Plastronics, LTL And The "Texas Two-Step"

• Published date: 29 November 2022
• Subject Matter: Corporate/Commercial Law, Insolvency/Bankruptcy/Re-structuring, M&A/Private Equity, Corporate and Company Law, Insolvency/Bankruptcy, Contracts and Commercial Law
• Law Firm: Pillsbury Winthrop Shaw Pittman
• Author: Mr Andrew V. Alfano

Chapter 1 0 o f t h e T e x a s B u s i n e s s Organizations Code permits an entity to undergo a "divisive merger" by splitting into two or more new entities and apportioning the assets and liabilities of the original entity among the new entities pursuant to a plan of merger.¹ The Texas statute is the subject of recent controversy because of its use by businesses to shed mass tort liabilities by using the so-called "Texas Two-Step." Step one of the Texas Two-Step involves an entity splitting into two or more new entities. One of the new entities is apportioned liabilities and limited assets (BadCo), and the other new entity is apportioned some or all the assets (GoodCo). Step two involves BadCo filing for bankruptcy. The newly vested liabilities of BadCo are then addressed in the chapter 11 plan process.

A nonbankruptcy decision by the U.S. Court of Appeals for the Federal Circuit casts some doubt on whether the "Texas Two-Step" is a viable legal maneuver in light of the text of the Texas statute. On Jan. 12, 2022, in a nonprecedential opinion, the Federal Circuit held that a licensee could not avoid contractual royalty obligations in a divisive merger because the statute does not "abridge [the] rights of any creditor under existing laws."² It is the first circuit-level decision of its kind involving the Texas divisive-merger statute.

Despite the Federal Circuit's decision in Plastronics and the text of the statute, both of which provide that creditors' rights cannot be "abridged" by a divisive merger, businesses have been successful thus far in using the Texas Two-Step by funneling creditors to a new entity and blocking those creditors from pursuing entities that could have been tagged with liability pre-merger.

For example, a recent and highly publicized Texas Two-Step case is In re LTL Management LLC, which is pending in the U.S. Bankruptcy Court for the District of New Jersey.³ The court endorsed the Texas Two-Step as a legitimate legal maneuver.⁴ The debtors in LTL, along with other businesses that have employed the Texas Two-Step, have relied, in part, on the ability to tap into pre-petition funding agreements with well-resourced, nondebtor affiliates to pay for liabilities. The decision in LTL Management is currently on appeal before the U.S. Court of Appeals for the Third Circuit.

This article examines the Federal Circuit's decision in Plastronics and the potential split in authority represented by In re LTL Management. The article concludes that, irrespective of whether the Texas Two-Step can ultimately withstand legal challenges through plan confirmation, the maneuver's utility likely lies in the settlement leverage it provides debtors over potential challengers. These challengers face significant and expensive hurdles in bringing a successful legal challenge, and the desire to side-step those hurdles may drive them toward a settlement.

Plastronics

Background
The plaintiff, Plastronics Socket Partners Ltd., and the defendant, Dong Weon Hwang, entered into a royalty agreement in 2005 that provided for the development and sale of a special spring pin, called the "H-Pin," invented by Hwang to receive and test semiconductor chips.⁵ The H-Pin became a commercial success due to its design, which made it cheaper to produce than competing devices.

The royalty agreement between the parties...