Good-Faith Filing & the Texas Two-Step
How In re LTL Management made immediate, apparent financial distress a Chapter 11 gateway in the Third Circuit — and how the Fourth Circuit’s Carolin standard, reaffirmed in Bestwall and applied in Aldrich Pump, lets solvent divisional-merger debtors stay in bankruptcy instead.
Immediate Distress or Objective Futility: The Two-Step Forum Split
The Third Circuit made financial distress the price of admission to Chapter 11. Dismissing LTL’s first petition, it held that a two-step debtor’s financial state "should be tested independent of any other entity" — courts "focus on its assets, liabilities, and, critically, the funding backstop it has in place to pay those liabilities." Timing is part of the test: "Financial distress must not only be apparent, but it must be immediate enough to justify a filing," and "[a]n attenuated possibility standing alone" that a debtor "may have to file for bankruptcy in the future" does not establish good faith In re: LTL Management LLC, 64 F.4th 84 (3d Cir. 2023). With a multi-billion-dollar J&J funding agreement guaranteeing payment of its talc liabilities, LTL flunked its own balance sheet.
The Fourth Circuit’s gate is far harder to shut. Bestwall LLC v. Sander L. Esserman, 71 F.4th 168 (4th Cir. 2023) confirmed that it "applies a more comprehensive standard to a request for dismissal of a bankruptcy petition for lack of good faith; that is, the complaining party must show both ‘subjective bad faith’ and the ‘objective futility of any possible reorganization’" — the burden sits on the movant, not the debtor. The court also turned away the manufactured-jurisdiction attack on the divisional merger: had the predecessor filed, the asbestos claims would have been in bankruptcy anyway, so "the corporate restructuring leaves the jurisdictional result the same."
A post-LTL decision shows how decisive the split is on the ground. Aldrich Pump LLC, No. 20-30608 (Bankr. W.D.N.C. Dec 28, 2023) refused to dismiss two solvent two-step debtors, holding that "the Carolin Two-Prong Test applies to Chapter 11 bad faith dismissal motions, even those involving solvent, and arguably financially non-distressed corporate debtors," and that "there are no cases holding ‘financial distress’ to be a constitutional requirement for filing a Chapter 11 case, much less a ‘jurisdictional’ prerequisite." Nor can movants smuggle the Third Circuit’s test in through § 1112(b): recast bad-faith arguments fail because "That which cannot be done directly cannot be done indirectly."
The same corporate structure that gets dismissed in New Jersey survives in North Carolina, so forum drives everything for a two-step debtor. In the Third Circuit, diligence the funding agreement first — what it pays, when it triggers, and whether it survives dismissal — because an intact backstop is fatal. In the Fourth, the movant must prove both Carolin prongs, and a solvent shell with no operating business can still clear the objective-futility bar.