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Emory Law Journal

Abstract

Since 1984, Chapter 11 has emerged as a forum of choice for mass tortfeasors to satisfy their liabilities. More recently, businesses have employed a state law maneuver known as the “Texas Two-Step,” whereby the “old debtor” parent company creates a “new debtor” subsidiary that assumes responsibility for all outstanding tort claims and subsequently files for Chapter 11 relief. The parent company or its healthy affiliates provide a funding agreement to backstop creditor repayment and the costs of the case but otherwise stay on the sidelines.

Section 1112(b) of the United States Bankruptcy Code determines whether Texas Two-Step debtors may enter bankruptcy. Section 1112(b) allows courts to dismiss filings “for cause”—a standard that courts almost unanimously agree imposes a good faith requirement on debtors. Specifically, the Third Circuit requires a debtor to be in “financial distress” to meet the good faith threshold. However, in light of recent two-step filings, this abstract line-drawing tool, which centers heavily on the funding agreement inherent in the two-step structure, ultimately may undermine creditor recoveries.

The Code demands that Chapter 11 preserve and maximize value for creditors. To best fulfill this purpose, every court would benefit from a more holistic good faith review that explicitly evaluates implications for claimants. This Comment proposes three additional criteria for courts to incorporate into their good faith analyses: (1) unequal treatment of future claimants; (2) availability of parent and affiliate assets to tort claimants; and (3) estimated compensation in the tort system and other claim aggregation processes. Under each criterion, this Comment provides appropriate factors that account for the unique realities of the two-step debtor with the goal of encouraging bankruptcy courts to more carefully balance both debtor and creditor interests before dismissing cases under § 1112(b).

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