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A federal appeals court in Philadelphia rejected Johnson & Johnson's use of chapter 11 bankruptcy to freeze roughly 40,000 lawsuits linking its talc products to cancer, blunting a strategy the consumer health giant and a handful of other profitable companies have used to sidestep jury trials.

The Third U.S. Circuit Court of Appeals dismissed on Monday the chapter 11 case of J&J subsidiary LTL Management LLC, which the company created in 2021 to move the talc injury lawsuits to bankruptcy court and freeze them in place. J&J is now exposed once again to talc-related cancer claims that have cost the company's consumer business $4.5 billion in recent years and are expected to continue for decades.

J&J tried to stanch those costs through an emerging corporate restructuring strategy that offered J&J and other companies the protections of bankruptcy, despite their solvent balance sheets and solid credit ratings, and put more than 250,000 injury lawsuits against the businesses on hold. Monday's decision marks the first time a federal appeals court has disapproved of the bankruptcy strategy, known in legal circles as the Texas Two-Step.

A Johnson & Johnson spokeswoman said the company would challenge Monday's ruling and that it put its subsidiary LTL into bankruptcy to equitably resolve the talc litigation for current and future injury claimants.

J&J's share price fell 3.7% on Monday, closing at $162.

The court's decision could mark tougher scrutiny of the legal tactic, which would make it harder for big companies to move past potentially costly and time-consuming personal-injury litigation. For J&J, the ruling means the talc litigation -- and the billions of dollars in potential liabilities -- could hang over the company for years, even after it hives off the consumer-products business that was home to the baby powder.

Bankruptcy allows companies swamped by lawsuits to drive settlements of legal liabilities through a chapter 11 plan and stop litigation from advancing in the civil justice system. But J&J and others including Georgia-Pacific LLC, U.S. units of Ireland's Trane Technologies PLC and France's Cie. de Saint-Gobain SA have gotten access to those benefits in recent years without filing bankruptcy themselves. They created new subsidiaries with limited operations under Texas law, filled them with tort liabilities and placed them in chapter 11.

Personal injury claimants and other critics have argued these solvent businesses shouldn't get the reprieve from litigation without subjecting their core businesses to bankruptcy-court oversight.

Consumers who have sued J&J celebrated Monday's ruling. Willie Gregory, who said his wife, Sonna Gregory, died in 2021 from ovarian cancer at age 59, said the ruling was a relief because he was worried J&J would be able to use its substantial resources to stop the talc lawsuits and "sweep it under the rug."

"It makes me feel like there is a sense of justice," Mr. Gregory said. "There are a lot of folks just like me who have lost loved ones because of this."

J&J has denied liability in Mr. Gregory's case. J&J, which has long maintained its talc products are safe, can request that all judges on the Third Circuit review Monday's decision, and it could later petition for review by the U.S. Supreme Court.

Unless overturned on further appeals, the appellate ruling could pose challenges for J&J as it is preparing to separate the consumer-health business that sells Johnson's Baby Powder into a standalone company to be called Kenvue.

J&J has decided to stop selling baby powder containing talc globally this year, and instead will sell only powder made out of cornstarch. It previously stopped talc powder sales in the U.S. and Canada, citing lower demand amid safety concerns.

After the separation, the remaining J&J, which will consist of pharmaceutical and medical-device units, will retain the talc-related liabilities for products sold in the U.S. and Canada. Kenvue will be responsible for liability arising from products sold outside the U.S. and Canada, according to a Kenvue securities filing. J&J expects to complete the separation of Kenvue this year.

J.P. Morgan analyst Chris Schott estimates J&J's liabilities for talc could end up in the range of $8 billion to $10 billion. Monday's ruling, if upheld, could prolong by several years the time it takes for J&J to resolve the talc litigation because the claims won't be in a consolidated bankruptcy proceeding, Mr. Schott said in a research note.

The court ruling could also affect 3M Co., according to legal observers. The company is using a similar plan to attempt to resolve about 230,000 personal injury claims involving its military earplugs through an affiliate's bankruptcy case. A 3M spokesman said it continues to support its bankrupt earplug unit, Aearo Technologies LLC, in a confidential mediation process.

J&J agreed to fund any settlement reached in LTL's bankruptcy case to resolve claims that Johnson's Baby Powder and Shower to Shower caused ovarian cancer or contained asbestos. Because of that backstop, the appeals court said the LTL subsidiary wasn't in financial distress, a requirement for accessing the powerful legal tools of chapter 11.

The company has argued that resolving the lawsuits in a chapter 11 plan is more efficient and fair for injury claimants than litigating or settling each claim one by one. The judge overseeing LTL's bankruptcy case agreed last year, saying that the J&J subsidiary acted in good faith and for a valid purpose when it filed for chapter 11.

Judge Thomas Ambro, writing for the Third Circuit panel, said the evidence showed that LTL was "highly solvent" by virtue of its funding agreement with J&J and had access to enough capital to meet any potential talc liabilities for the foreseeable future. Ignoring the "safety net" of a parent company like J&J "would allow tunnel vision to create a legal blind spot. We will not do so," he said.

Judge Ambro said the funding agreement gave LTL access to as much as $61.5 billion at the time it filed for chapter 11 as well as direct access to J&J's "exceptionally strong balance sheet." That value far exceeded approximately $4.5 billion in aggregate costs J&J accumulated in the talc litigation over the past five years, he said.

Judge Ambro, considered a leading authority on bankruptcy law, said the funding agreement meant LTL wasn't in immediate financial distress, which would necessitate a bankruptcy filing. Dismissing the chapter 11 case would ensure that injury claimants' rights to a jury trial "are disrupted only when necessary," he said.