The Texas Two-Step is both a style of line dancing and a legal maneuver used by several large, profitable companies to enable a newly created entity to access the bankruptcy system and, thus, discharge the tort liabilities of its predecessor. This type of filing has been criticized by some as a tool used by healthy companies to evade responsibility for their tortious conduct and lauded by others as an efficient means to achieve a global resolution of crushing mass tort liability. Whether Texas Two-Step filings may properly access the bankruptcy courts is a question governed by § 1112(b) of the U.S. Bankruptcy Code. Section 1112(b) provides grounds to dismiss filings “for cause,” a standard that courts have long interpreted to impose a good faith requirement on all bankruptcy filings.
But this backstop may no longer be effective. In fact, although there have been five Texas Two-Step filings to date, only one has been dismissed for bad faith. Instead, in most cases, savvy practitioners have structured such filings around existing “good faith” case law to avoid dismissal. This Note argues that Texas Two-Step filings may well be “bad faith” filings that can be dismissed under § 1112(b). However, courts considering them have applied historic good faith filing standards too narrowly by ignoring the good or bad faith of the debtor’s predecessor—the entity initially responsible for the allegedly tortious conduct and the transactions leading to a Texas Two-Step filing.
Good faith standards have been developed by judges in response to three types of cases: the single-asset real estate debtor, the healthy debtor seeking a litigation advantage provided by bankruptcy, and the nearly insolvent mass tort defendant seeking to discharge crippling liability. Because each of these is distinctly different from the Texas Two-Step debtor, this Note argues that Texas Two-Step transactions require a broader good faith analysis that considers the circumstances and conduct of both the debtor and the debtor’s predecessor. It then proposes an expanded test for good faith filings under § 1112(b) of the Bankruptcy Code to address future Texas Two-Step filings precisely because they are strategically engineered to satisfy the letter but not the spirit of the traditional good faith filing test.