The US Court of Appeals for the Third Circuit Monday ruled against Johnson and Johnson’s (J&J) attempt to resolve its multi-billion dollar litigation over claims that its talcum-based powders were carcinogenic. The decision reversed an early Bankruptcy Court order in favor of J&J. The circuit court’s decision is the first judicial rejection of the so-called “Texas two-step,” a novel and controversial legal strategy in which large corporations attempt to shield themselves from mass tort liability through bankruptcy claims.

The Texas two-step, formally termed a “divisional merger,” occurs when a company restructures itself into two new entities. The company then bestows its assets on one and its tort liability on the other. The entity with the tort liability then files for bankruptcy.

In this case, J&J split itself into a new parent company–also called J&J–and a separate entity called LTL Management LLC. LTL took on essentially all of the old J&J’s talc-related liabilities, as well as a funding backstop to pay those liabilities which included $2 billion in assets. Meanwhile, the new J&J took on virtually all of the old J&J’s productive business assets. In other words, J&J followed the Texas two-step to freeze ongoing tort claims and shift them from trial courts to bankruptcy court settlements.

The US Court of Appeals for the Third Circuit ruled that LTL was not in sufficient financial distress to file for bankruptcy. The court found the Bankruptcy Court failed to properly consider that LTL’s funding backstop would allow it to draw from J&J’s substantial resources. However, the court refrained from stating that any divisional merger intended to erase the liability and stigma of dangerous products contradicts the principles and purposes of the Bankruptcy Code. The court reasoned that such a decision “is a call that awaits another day and another case.”

J&J claimed that settling the lawsuits through bankruptcy courts rather than mass litigation in trial courts would resolve claims more efficiently, ensure more balanced recoveries among claimants and preserve funds for future claimants. J&J stated, “[R]esolving this matter as quickly and efficiently as possible is in the best interests of claimants and all stakeholders.”

However, the Texas two-step and similar legal strategies have been heavily criticized as major threats to consumer protections and mass tort claimants. This is because, critics argue, the legal strategies allow multi-billion dollar companies and organizations, who would not otherwise qualify for bankruptcy, to shield themselves through processes that strip procedural protections and rights from claimants in addition to pressuring them into immediate settlements that severely limit damages.