As Johnson & Johnson is preparing its third attempt to resolve a talc-related cancer lawsuit through bankruptcy, but courts remain divided on how to determine whether a company is filing in “good faith” for Chapter 11.

There is no standardized method in U.S. bankruptcy law for evaluating good faith bankruptcy filings, so courts must decide for themselves how to handle the matter.

When the U.S. Court of Appeals for the Third Circuit last month upheld a bankruptcy court’s dismissal of a J&J subsidiary’s second Chapter 11 filing, it said the case was not filed in good faith because the company was not in financial trouble. The National Rifle Association and a unit of 3M Co. have suffered a similar fate in recent years.

The lack of a clear definition of “good faith” in bankruptcy law gives litigants leeway to challenge the legitimacy of a case. Opponents often claim the company is financially sound and is wrongly filing for bankruptcy protection to stave off legal trouble.

But introducing a well-defined good faith requirement such as Chapter 11 bankruptcy would add additional complications for struggling companies and could have lasting consequences, bankruptcy experts say.

“A requirement to file a good faith petition would need to allow for a great deal of flexibility, but would generally be based on proof of the debtor’s need rather than financial hardship,” said bankruptcy attorney Hannah Waldman of Greenberg Glusker Fields Claman & Machtinger LLP.

A hypothetical good faith rule “needs to be defined narrowly enough that it doesn’t become the basis for litigation at the outset of every Chapter 11 bankruptcy filing and potentially prevent legitimate filings,” said Daniel Cohn, a partner at Murtha Cullina LLP who advises financially troubled companies. “In these litigious times, people will take any opportunity to fight.”

To avoid unnecessary litigation, “courts should be perfectly clear about what is meant by the absence of a legitimate purpose under Chapter 11 and should grant a motion to dismiss only when the absence of such a purpose is clear on the basis of incontrovertible facts,” Cohn said.

The journey of J&J

People who claim that J&J baby powder caused their cancer have overwhelmingly voted in favor of a settlement that will be settled as part of a third talc bankruptcy.

J&J is expected to file its third lawsuit in Texas after being dismissed by bankruptcy courts in New Jersey and North Carolina. Because Texas is part of the Fifth Circuit, that means J&J is not bound by the Third Circuit’s interpretation of good faith.

In such cases, individual bankruptcy courts rely on their “gut feeling” when evaluating good faith filings, says Matthew Gensburg of Gensburg Calandriello & Kanter PC, who leads the firm’s bankruptcy, commercial litigation and restructuring practice group.

“Although there are factors that determine what is evidence of good faith and what is evidence of bad faith, no single factor will be decisive,” Gensburg said. “It will be cumulative.”

Johnson & Johnson has long claimed that its products are safe. In more than 61,000 lawsuits, the talc in its powders has been accused of causing ovarian cancer and asbestos-related cancer.

The Third Circuit’s July decision, which upheld a New Jersey bankruptcy court’s dismissal of the J&J subsidiary’s second case, focused on the financial situation of J&J subsidiary LTL Management LLC. That’s “a bit of a new horizon,” said Douglas Mintz, a partner at Schulte Roth & Zabel who is representing creditors in the financial restructuring.

“Reality has actually proven itself,” Mintz said, in the case of Chapter 11 bankruptcy filings like LTL, which were filed specifically to benefit a third party, such as the parent company, rather than the debtor itself.

J&J plans to ask the U.S. Supreme Court to review the Third Circuit’s decision, Erik Haas, the company’s global vice president of litigation, said in July. The ruling will not affect the company’s plan to settle the talc claims through a third bankruptcy, Haas said.

When a “bankruptcy is used as a sword rather than a shield,” it is usually dismissed for malicious intent, Waldman said. “This is especially true when no value can be created through the bankruptcy.”

Insolvency is generally defined in the bankruptcy code as a debtor’s inability to pay its debts as they become due, but it is not a prerequisite for filing for bankruptcy. One could argue that a seemingly healthy company files for Chapter 11 bankruptcy because it has “contingent liabilities that are not obvious to an observer and that justify a good faith bankruptcy petition,” Mintz said.

However, there is a “never-ending metronomic back and forth in which bankruptcy lawyers push the boundaries,” Mintz said.

“Objective senselessness”

The way in which courts assess good faith could well be a “reflection of economic processes,” said Gensburg.

When the real estate market ran into trouble in the 1980s, “there were numerous court decisions addressing the bona fide issue surrounding individual properties, largely due to the sheer volume of filings,” he said.

In some of these cases, debtors appeared to be “abusing the automatic stay,” Waldman said.

Before the U.S. Court of Appeals for the Fourth Circuit, a debtor who defends his bankruptcy challenge must refute the charge of “objective futility” after a 1989 decision took that factor into account in assessing good faith, she noted.

Under that standard, a Chapter 11 filing can be denied if it is “demonstrated that restructuring is not realistically possible within a reasonable period of time,” Waldman said.

In 1988, the U.S. Court of Appeals for the Eleventh Circuit ruled that a bad-faith lawsuit could be dismissed even if reorganization was possible, Waldman said.

“It’s not always about reorganization,” says Gensburg. “Sometimes it’s about maximizing value.”

Most federal appeals courts consider other factors, bankruptcy experts say, including whether a company has made false or misleading statements, whether it has violated court orders or regulations, and whether there have been multiple consecutive bankruptcy filings without any change in its financial situation.

A dozen exceptions

3M subsidiary Aearo Technologies is among the companies that have been pushed out of bankruptcy in efforts to settle tens of thousands of lawsuits over defective earplugs.

The U.S. Bankruptcy Court for the Southern District of Indiana found that Aearo’s bankruptcy was not a legitimate reorganization. 3M eventually reached a $6 billion settlement outside of bankruptcy in March, and then withdrew its appeal of the bankruptcy order in July.

“If a Chapter 11 debtor cannot demonstrate that he needs to take advantage of the protections afforded by the law, other than harassing or stalling creditors, it is a bad faith filing,” Waldman said.

The NRA’s Chapter 11 case was dismissed in 2021 after the U.S. Bankruptcy Court for the Northern District of Texas agreed with New York government officials that the case was filed in bad faith to evade oversight.

Some of the factors used by the courts are not always transferable to different types of commercial debtors, Gensburg said. Whether a company filed for bankruptcy in good faith must be assessed on a case-by-case basis, bankruptcy experts say.

“In legal practice, there is the general rule and then there are a dozen exceptions to the general rule,” said Gensburg. “This also applies to good faith.”