3rd & 4th Circuit have Split Decisions on Bankruptcy Filings

Bankruptcy law is supposed to provide a uniform federal system. Yet when a financially healthy company faces a mountain of lawsuits and asks for Chapter 11 protection, geography can suddenly matter a great deal. A filing that faces dismissal in the Third Circuit may have a considerably better chance of surviving in the Fourth Circuit.

That tension has become one of the most important developments in modern corporate bankruptcy law. The Third Circuit’s decision involving Johnson & Johnson affiliate LTL Management emphasized that a Chapter 11 debtor must have genuine financial distress to satisfy the good-faith requirement. The Fourth Circuit, dealing with Georgia-Pacific affiliate Bestwall, took a more permissive approach to federal bankruptcy jurisdiction and operates under a notably demanding standard for dismissing a Chapter 11 case as a bad-faith filing.

The result is often described as a circuit split over bankruptcy filings by solvent or financially secure companies. That description is useful, but it needs one lawyerly footnotebecause lawyers love footnotes almost as much as restructuring professionals love acronyms. The two appellate decisions did not answer precisely the same procedural question. Even so, their practical approaches point in significantly different directions.

Why the Third and Fourth Circuit Bankruptcy Split Matters

The controversy centers on a deceptively simple question: How financially troubled must a company be before it can legitimately use Chapter 11?

The Bankruptcy Code does not impose a general insolvency requirement on ordinary Chapter 11 debtors. A company does not necessarily have to wait until the checking account is empty, payroll is due tomorrow, and the chief financial officer is searching the office couch cushions for spare change. Chapter 11 has long been used proactively to reorganize debts, preserve enterprise value, resolve complex liabilities, and prevent a disorderly race among creditors.

At the same time, bankruptcy provides extraordinary benefits. A filing can trigger the automatic stay, centralize disputes in one forum, alter negotiating leverage, facilitate a restructuring plan, and, in asbestos cases, potentially support a trust and channeling injunction under Section 524(g). Courts therefore have an obvious reason to ask whether a debtor is using bankruptcy to solve a genuine financial problem or simply to obtain litigation advantages unavailable outside Chapter 11.

That is where the Third and Fourth Circuits begin to diverge.

The Third Circuit’s Approach: Financial Distress Is the Gateway

How LTL Management reached bankruptcy court

LTL Management was created through a corporate restructuring connected to Johnson & Johnson’s talc-related liabilities. The transaction used a divisional-merger structure commonly nicknamed the Texas Two-Step. In simplified terms, a company divides into separate entities, assigns substantial tort liabilities to one entity, and that liability-bearing entity files for Chapter 11.

The strategy is designed to move large numbers of present and future claims into a centralized bankruptcy process rather than continuing thousands of individual lawsuits in courts around the country. Supporters argue that this can produce a more orderly and equitable resolution. Critics argue that a profitable corporate group should not be able to manufacture a bankruptcy debtor and use Chapter 11 to escape the ordinary tort system.

In In re LTL Management, LLC, the Third Circuit focused heavily on whether LTL itself was actually experiencing the kind of financial distress that justified Chapter 11. The court concluded that it was not. A major factor was the value of LTL’s funding rights against Johnson & Johnson and another affiliated entity, which substantially reduced the immediate financial danger posed by the talc claims.

The Third Circuit’s good-faith rule

The Third Circuit held that good faith is an important gateway to Chapter 11. Under its precedents, a debtor without financial distress cannot demonstrate that its petition serves a valid bankruptcy purpose. The court stressed that insolvency is not strictly required, but financial difficulty must be real enough and immediate enough to justify the extraordinary machinery of bankruptcy.

That distinction is crucial. The Third Circuit did not announce a simple balance-sheet test under which liabilities must exceed assets. Instead, it asked whether the debtor faced problems Chapter 11 was designed to address. Cash-flow pressure, looming liabilities, impaired access to capital, operational deterioration, or other forms of genuine and sufficiently immediate distress may qualify.

What is not enough, under this approach, is a remote possibility that financial trouble may arise someday. A company cannot necessarily point to a dark cloud on the distant horizon and demand a bankruptcy umbrella while the sun is still shining and a well-funded affiliate is standing nearby with a very large checkbook.

For LTL, the financial resources available through its funding arrangement were central. The Third Circuit concluded that the debtor was not in financial distress when it filed and therefore lacked the valid bankruptcy purpose required for good faith. The Chapter 11 case was ordered dismissed.

The Fourth Circuit’s Approach: Bestwall Stays in Bankruptcy

Bestwall and another Texas Two-Step structure

Bestwall arose from a different corporate group but presented a familiar structure. Georgia-Pacific had faced decades of asbestos litigation associated with building products. In 2017, a divisional merger separated the business so that Bestwall became the entity primarily responsible for asbestos liabilities. Bestwall then filed Chapter 11 in the Western District of North Carolina.

According to the Fourth Circuit’s 2025 opinion, approximately 64,000 asbestos claims were pending when the restructuring occurred, with additional future claims anticipated. The contemplated bankruptcy process involved the possibility of resolving asbestos liabilities through the specialized framework associated with Section 524(g).

Claimants challenged Bestwall’s bankruptcy from several directions. One major argument eventually presented to the Fourth Circuit was that federal courts lacked subject-matter jurisdiction over a bankruptcy filed by a debtor capable of paying its obligations.

The Fourth Circuit rejected the jurisdictional challenge

In August 2025, the Fourth Circuit affirmed the denial of the motion to dismiss for lack of subject-matter jurisdiction. The majority framed the question narrowly: can federal courts have subject-matter jurisdiction over a bankruptcy case involving a debtor that may be solvent or able to pay its debts? The answer was yes.

The court reasoned that a petition under the federal Bankruptcy Code arises under federal law. It emphasized that a debtor’s financial condition can matter at other stages and under other doctrines, but solvency does not eliminate federal subject-matter jurisdiction over the bankruptcy case.

This is an important point of precision. The Fourth Circuit expressly said that its 2025 decision was not a final endorsement of every Texas Two-Step transaction and was not deciding every possible challenge to Bestwall’s eligibility for bankruptcy relief. The ruling addressed the narrower jurisdictional argument.

Still, the broader Fourth Circuit legal environment is more favorable to debtors defending against bad-faith dismissal. Under the circuit’s longstanding Carolin Corp. v. Miller standard, dismissal for a bad-faith Chapter 11 filing requires both objective futility and subjective bad faith. That two-part standard has been described as particularly demanding.

Is This a True Circuit Split?

In practical terms, yesbut in technical terms, the answer deserves some nuance.

The Third Circuit’s LTL decision addressed the debtor’s good faith and the need for financial distress to establish a valid bankruptcy purpose. The Fourth Circuit’s 2025 Bestwall decision addressed subject-matter jurisdiction and expressly declined to resolve every merits-based objection to the bankruptcy.

That means the holdings are not perfect mirror images. One court did not say, “Financial distress is required,” while the other answered the identical question with, “No, it is not.”

Nevertheless, the practical divide is substantial. The Third Circuit treats genuine financial distress as a critical entrance requirement for a good-faith Chapter 11 case. In the Fourth Circuit, solvent-debtor status does not defeat jurisdiction, and the circuit’s two-pronged bad-faith standard makes dismissal on that ground comparatively difficult.

So, for corporate restructuring lawyers, lenders, mass-tort claimants, boards of directors, and anyone else who has learned that the phrase “venue strategy” can generate a 70-page legal memo, the difference is very real.

A Simple Example of How the Outcomes Can Diverge

Imagine a newly created company called LiabilityCo. It receives billions of dollars in contingent tort claims but also receives a binding funding commitment from a financially powerful corporate affiliate. LiabilityCo can currently pay its obligations and has access to enough capital to cover reasonably expected liabilities for years.

Under the Third Circuit approach

A court would closely examine whether LiabilityCo is in genuine, apparent, and sufficiently immediate financial distress. The existence of a strong funding agreement could seriously undermine the argument that Chapter 11 is presently necessary. If the filing appears premature or primarily designed to gain litigation advantages, dismissal for lack of good faith becomes a significant risk.

Under the Fourth Circuit framework

The company’s ability to pay its debts would not, by itself, deprive the federal courts of subject-matter jurisdiction. A bad-faith dismissal challenge would also encounter the demanding requirement of showing both subjective bad faith and objective futility under Fourth Circuit precedent.

The hypothetical debtor could still face objections, confirmation disputes, constitutional arguments, creditor challenges, and intense scrutiny of its restructuring strategy. But the path to keeping the case alive may be wider.

Why the Split Is So Important for Mass-Tort Bankruptcies

Traditional Chapter 11 cases often involve familiar financial distress: missed payments, unsustainable debt, declining cash flow, failed refinancing efforts, or an operational crisis. Mass-tort cases can look very different. The debtor may face enormous potential liabilities, but the amount and timing of those liabilities can remain uncertain for decades.

Bankruptcy offers features that can be attractive in that environment. It can centralize claims, establish procedures for estimating liabilities, create trusts, coordinate present and future claimants, and provide a route toward global resolution.

The problem is deciding when those benefits are legitimately available.

Debtors argue that waiting for a company to become insolvent can destroy value and reduce the assets ultimately available to claimants. Creditors and tort plaintiffs respond that Chapter 11 should not become a premium litigation-management subscription service for corporations that can comfortably pay their debts.

The Third Circuit leans toward requiring evidence that the financial problem has become sufficiently concrete. The Fourth Circuit leaves more room for bankruptcy proceedings to continue, at least where the challenge is framed as jurisdictional and where the demanding Carolin bad-faith test applies.

The Supreme Court Left the Divide in Place

The Bestwall dispute reached the U.S. Supreme Court through a petition for a writ of certiorari. On June 1, 2026, the Court denied the petition. The denial came without a decision on the merits, so it should not be read as Supreme Court approval of the Texas Two-Step or as a nationwide ruling that financial distress never matters. It simply left the Fourth Circuit judgment standing.

For now, that means the practical divergence remains unresolved at the national level. The Third Circuit’s financial-distress requirement continues to shape filings within its jurisdiction, while the Fourth Circuit’s Bestwall ruling and existing bad-faith doctrine remain important authorities for cases within that circuit.

The Supreme Court’s refusal to hear the case also increases the importance of future appellate decisions, congressional action, and the way bankruptcy courts distinguish between genuine restructuring needs and manufactured distress.

What the Split Means for Corporate Debtors

Companies considering Chapter 11 cannot treat financial condition as a box to be checked with a few gloomy PowerPoint slides. In a jurisdiction following the Third Circuit’s reasoning, the debtor should be prepared to demonstrate why the problems are real, why they are sufficiently immediate, and why bankruptcy offers a solution tied to financial rehabilitation or preservation of estate value.

Important evidence may include cash-flow forecasts, maturity schedules, liquidity constraints, insurance limitations, claim projections, refinancing difficulties, operational risks, and the realistic availability of affiliate support.

Funding agreements deserve especially careful attention. A parent-company commitment intended to reassure a bankruptcy court that claimants will be paid can simultaneously weaken an argument that the debtor is financially distressed. That is the restructuring equivalent of bringing an industrial-size fire extinguisher and then trying to convince everyone the building is moments from burning down.

What the Split Means for Creditors and Claimants

Creditors challenging a filing must choose their arguments carefully. Is the issue statutory eligibility? Good faith? Subject-matter jurisdiction? Constitutional authority? Objective futility? A debtor’s motive? The answer can affect both the legal standard and the timing of appellate review.

The Bestwall decision demonstrates why labels matter. The Fourth Circuit distinguished a jurisdictional attack from other arguments about whether bankruptcy protection should ultimately be available. A challenge that fails as a jurisdictional objection may still reappear in another form at a later stage of the case.

For mass-tort claimants, the stakes extend well beyond legal doctrine. Bankruptcy can change where claims are resolved, how long resolution takes, how collective settlements are structured, and how much leverage individual plaintiffs possess. Supporters of centralized bankruptcy resolution emphasize consistency and equal treatment. Opponents emphasize delay, reduced jury access, and the concern that solvent corporate groups can use restructuring tools to limit ordinary tort exposure.

Forum Shopping Is Now an Even Bigger Issue

A federal bankruptcy system is supposed to be uniform, but circuit-level differences inevitably influence venue strategy. When the legal survival of a multibillion-dollar restructuring can depend partly on the governing appellate precedent, debtors and creditors will pay very close attention to where a case is filed.

The Third-Fourth Circuit divide therefore raises concerns about forum shopping. A corporate group considering a liability-management transaction may prefer a jurisdiction with a more forgiving approach to Chapter 11 access. Claimants may seek transfer, dismissal, or other procedural routes toward a less debtor-friendly forum.

This does not mean a company can simply pick any courthouse with an attractive ZIP code. Bankruptcy venue is governed by statutory rules and factual connections. But the incentives created by differing circuit standards are difficult to ignore.

Practical Experience: What This Split Teaches Bankruptcy Case Teams

One of the most useful practical lessons from the LTL and Bestwall litigation is that a bankruptcy filing should be tested from the perspective of the skeptical judge before the petition is ever filed. A restructuring team may spend months designing a transaction that is perfectly authorized under corporate law, only to discover that the more important question is whether the resulting debtor has a credible bankruptcy problem.

Experienced case teams therefore build the record early. They examine projected liabilities under multiple scenarios rather than relying on a single catastrophic estimate. They test available liquidity, affiliate funding, insurance recoveries, defense costs, settlement trends, and the timing of future claims. They also ask an uncomfortable but necessary question: What happens if the court treats our strongest financial protection as evidence that bankruptcy is unnecessary?

That question became particularly important after LTL. A robust funding commitment can help demonstrate that claimants are protected, but it may also make immediate financial distress harder to prove. The lesson is not to weaken a debtor deliberately. The lesson is to understand that transaction documents can have consequences beyond their original purpose.

Another practical experience is the importance of separating legal theories. Bankruptcy litigation becomes messy when parties use “jurisdiction,” “eligibility,” “good faith,” and “constitutional authority” as though they were interchangeable. They are not. Bestwall demonstrates that a court may possess jurisdiction over a case while leaving open serious disputes about whether the debtor should ultimately receive particular bankruptcy relief.

For creditors, the same discipline matters. A motion to dismiss should identify the strongest doctrinal path rather than throwing every available objection into one very expensive soup. In the Third Circuit, the debtor’s actual financial condition may provide a powerful good-faith argument. In the Fourth Circuit, challengers must account for Carolin‘s demanding dual requirements and may need to focus on other stages of the case, including plan confirmation and the specific relief requested.

A third lesson concerns timing. Financial distress is not static. A debtor that lacks sufficient distress today may face genuine distress later. Conversely, a company that appears endangered may obtain financing, insurance proceeds, settlements, or parental support that changes the analysis. Lawyers evaluating a possible Chapter 11 filing should therefore treat financial condition as a moving factual record, not a slogan frozen on the day the board first discussed restructuring.

Finally, the split reinforces a basic truth about major bankruptcies: legal strategy and credibility are inseparable. Courts are more likely to scrutinize transactions that appear engineered primarily to capture bankruptcy advantages while leaving the broader enterprise financially untouched. Clear evidence of a legitimate restructuring need, transparent governance, realistic financial projections, and a plan that produces identifiable benefits for creditors can matter enormously.

The best practical approach is not to assume that a clever structure will defeat every challenge. It is to prepare for the question both circuits are asking in different ways: Why does this debtor need bankruptcy, and why now? A convincing answer can be more valuable than another hundred pages of corporate diagramsalthough, in a major Chapter 11 case, there will probably be those hundred pages too.

Conclusion

The split between the Third and Fourth Circuits reflects a larger debate about the proper boundaries of Chapter 11. The Third Circuit’s LTL decision places genuine financial distress at the center of the good-faith analysis and warns financially healthy entities against using bankruptcy primarily for litigation advantage. The Fourth Circuit’s Bestwall decision confirms that solvency does not eliminate federal subject-matter jurisdiction, while the circuit’s existing bad-faith doctrine creates a demanding standard for dismissal.

The distinction is legally nuanced but commercially significant. Debtors, creditors, tort claimants, boards, insurers, and restructuring professionals must now evaluate not only the debtor’s balance sheet but also the governing circuit’s conception of what Chapter 11 is for.

With the Supreme Court having declined review of the Bestwall case in June 2026, there is no nationwide resolution yet. The result is an unusually important geographic divide in federal bankruptcy practiceand a reminder that, despite the promise of “uniform Laws on the subject of Bankruptcies,” the road into Chapter 11 can still look very different depending on which circuit’s courthouse sits at the end of it.

Note: This article is for general informational and educational purposes only. Bankruptcy law is highly fact-specific, and the decisions discussed involve complex procedural and constitutional issues. Businesses, creditors, and claimants should obtain advice from qualified legal counsel regarding particular cases or transactions.