On August 29th, 2023, 3M announced a wide-ranging $6 billion settlement reached with plaintiffs’ counsel meant to resolve pending and future litigation related to Combat Arms Earplugs produced by its subsidiary Aearo Technologies. The deal represents $5 billion in cash and $ 1 billion in 3M common stock over the course of 2023-2029. The currently pending multi-district litigation in Florida regarding Combat Arms Earplugs has grown to staggering levels, representing over 250,000 active individual actions and roughly 30% of all pending litigation in federal district courts. This development comes just one day after the Court of Appeals for the Seventh Circuit announced that it had accepted the appeal of 3M and Aearo to dismissal of Aearo’s Chapter 11 Bankruptcy filing in the Southern District of Indiana. As part of its litigation strategy, 3M was attempting to spin off Aearo in a maneuver commonly referred to as the “Texas Two-Step,” wherein two new entities are created, one holding the majority of the old entity’s assets and the other, which proceeds to Chapter 11, holding all, or the majority of, the old entity’s liabilities.
Judge Jeffrey Graham of the Southern District of Indiana dismissed Aearo’s bankruptcy filing earlier this June, finding that the bankruptcy was filed in bad faith and did not serve a valid bankruptcy purpose as Aearo was not in “financial distress” but remained financially healthy. His decision focused on a funding agreement between 3M and Aearo covering future litigation expenses, as well as the fact that, while the potential future cost of verdicts was great, Aearo was not currently faced with any final judgments it needed to pay. Per Judge Graham, allowing Aearo to take advantage of Chapter 11 and its expanded trust provisions while still financially healthy risked turning the Bankruptcy Court into a court of general jurisdiction.
In reaching his decision, Judge Graham’s opinion quoted another recent decision of the Third Circuit Court of Appeals in a bankruptcy case involving Johnson & Johnson and its newly spun-off entity, LTL Management, where J & J attempted to utilize the Texas Two-Step strategy to resolve litigation involving its talc powder in Chapter 11. The Third Circuit similarly found bad faith and no valid bankruptcy purpose where J & J’s funding agreement with the LTL entity prevented any finding of “financial distress.” While settlement of 3M’s case will prevent further clarity on the Seventh Circuit’s position and whether it will follow the precedent of the Third Circuit, it emphasizes the uncertainty faced by large companies as to the viability of the Texas Two-Step strategy and their ability to take advantage of Chapter 11 provisions while remaining financially viable. J&J/LTL have recently appealed the dismissal of their bankruptcy by the New Jersey District Court following the ruling of the Third Circuit.