My favorite is the Texas "divisive merger" which is actually one company dividing into two. Unbelievable. That's like calling a divorce a "divisive wedding".
Many thanks to Adam Levitin for spreading awareness of this. From my perspective as an investment adviser, should you invest in clever companies who employ this scam? I wouldn't. It's only a matter of time before it becomes illegal. Again.
The Texas Two-Step: The New Fad in Fraudulent Transfers
There's a new fad in fraudulent transfers. It's called the Texas Two-Step. Here's how it goes. A company has a lot of tort liabilities (e.g., asbestos, talc, benzene, Roundup). The company transforms into a Texas corporate entity (the particular type doesn't matter). The new Texas entity then undertakes a "divisive merger" that splits the company into two companies, and it allocates the assets and liabilities as it pleases among the successor entities.
The result is that one successor entity ends up saddled with the tort liabilities (BadCo) and the other with the assets (GoodCo). The companies then convert to whatever type of entity they want to be going forward for corporate governance (or venue) purposes, and the BadCo files for bankruptcy, while GoodCo keeps chugging away. The tort victims find themselves creditors in the bankruptcy of BadCo and get bupkes, while the bankruptcy plan inevitably includes a release of all claims against GoodCo. Pretty nifty way to hinder, delay, or defraud creditors if it works, right?
Well, that's the question: does this work? We've only seen two Texas Two-Steps to date. There have been a few Texas Two-Steps to date (and one might be a Wilmington Waltz). First was BestWall's asbestos bankruptcy. BestWall (formerly part of Georgia Pacific) is a subsidiary of Koch Industries, and its bankruptcy is pending in the Western District of North Carolina. No plan has been confirmed, but the case has been dragging on since 2017, and the asbestos victims have been enjoined from suing any of the non-bankrupt Koch entities. Plan exclusivity has long-lapsed, but the court won't dismiss the case and doesn't seem willing to consider any alternatives. Even if the Two-Step isn't completely successful in the end, it will surely reduce whatever settlement the Koch entities have to pay.
Then there's DBMP (CertainTeed), another asbestos case, again in the Western District of North Carolina. Same story going on there; there's an adversary proceeding pending about the preliminary injunction. Also in WDNC, before the same judge is Aldrich Pump. Same judge as DBMP, and again a preliminary injunction. And then pending in Delaware is Paddock Enterprises, LLC, the rump of Owens-Illinois. The UST filed an examiner motion over the divisive merger transaction. Denied.
In any case, the Two-Step looks promising enough that Johnson & Johnson is supposedly considering using it for its talc liabilities.
For those of you who want to go under the hood, the key to the Texas Two-Step is a quirk of Texas law. It's possible in every state to split a company's assets and liabilities just through a spin-off (dividend up a sub's shares to shareholders, resulting in them directly holding two companies), and we've seen spin-offs used as fraudulent transfers: Andarko/Tronox and Sears/Lands End. But Texas offers another method for doing so, basically lower cost asset partitioning that also might evade fraudulent transfer liability.
Texas law defines "merger" as including not just two companies merging into one, but also the exact opposite, when a company divides into two or more entities. This sort of corporate division is sometimes called a "divisive merger". Texas is one of two states that allow for divisive mergers. Delaware is the other, but it only provides for divisive merger for LLCs. (Texas seems to be competing with Delaware in a corporate law race to the bottom--look at waiver of fiduciary duties--but that's for another blog.)
Why would it matter that a division is defined as a "merger" under Texas law? Because the Texas Business Organizations Code provides that a merger operates "without ... any transfer or assignment having occurred." The thinking is that if there's no transfer in a divisive merger, then there cannot be a fraudulent transfer. The deemed lack of a transfer is what makes the Texas Two-Step special.
Now, it is far from clear that Texas's fraudulent transfer law--or any other jurisdiction's--would defer to the Texas Business Organizations Code regarding whether there is a transfer, but there's no law on that point (but it has gotten some consideration in this thoughtful law review comment). The conversion into a Texas entity might itself be considered a transfer and step transaction doctrine might bundle everything together. Still, that lack of clarity is important settlement leverage. Maybe GoodCo ends up chipping in a bit to the bankruptcy in exchange for a release. But GoodCo's ability to make a credible argument that it has no liability on account of the Texas Two-Step is surely going to reduce what GoodCo has to pay and by an amount that vastly exceeds the transaction costs for these shenanigans.
So where does this all point? On one level, it points to a problem of states undermining fraudulent transfer law somewhat deliberately (I think). But more broadly, it points to a need to substantially strengthen fraudulent transfer law: longer statutes of limitations, a statutory step doctrine, treble damages for actual (deliberate) fraudulent transfers, aiding and abetting liability, and criminal penalties for actual fraudulent transfers (which will mean that lawyers cannot ethically counsel such transactions). Unfortunately, that's a political fight between the wolves and the lambs. The wolves know that this stuff matters and will fight tooth and nail, and even though the lambs outnumber the wolves, they are clueless and won't do anything to protect themselves. And that's why we're all likely to be seeing more of the Texas Two-Step.
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