Johnson & Johnson (NYSE:JNJ) has been a top healthcare company for decades. From selling pharmaceuticals to producing a wide range of consumer products, it's become a household name. It's also a popular stock for investors, consistently generating strong numbers plus paying a generous dividend that, at 2.4%, is well above the S&P 500 average (1.3%).

However, the company faces many legal challenges that could put a dent in its financials. Lawsuits relating to opioids and talc-based baby powder may saddle it with billions in legal fees for years to come. Talc lawsuits are particularly concerning for investors, given how many of them there are. But there is a way the company can significantly reduce its liabilities.

A medical professional looking at a tablet with another person.

Image source: Getty Images.

Texas two-step bankruptcy law would allow Johnson & Johnson to split its business

Johnson & Johnson could use a "Texas two-step bankruptcy" to create a separate entity into which it could divert its talc liabilities. Then, it can bankrupt that other business (while still carrying on with its existing operations) and thus limit the amount it would have to pay out in relation to its talc liabilities. Plus, the company would avoid costly legal fees that would be inevitable from defending itself in those lawsuits.

Some plaintiffs who have sued the healthcare company say they developed cancer from its talc-based baby powder products. Related payouts have been significant; the courts have ordered Johnson & Johnson to pay $2.1 billion to just 20 women (down from the initial $4.7 billion awarded to these plaintiffs in 2018). And there are over 34,000 lawsuits connected with this issue still pending. The current estimate for talc-related liabilities is approximately $24 billion, and that's just from possible damage claims -- it doesn't reflect all the expenses the company would incur along the way. That amount is more than the $23.3 billion that the company reported in revenue in its most recent quarterly results (for the period ending July 4).

Plaintiffs are trying to prevent the bankruptcy from happening

Lawyers for the plaintiffs are trying to stop Johnson & Johnson from deploying the move. The company hasn't formally announced that it will actually proceed with the two-step bankruptcy, only that it is considering it. However, Laurie Selber Silverstein, a federal bankruptcy judge, recently denied a request from the plaintiffs' lawyers, potentially clearing the way for the moves (which the company's lawyers refer to as "legitimate business transactions") to proceed. But the battle continues, as plaintiffs are now taking the issue to the courts in New Jersey (where Johnson & Johnson is based) to try and stop the move there.

Is there too much risk to invest in Johnson & Johnson?

Johnson & Johnson has been involved in numerous legal battles over the years, and they go beyond just talc. In 2019, a judge ordered the company to pay $465 million for an opioid-related lawsuit in Oklahoma. It may have to pay out another $5 billion more; along with other distributors and drugmakers, the company recently came to a $26 billion opioid settlement involving 42 states and five territories, plus Washington, D.C. In 2020, the company also paid a judgment related to schizophrenia drug Risperdal after a boy developed breasts from the treatment. A judge reduced the initial $8 billion award to $6.8 million.  

The big unknown for investors is how large these future settlements may get and how much they may hinder the company's operations. Johnson & Johnson generated free cash flow of $22.6 billion over the past 12 months, which would be plenty of money to cover these legal bills. But there's potential for the penalties to increase. And while things are going well for the business right now, its brand could take a hit due to these mounting issues, which could persuade consumers to use other products from other companies. The long-term picture for Johnson & Johnson is unclear, and that's why even though the stock is known for its consistency, investors should be careful not to assume that things will stay the way they've been.

Regardless of whether you like the stock for its dividend or growth potential, there are better investments out there that will likely be less of a headache than Johnson & Johnson.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.