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Summary

On May 12, 2015, Justice Newbould of the Ontario Superior Court of Justice[i] and Judge Gross of the United States Bankruptcy Court for the District of Delaware[ii] simultaneously issued rulings to allocate the approximately US$7.3 billion proceeds of sale of the Nortel group’s assets amongst insolvent estates administering the now defunct company in each of Canada, the United States (“US”) and Europe.

Both Courts ruled that Nortel’s proceeds should be split among the insolvent estates on a pro rata basis. TGF represented the Nortel Networks UK Pension Trust Limited and the Board of Directors of the Pension Protection Fund (collectively, the “UK Pension Claimants”) who in turn represent the interests of approximately 36,000 surviving pensioners of Nortel’s British subsidiary, Nortel Networks UK Limited[iii].  The buy-out deficit of the Nortel Networks UK pension plan was in excess of US$3 billion, making the UK Pension Claimants the second largest creditor of the Nortel group.

TGF advocated for a pro rata result on allocation and the Courts’ rulings represent an unprecedented victory for the UK Pension Claimants.  The decision will also have a significant impact on future global insolvencies involving highly integrated multinational enterprise groups of companies.

History and Global Insolvency Proceedings

Nortel was once the crown jewel of Canada’s technology sector.  In 2000, Nortel employed more than 100,000 people across the globe and had a market capitalization of approximately US$260 billion. On January 14, 2009, Nortel’s Canadian entities filed for protection under the Companies’ Creditors Arrangement Act (“CCAA”).[iv]  On that same day, Nortel’s US subsidiaries filed for protection under Chapter 11 of the US Bankruptcy Code and a number of its subsidiaries in Europe, the Middle East and Africa (“EMEA”) were granted Administration Orders under the UK Insolvency Act, 1986, which is similar to a Canadian CCAA proceeding.

The Canadian and US insolvent estates had sought and obtained recognition orders from the Courts in those two jurisdictions, but neither chose to seek recognition of the CCAA or Chapter 11 proceedings from the UK Court overseeing the EMEA insolvency proceedings.  As a result, the UK Court was not involved in the determination of the allocation of the global proceeds of sale, which was determined solely by the Canadian and US Courts.

Nortel’s Unique Structure

Nortel’s global business was profoundly integrated and organized across geographic boundaries and legal entities, with employees in all regions sharing information and performing research and development (“R&D”), sales and other functions.  Both Courts found that no one single entity or jurisdiction could have carried on a portion of Nortel’s business alone.  While the bulk of Nortel’s patents were registered in the name of its Canadian parent, important and valuable R&D was performed by a number of Nortel’s subsidiaries around the world to create the intellectual property that gave rise to the patents.

The Asset Sales

Shortly after the insolvency proceedings were commenced it was determined that a global liquidation of the Nortel group’s assets would be necessary, involving cooperation by the Administrators of the Canadian, US and EMEA insolvency estates. The Nortel group then sold its four major lines of business and its residual patent portfolio through various sales for aggregate proceeds of approximately US$7.3 billion.[v]  These funds were placed in a lockbox (the “Lockbox Fund”), the allocation of which was to be either: (i) agreed upon by the Canadian, US and EMEA estates or (ii) determined by the Canadian and US Courts if the debtor estates could not reach an agreement.

The Joint Allocation Determination

In 2013, after several failed rounds of formal mediation, the Canadian and US Courts directed the allocation of the Lockbox Fund to be determined by way of a historic and precedent-setting joint trial before the two Courts. Lasting 24 days, the joint trial was conducted by video link between the Ontario and Delaware Courts between May and September, 2014.  Canadian and US counsel were permitted to appear and make submissions in both Courts.  The litigation process involved the review of over 3 million documents, depositions of over 140 witnesses around the world and the submission of more than fifty expert reports.

In addition to the Canadian, US and EMEA debtor estates, the Judges permitted key stakeholders to participate equally in the dispute as “Core Parties”. These additional stakeholders included representatives of Nortel’s Ad Hoc Bondholder Committee (the “Bondholders”), the Canadian Creditors’ Committee representing the former Canadian employees and pensioners (the “CCC”), the US Unsecured Creditors’ Committee (the “UCC”) and the UK Pension Claimants. The debtor estates and all Core Parties other than the UK Pension Claimants advocated for diametrically opposed allocations of the Lockbox Fund based, in part, on their own interpretation of a Master R&D Agreement (“MRDA”) previously reached between Nortel entities in Canada, the US, the UK, France and Ireland.

The Canadian estate (through its Court-appointed Monitor) argued that it was entitled to US$6.3 billion dollars of the Lockbox Fund (approximately 82%) on the basis that: (i) it was the legal title holder to all of the patents in the residual patent portfolio; and (ii) as the registered title-holder of most of the patents transferred in the business line sales, it was also entitled to approximately 55% of the value of the business line sales. The CCC adopted the Canadian Monitor’s position as its main allocation theory.[vi]

The US estate argued that it was entitled to US$5.3 billion dollars of the Lockbox Fund (approximately 72%) on the basis that the majority of the Nortel’s group’s world-wide revenue was earned in the US market, in which the US operating subsidiary had the exclusive right to sell products. The Bondholders and the UCC adopted the position of the US estate.

The EMEA estate argued that each debtor estate was entitled to an allocation of the Lockbox Fund commensurate with its relative contribution to the creation of Nortel’s intellectual property.  This contribution could be measured by the amount each party to the MRDA had spent over a number of years in developing the intellectual property giving rise to the patents.

The UK Pension Claimants argued that each debtor estate was entitled to a share of the Lockbox Fund so as to provide all creditors of the Nortel group (irrespective of the Nortel entity against which they had a claim) with a pro rata, pari passu recovery on their claims. This argument was premised on the following factors: (i) prior to its insolvency, the Nortel group operated as one highly integrated multinational corporation; (ii) Nortel’s most valuable assets were collaboratively developed and jointly sold by all of the debtor estates – no one entity or debtor group could claim ownership to them; and (iii) a pro ratadistribution of the Lockbox Fund was the most equitable, credible and economically rational way to disentangle the assets that ultimately formed the Lockbox Fund.

Throughout, the UK Pension Claimants took the position that the MRDA had no application to the distribution of the Nortel group’s proceeds of sale in an insolvency.  The pro rata allocation position advanced by the UK Pension Claimants also provided the Courts with mechanisms by which prior court-approved settlement of claims, inter-company claims and claims based on guarantees against other members of the Nortel group could be accommodated if the Courts chose to do so.

The Rulings

On May 12, 2015, Justice Newbould and Judge Gross simultaneously issued rulings on the allocation of the Lockbox Funds. Both judges agreed that the Lockbox Fund should be allocated among the debtor estates on a pro rata basis by reference to the aggregate amount of proven claims against each entity within that debtor estate, and that the MRDA had no application to the distribution of the Lockbox Fund.  In reaching this decision, both Judges had regard to the highly integrated nature of Nortel’s business and intellectual property assets and the manner in which the Nortel group operated prior to its collapse. Justice Newbould observed that the creation of Nortel’s valuable intellectual property was a joint effort contributed to by all of the now defunct Nortel entities:

This was not one corporation and one set of employees inventing IP that led to patents. Nortel was a highly integrated multi-national enterprise with [various subsidiaries] doing R&D that led to patents being granted. …[vii]

This is an unprecedented case involving insolvencies of many corporations and bankrupt estates in different jurisdictions. The intangible assets that were sold, being by far the largest type of asset sold, were not separately located in any one jurisdiction or owned separately in different jurisdictions. They were created by all of the RPEs [intellectual property producing entities] located in different jurisdictions. Nortel was organized along global product lines and global R&D projects pursuant to a horizontally integrated matrix structure and no one entity or region was able to provide the full line of Nortel products and services. R&D took place in various labs around the world in a collaborative fashion. R&D was organized around a particular project, not particular geographical locations or legal entities, and was managed on a global basis. The fact that Nortel ensured that legal entities were properly created and advised in the various countries in which it operated in order to meet local legal requirements does not mean that Nortel operated a separate business in each country. It did not.[viii]

Both Judges rejected the various allocation theories advanced by the debtor estates and their supporters on the basis that the theories were unworkable, unfair and in no way reflected the manner in which the Nortel group operated. As Judge Gross observed in his judgment:

The Courts also agree that the self-serving allocation positions of the Canadian Interests, the US Interests and the EMEA Debtors are not determinative or helpful.[ix]

Despite the fact that a pro rata allocation of the Lockbox Fund was a novel solution that had not arisen in other global insolvency proceedings, both Courts found that they had the jurisdiction to order such a remedy in light of the unique circumstances of the case.[x] In particular, Justice Newbould found that after six years of legal wrangling and the expenditure of enormous costs, a global solution was required that comported with the fundamental tenet of insolvency law that all debts should be paid pari passu and all unsecured creditors receive equal treatment. “A pro rata allocation in this case goes partway towards such a result.”

Implications of the Decisions

While the Nortel case arose from a unique set of circumstances, its importance and future precedential value should not be underestimated.  The Courts’ rulings will be carefully considered in the context of the burgeoning body of work on the treatment of insolvent corporate enterprise groups by academics and practitioners alike.

TGF is proud to have had the opportunity to represent the UK Pension Claimants in achieving this successful and groundbreaking result.[xii]

For more information on the Nortel allocation rulings or to discuss their implications, please contact any member of TGF’s Nortel team: D.J. Miller, John Finnigan, Andrea McEwan, Rebecca Kennedy, Michael Shakra or Henry Wiercinski.