The ‘Texas Two-Step’ Legal Strategy

The Texas two-step is legal under Texas law, which allows companies to split themselves into two or more companies. However, some experts have criticized the strategy, arguing that it enables businesses to avoid their legal obligations.

If you have been impacted by the Texas two-step legal strategy, it is important to take action as soon as possible. Van Law Firm can help you understand your legal rights, protect your interests, and get you the compensation you deserve.

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What Is the Texas Two-Step?

The Texas two-step is a strategy that companies use to avoid corporate liability. The strategy involves two steps: (1) the company creates a new subsidiary and transfers all of its liabilities to the subsidiary; and (2) the subsidiary then files for bankruptcy.

The Texas two-step is controversial because it allows companies to shield themselves from liability for their actions. Critics argue that the strategy is unfair to victims of corporate wrongdoing and that it undermines the integrity of the bankruptcy system.

This strategy is not illegal, but it has its risks. If a court finds that the company used the strategy in bad faith, it may be able to void the bankruptcy filing. The company may be liable for punitive damages if it is found to have engaged in fraud or other misconduct.

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Step 1: Create a New Subsidiary and Transfer All of the Company’s Tort Liabilities to the Subsidiary

The first step in the Texas two-step is for the company to create a new subsidiary. The subsidiary can be created in any state, but Texas is often chosen because of its favorable corporate laws. 

Once the subsidiary is created, the company must transfer all of its tort liabilities to the subsidiary. Tort liabilities are legal obligations that arise from harm caused to another person. Some examples include negligence, product liability, and medical malpractice. 

The company can transfer its tort liabilities to the subsidiary in a number of ways. One common way is to simply assign the liabilities to the subsidiary. Another way is to merge the company into the subsidiary.

Step 2: The Subsidiary Files for Bankruptcy

Once the company has transferred its tort liabilities to the subsidiary, the subsidiary can file for bankruptcy. The bankruptcy filing will stop all lawsuits against the subsidiary, including lawsuits filed by victims of the company’s wrongdoing. 

The bankruptcy filing will also protect the subsidiary’s assets from being seized by creditors. This means that the victims of the company’s wrongdoing may not be able to collect any damages from the subsidiary.

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Criticisms of This Strategy

One of the main criticisms is that the Texas two-step allows companies to create subsidiaries that are specifically designed to fail. These subsidiaries are called “zombie companies” because they are created with the sole purpose of filing for bankruptcy. 

Zombie companies typically have few assets and a large number of liabilities. This makes them very likely to file for bankruptcy, which allows the parent company to avoid paying its debts. 

Another criticism of the Texas two-step is that it allows companies to hide their assets from creditors. When a company files for bankruptcy, its assets are protected from creditors under an automatic stay. 

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What Companies Used Texas Two-Step?

The Texas two-step has been used by a number of large companies, including Johnson & Johnson, DuPont, and Owens-Illinois. In each case, the company created a subsidiary and transferred all of its asbestos liabilities to the subsidiary.

Purdue Pharma also used the Texas two-step to transfer its assets and liabilities to a new subsidiary. The subsidiary then filed for Chapter 11 bankruptcy, which allows it to reorganize its finances and avoid paying out billions of dollars in damages.

Additionally, Volkswagen created a subsidiary called Volkswagen Group of America, Inc., which was responsible for all of the company’s emissions-related liabilities. Volkswagen Group of America, Inc. then filed for bankruptcy, which effectively shielded Volkswagen from the claims.

Challenges to the Texas Two-Step

The Texas two-step has been debated in court, but it has so far been upheld. The legality of the Texas two-step strategy has been challenged on a number of grounds, including:

• Fraudulent transfer: A fraudulent transfer is one that is made with the intent to hinder, delay, or defraud creditors. Some argue that the Texas two-step strategy is a form of fraudulent transfer because it is designed to shield a company from liability judgments.
• Abuse of the bankruptcy process: The bankruptcy process is designed to help people and businesses who are unable to pay their debts, not to help companies avoid paying for their wrongdoing.
• Violation of the automatic stay: The Texas two-step strategy has been challenged as a violation of the automatic stay because it allows companies to transfer assets to a new entity while they are still in bankruptcy.