁴

Several major companies and organizations have attempted this strategy in the recent past with varying degrees of success. In re Bestwall LLC,⁵ the debtor filed a Chapter 11 to resolve mass asbestos claims through Section 524(g) after being created using the divisive merger statute. After the bankruptcy court appointed an official committee of asbestos claimants, the committee filed amotion seeking to dismiss the Chapter 11 petition as a bad faith filing.⁶ In the alternative, the committee requested that venue be transferred for the convenience of the parties or in the interests of justice.⁷ As the bankruptcy court explained, the former Georgia-Pacific LLC, which had a long history of asbestos litigation, effectuated a corporate restructure though a Texas divisional merger.⁸ As a result, Bestwall received certain assets and liabilities, including the asbestos liabilities (64,000 asbestos claims were pending as of the petition date).⁹

The bankruptcy court declined to dismiss the Chapter 11 proceeding for several reasons. First, the court noted that attempting to resolve asbestos claims through Section 524(g) of the Bankruptcy Code is a valid reorganizational purpose.¹⁰ The court also analyzed the debtor's finances and concluded that Bestwall had the resources with which to reorganize.¹¹ Having concluded that the case was not objectively futile, the court saw no need to review subjective bad faith.¹²

The Bestwall bankruptcy court also rejected the request to transfer venue¹³ even though Bestwall formed as a Texas LLC (in a divisional merger) and then transferred its domicile to North Carolina only 94 days before filing its...