Home > Journals > St. John's Law Review > Vol. 99 > No. 3
Document Type
Note
Abstract
(Excerpt)
A majority of corporate bankruptcies occur within the scope of a Chapter 11 reorganization, as the process allows a debtor to retain control over most business operations and act in place of the trustee. Most frequently, a debtor will file for Chapter 11 when they are facing debts they are unable or unwilling to repay when due. However, given the absence of an insolvency requirement in the Bankruptcy Code, some corporations utilize a Chapter 11 bankruptcy filing to handle their debts even if they are not entirely insolvent. Many corporations that have taken advantage of solvent debtor filings have done so through the “Texas two-step” method, which allows a corporation organized under Texas law to divide its assets and liabilities into two separate corporations.
To put this into perspective, think of a corporation that has over $100 trillion in assets, but was recently found liable in a tort lawsuit that awarded class action plaintiffs damages of $2 billion. The corporation, instead of paying those awards outright, reincorporates in Texas. Then, the corporation creates two new companies, one of which gets $100 trillion in assets, while the other gets the burden of $2 billion in liabilities. The liability corporation then files for Chapter 11 bankruptcy, as it has too many liabilities, and has no assets to help pay those claimants. While this bankruptcy filing stays all actions against them for those $2 billion in tort claims—leaving the tort claimants with nothing—the corporation continues on with its usual business procedures, using its $100 trillion however it chooses. This process sounds inherently unfair, as it prevents people who won a judgment in court from actually receiving that judgment, or other creditors who loaned someone money from actually getting that money back. Further, this maneuver allows a corporation to file for bankruptcy, stay all actions against it, and restructure the payment plan, while keeping its assets completely separate and protected from the reorganization. Recently, there was a disruption to this accepted practice when the Third Circuit ruled in 2023 that this maneuver of the bankruptcy system violated the requirements for a good faith filing.
Part I of this Note looks at how the development of favorable laws to corporations allows them to use the bankruptcy system to escape massive liabilities as a result of litigation. Part II examines how the “Texas two-step” has been litigated in the Third Circuit, which led to the creation of a standard preventing the continued use of this maneuver. Part III touches on the Fourth Circuit’s more outdated test for determining bad faith in solvent corporate debtor filings. Finally, Part IV of this Note argues why the Third Circuit’s approach is more in line with the Bankruptcy Code’s requirement of good faith, and how all bankruptcy courts should apply this test when facing a Chapter 11 filing by a solvent corporate debtor