Legal issues are one of the biggest risks that Johnson & Johnson (JNJ 0.22%) faces today. From its role in the opioid crisis to lawsuits involving its pharmaceutical and consumer products, it's not uncommon to see the company spend billions in litigation expenses during a year. One of the biggest legal challenges it is facing right now includes its talc baby powder products, which plaintiffs allege led to them developing cancer.
The company is trying to minimize its potential liability due to these lawsuits by using a controversial strategy known as the Texas Two-Step, where it would put all the claims in a subsidiary and then bankrupt it. However, an appeals court recently threw out that case.
Appeals Court says Johnson & Johnson isn't distressed
In 2021, Johnson & Johnson created a subsidiary, LTL Management LLC, for the purpose of shifting its talc lawsuits there and bankrupting the company to avoid the uncertainty and hefty costs that could come with the related litigation.
There are, after all, around 40,000 cases involving its talc products. Simply going through and fighting all of those cases can lead to significant costs for the company, so there's a huge incentive for the business to avoid that. But Judge Thomas Ambro, in the Third U.S. Circuit Court of Appeals, did not agree with the strategy, recently saying that with Johnson & Johnson's funding agreement, LTL was solvent and wasn't in financial distress -- something that is necessary for a bankruptcy filing.
For Johnson & Johnson, that puts the issue right back into the open, with respect to how much those legal claims may cost the business. When it set up LTL, Johnson & Johnson promised to set up a trust for $2 billion. But the company's liability, if left uncapped, could go well beyond that.
The costs can be difficult to forecast
A big challenge with estimating the potential legal costs related to these talc lawsuits is that there are so many of them. While many of them may be dismissed and the healthcare company may even succeed in winning the majority of them, that doesn't mean it would be able to avoid a big payout.
One of the more costly decisions came involving a $2.1 billion penalty that a jury awarded to just 22 women. And that was after it was reduced from $4.7 billion. Even just a few of these types of rulings could prove to be incredibly costly for the business.
Sifting through 40,000 cases, and more that may come in the future makes it next to impossible to try and predict how much of an impact this may have on the business. And that's why it makes a lot of sense for the company to deploy a strategy like the Texas-Two Step because while Johnson & Johnson may want to downplay the risk to investors, the reality is that it's a significant unknown that could cost it tens of billions of dollars if there is no way to put a limit on it.
Is Johnson & Johnson too risky to invest in?
Johnson & Johnson reported just under $18 billion in profit last year. And the year before that, its bottom line was at nearly $21 billion. Given the company's financial strength, it seems unlikely that Johnson & Johnson would go out of business due to the talc lawsuits, but they could certainly put a dent in its earnings numbers.
Plus, the company is still fighting this legal battle and will appeal this latest decision. And so based on the available information today, the talc lawsuits, while concerning, may not be enough of a reason to be worried about an investment in Johnson & Johnson just yet. The business is highly profitable, and by spinning off its slow-growing consumer business, it may end up being an even better growth investment in the long run. Investors should monitor the talc situation but as of now, I wouldn't dump Johnson & Johnson's stock because of it.
