The Delaware Two-Step doesn’t work either

Step 1 of the original Texas-Two-Step is to take a single, solvent, and otherwise healthy company and divide it under the Texas divisive merger statute¹ into two separate, solvent companies, similar to a spin-out².  A divisive merger is, in many cases, superior to a spin-out because a divisive merger does not constitute a “transfer” under the applicable Texas statute. Since there is no “transfer,” things like licenses remain intact and change in control provisions are unaffected, and parties can avoid potential liability under fraudulent transfer statutes if it turns out later that one of the entities was unknowingly insolvent at the time. Step 1 is the non-controversial part: it is simply a standard liability management and organizational tool.

But, Step 2 is then to immediately place “badco,” (the company with the problematic and unwanted historical liabilities) into bankruptcy for purposes of (a) corralling all litigation wherever located into the bankruptcy court, (b) ultimately channeling all of “badco's” liabilities through a chapter 11 plan, and (c) enjoin any potential actions against “goodco” and protect “goodco” from “badco's” liabilities.  This strategy has been attempted in several situations, some well-known, and so far without success. Courts have denied these attempts on various grounds, including recently in the Third Circuit for a lack of financial distress and therefore a lack of good faith³. In that case, the entity was a solidly solvent company, with ample funding from its parent entity, only experiencing the frustrating (but not debilitating) existence of tort liabilities, which have been complex and expensive to manage, causing a drag on the financial performance of the original, single company.

The Red River⁴ decision would have appeared to be the death knell for future Texas Two-Steps, at least for solvent companies with historical tort liabilities. There, Judge Lopez in the Southern District of Texas dismissed the case for several reasons, including most relevantly that the case overall showed evidence of bad faith, given that the sole purpose of the solvent case appeared to be resolving mass tort claims.      

But, what about a Delaware⁵ Two-Step for a solvent company trying to shed operating liabilities utilizing the Delaware divisive merger statute, followed by a District of Delaware Chapter 11 bankruptcy? Could that work, particularly in the absence of mass tort liabilities?

The short and decisive answer is no⁶. Why not?  Essentially the same reasons that were stated in the LTL Management and Red River cases before it: it is not good-faith to file a solvent company that is not in financial distress for bankruptcy, even if there are sound commercial reasons for trying to do so. Here's a little more on the specifics:

The Bedmar Decision

Bedmar, LLC (“Bedmar”) filed for Chapter 11 in Delaware in June 2025 following a Delaware divisive merger that, essentially⁷ took the original company National Resilience, Inc., and split it into the go-forward entity, National Resilience, and Bedmar, which was allocated certain unwanted leases, guarantees on those and other leases, and $41.4 million of cash and receivables. The stated goal of the filing was for the winding down operations and addressing more than $370 million in lease obligations, which under the statutory cap in § 502(b)(6) of the Bankruptcy Code on rejected leases would leave landlord claims at approximately $33 million. The debtor Bedmar had little ongoing business activity and no revenue.

Several landlords and the U.S. Trustee challenged the filing, arguing it was not a good-faith use of bankruptcy because the company's real purpose was solely to take advantage of the statutory cap on landlord claims. Judge J. Kate Stickles agreed and dismissed the case in late August, finding that the petition served mainly as a litigation tactic and did not offer a legitimate reorganization pathway for creditors as a whole, i.e. the bankruptcy filing lacked good faith.

In her decision, Juddge Stickles cited the growing line of Third Circuit authority—SGL Carbon,⁸ Integrated Telecom,⁹ 15375 Memorial,¹⁰ and the recent LTL Management opinions—which stress that Chapter 11 is available only when a debtor faces real financial distress and proposes a bankruptcy process that maximizes or preserves value beyond tactical litigation goals. The court applied those standards and concluded that any “distress” attributable to Bedmar was essentially self-created and that the bankruptcy offered no broader creditor benefit. Notably, here, unlike in LTL Management, there was no significant guaranty or backstop by the debtor's parent company: the court analyzed the debtor's financial state entirely independently. In a two-prong analysis, the court reiterated (a) that a company filing for bankruptcy must have a “valid purpose,” which includes preserving a going concern or maximizing the value of the estate, and (b) an application of the Primestone factors¹¹ will fail when applied to solvent company like Bedmar, using bankruptcy chiefly to gain claim-capping or bargaining leverage¹². Under both of these tests, the debtors' bankruptcy petitions were not found to be filed in good faith.

Interestingly, the Bankruptcy Court did not address the question of whether the divisive merger satisfied the Delaware statute and whether transferring $370+ million of liability to an entity that had approximately $50+ million in total assets was a fraudulent transfer.  Presumably because it was not raised by the parties and was not necessary for the opinion, but leaves open the question of the ultimate viability of even Step 1 of the Delaware Two-Step.

Authored by Christopher R. Donoho III and Danielle Ullo.