3M’s “Texas Two-Step” Failure and the Future of Corporate Liability

The largest mass tort litigation in U.S. history has come to an end. On August 29, 2023, 3M, a company specializing in the manufacturing and distribution of industrial, safety, and consumer products, reached a $6 billion settlement, resolving hundreds of thousands of lawsuits filed by U.S. military service members (the “Plaintiffs”). The Plaintiffs claimed that they suffered hearing loss from the use of 3M’s earplugs. (Brendan Pierson, Reuters). The settlement followed 3M's failed attempt to limit its liability through a controversial legal maneuver known as the “Texas Two-Step.” Id. This article explores 3M’s legal battle, specifically its unsuccessful Texas Two-Step, and the potential impact from the failed maneuver on future corporate liability.

The 3M litigation began in 2016 when Moldex-Metric, Inc., 3M’s competitor, filed a whistleblower lawsuit with the Department of Justice (the “DOJ”) against 3M alleging that the company had knowingly sold defective earplugs. (Mari Gaines, Forbes). 3M eventually settled this lawsuit with the DOJ in 2018. Id. Following this settlement, individual military service members (the “Plaintiffs”) who used 3M’s earplugs filed their own lawsuits against the company alleging that the defective earplugs caused them to develop hearing loss and tinnitus. Id. The Plaintiffs argued that 3M “hid design flaws, fudged test results, and failed to provide instructions for the proper use of the earplugs, leading to hearing damage.” (Natasha Bakirci, FindLaw).

In an effort to limit its liability, 3M employed a bankruptcy strategy known as the “Texas Two-Step,” originating from Texas’s divisive merger statute. The statute allows companies to split into two separate entities, effectively transferring liability to just one of them while insulating the other. (Jamie Smyth, Financial Times). The first step of the Texas Two-Step involves a corporation undergoing a divisional merger to create two distinct entities: one that retains the company’s core business and another that assumes potential liabilities. (Marc Casarino, Kennedys Law). Next, the newly formed, liability burdened entity files for bankruptcy. Id. This process safeguards the assets of the first entity and places the liability-bearing entity under the protection of bankruptcy proceedings. Id. 3M utilized this strategy to transfer its liabilities to its subsidiary, Aearo Technologies (“Aearo”), which manufactured the earplugs (Bakirci, FindLaw). In 2022, Aearo, as a discrete company, filed for bankruptcy, accepting responsibility for the claims. Id. However, the bankruptcy filing was later dismissed in U.S. bankruptcy court. Id. The judge stated, “[a]llowing an otherwise financially healthy debtor with no impending solvency issues (Aearo) to remain in bankruptcy exceeds the boundaries of the Court’s limited jurisdiction.” Id. Ultimately, 3M’s attempt to shield itself from liability through a bankruptcy filing was unsuccessful.

The 3M case is not the only recent instance of the Texas Two-Step strategy falling flat. In a case involving Johnson & Johnson (“J&J”) and its spin-off entity, LTL Management (“LTL”), J&J attempted to use the Texas Two-Step to insulate itself from thousands of claims that its talcum baby powder caused cancer. (Smyth, Financial Times). The Third Circuit Court of Appeals dismissed LTL’s bankruptcy filing, finding “bad faith and no valid bankruptcy purpose” due to a funding agreement between J&J and the LTL entity that precluded any determination of financial distress. (Zachary Wasserstein, Maron Marvel). Simillar to 3M, J&J failed to demonstrate a legitimate bankruptcy purpose due to its inability to provide evidence of financial distress, rendering its Texas Two-Step unsuccessful. (Fredric Sosnick & Kyle Jaksa, Law360).

What does this mean for corporate liability moving forward? Courts are exhibiting heightened scrutiny toward bankruptcy maneuvers and becoming less tolerant of these practices, specifically in situations where large, profitable corporations appear to be seeking shelter from accountability for widespread harm. As a result of this trend, corporations may find it increasingly difficult to employ the Texas Two-Step strategy, especially in the Third and Seventh Circuits where LTL and Aearo’s bankruptcy filings were dismissed. (William Organek, Harvard Law School). Corporations will have to grapple with the challenge of ensuring that their subsidiaries will be adequately funded in bankruptcy, while also demonstrating that the corporation cannot fulfill its funding responsibilities without a court injunction. (Sosnick & Jaksa, Law360). Absent evidence of financial hardship, corporations may need to explore alternative methods for addressing liability. (Organek, Harvard Law School). This may involve enhancing transparency concerning product risks, improving product testing standards, and focusing on quality assurance. Furthermore, corporations may consider reevaluating their insurance coverage and financial strategies to better equip themselves for potential legal liabilities. Overall, 3M’s case emphasizes the uncertainty large companies face regarding the Texas Two-Step strategy and their ability to leverage bankruptcy while maintaining financial viability. (Wasserstein, Maron Marvel).

When it comes to issues involving public health and safety, corporations should be held accountable for their actions. Critics argue that the Texas Two-Step enables "profitable, solvent corporations to delay mass tort litigations and potentially secure bankruptcy discounts.” (Casarino, Kennedys Law). The purpose of the bankruptcy process is to provide efficient and equitable resolutions to victims. Id. It was never intended to be abused by highly profitable corporations “as a means to delay or prevent victims from having their day in court.” Id. The Texas Two-Step and similar strategies should not serve as loopholes for corporations to evade their responsibilities to consumers. While efficient and equitable resolutions are essential, they should not come at the expense of justice for consumers impaired by corporate negligence. Ultimately, these cases highlight the need for corporations to strike a balance between protecting their interests and satisfying their obligations to the public.