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On May 3, 2016, the Ontario Court of Appeal released its decision (the “Leave Decision”)¹ denying parties leave to appeal from Justice Newbould’s decision which held that global proceeds of sale in the amount of US$7.3 billion (the “Lockbox Funds”) should be distributed to the worldwide Nortel debtor estates on a pro rata basis (the “Allocation Decision”).²

Two days later, on May 5, 2016, the Supreme Court of Canada denied leave to a group of Nortel’s bondholders who sought to appeal the Ontario Court of Appeal’s previous ruling that they were not entitled to more than US$1.6 billion in post-filing interest on their unsecured claims against Nortel, that had accrued since the insolvency proceedings were commenced in January, 2009.

The Ontario Court of Appeal and Supreme Court of Canada’s rulings are welcome steps forward in the push to bring Nortel’s insolvency proceedings to an end. The rulings are strong signals from the Courts that it is time for Nortel’s lengthy and expensive worldwide insolvency proceedings to an end, so that Nortel’s creditors can finally receive a distribution on their claims.  Moreover, the Leave Decision provides useful guidance on the application of the leave to appeal test from Orders made in CCAA proceedings.

TGF acts as Canadian counsel for the UK Pension Claimants which was the lead respondent opposing attempts by various US parties to appeal the Allocation Decision to the Court of Appeal, and had argued at trial for a pro rata allocation of the Lockbox Funds.  They were also a respondent opposing the bondholders’ application for leave to appeal the post-filing interest decision to the Supreme Court of Canada.  The UK Pension Claimants comprise over 33,000 surviving pensioners of Nortel Networks UK pension plan and are the largest single creditor in Nortel’s global insolvency proceedings. 

Ontario Court of Appeal Decision (Denying Leave from Allocation Decision)

On January 14, 2009, Nortel’s Canadian entities filed for protection under the CCAA.  On that same day, certain of Nortel’s U.S. subsidiaries (the “US Debtors”) commenced proceedings pursuant to Chapter 11 of the U.S. Bankruptcy Code, and 19 of Nortel’s subsidiaries incorporated in Europe, the Middle East, and Africa (“EMEA”) commenced insolvency proceedings in the U.K. pursuant to the Insolvency Act 1986. Between 2009 and 2011, the Nortel group of worldwide companies sold all business lines and residual intellectual property, which proceeds comprise the Lockbox Funds.

Pursuant to an agreement among Nortel’s 40 debtor estates and creditor constituents, the Lockbox Funds could only be released from escrow and delivered to the debtor estates upon either: (i) agreement of the parties; or (ii) final orders of the Canadian and US Courts.  Several failed mediations demonstrated that an agreement among the parties would not be possible, so the Canadian and US Courts conducted an unprecedented joint trial in 2014 to determine the appropriate allocation of the Lockbox Funds.  On May 12, 2015, Justice Newbould of the Ontario Court and Judge Gross of the Bankruptcy Court for the District of Delaware simultaneously released separate consistent decisions directing that the Lockbox Funds be allocated to each Nortel debtor on a pro rata basis by reference to the aggregate amount of proven claims against such Nortel debtor.

Shortly after the Allocation Decision was released, the US Debtors and certain parties aligned in interest sought to have the Ontario and Delaware Courts “reconsider or clarify” the Allocation Decision.  After a joint hearing by both Courts, substantially all of the relief sought by the parties seeking reconsideration or clarification of the Allocation Decision was denied.³

In Delaware, an appeal as of right was made by the US appellants to the United States Court for the District of Delaware. The appeal in Delaware was argued on April 5, 2016 before Judge Leonard Stark and is currently under reserve.  Unlike in Ontario, there are two appeal routes available in Delaware. An appeal of the US Bankruptcy Court’s ruling can be taken to the Delaware District Court (as occured in this case) or it can be certified for direct appeal to the United States Court of Appeal for the Third Circuit. A ruling by the Delaware District Court can be appealed as of right to the Third Circuit.

In Ontario, leave to appeal was sought as required by section 13 of the CCAA.  As noted by the Court of Appeal, leave to appeal is granted sparingly in CCAA proceedings and only where there are serious and arguable grounds that are of real and significant interest to the practice.  In addressing whether leave should be granted, appellate courts will consider whether:

 

• the proposed appeal is prima facie meritorious or frivolous;
• the points on the proposed appeal are of significance to the practice;
• the points on the proposed appeal are of significance to the action; and
• the proposed appeal will unduly hinder the progress of the action.

(i)  Prima Facie Meritorious

The moving parties maintained that leave should be granted because the appeal was prima facie meritorious. In that regard, the moving parties advanced three main arguments.

First, the moving parties argued that a pro rata allocation of the Lockbox funds was tantamount to a worldwide “substantive consolidation” of the debtor estates that ignored well-established principles of corporate separateness.  Moreover, it was argued that Justice Newbould erred in considering an inappropriately low threshold for the application of substantive consolidation.  The Court of Appeal dismissed the moving parties’ arguments and noted that Justice Newbould found that a pro rata allocation did not constitute a substantive consolidation of the Nortel debtors’ estates. It further found that there was no basis to interfere with this conclusion as it was based on factual findings.  Absent a palpable and overriding error, such factual findings are afforded deference by an appellate court.

Second, the moving parties argued that Justice Newbould erred in finding that an agreement which addressed transfer pricing tax issues between certain Nortel debtors while they were engage in ongoing operations (the “Master R&D Agreement” or “MRDA”), and which had formed the basis of the appellants’ theory of allocation at trial, was never intended to and did not govern the allocation of the Lockbox Funds. Again, the Court of Appeal found that there was no reason to interfere with Justice Newbould’s interpretation of the MRDA as there was no palpable or overriding error in his findings.  In addition, the Court of Appeal found no reason to interfere with Justice Newbould’s decision on the basis that he misapplied the law on the application of evidence dealing with the factual matrix or the surrounding circumstances of the MRDA.

Third, the moving parties argued that they were denied procedural fairness and that the Allocation Decision was arbitrary.  The Court of Appeal dismissed the procedural fairness argument on the basis that all of the moving parties were clearly aware that a pro rata allocation could be ordered by the Court and had vigorously opposed a pro rata allocation throughout the course of the litigation.  The fact that the specific terms of the method of allocation ordered by Justice Newbould were not identical to those advanced by certain parties at trial did not, in the Court of Appeal’s view, create any unfairness to the moving parties.  Moreover, the Court of Appeal found that the Allocation Decision could not be considered arbitrary simply because it excluded US$4 billion in bondholder guarantee claims from the pro rata allocation. The US $4 billion in bondholder claims will be counted for allocation purposes against the issuer company but not against the guarantors.

(ii) Significance to the Practice

With respect to whether the issues raised on appeal were of significance to the practice, the Court of Appeal found that the unique and exceptional facts of the case would not provide an opportunity to provide guidance on legal issues of significance generally to the practice.

 

(iii) Significance to the Proceeding

With respect to whether the issues on appeal were significant to Nortel’s CCAA proceeding, the Court of Appeal accepted that the allocation of the Lockbox Funds was significant to Nortel’s CCAA proceeding.  However, the Court of Appeal concluded that this factor alone was insufficient to warrant granting leave to appeal.

 

(iv) Progress of the Proceeding

On this issue, the appellants argued that the proposed appeal would not unduly hinder the progress of Nortel’s CCAA proceedings, as main steps and issues remained to be finalized before distributions to creditors could be made.  The Court of Appeal rejected this argument.  In particular, the Court of Appeal noted that Nortel’s CCAA proceeding had been languishing for more than seven years and have been described as eclipsing all other CCAA cases in both duration and expense.

While asymmetric appeal routes exist in Ontario and Delaware, the Court of Appeal found that this fact did not diminish the need to bring Nortel’s CCAA proceeding to a conclusion.  In that respect, the Court of Appeal found that any additional steps, which include further appeals, would be a barrier to progress.

Supreme Court of Canada Decision (Denying Leave on Post-Filing Interest)

On May 5, 2016, the Supreme Court of Canada denied a group of Nortel’s bondholders leave to appeal the Ontario Court of Appeal’s previous ruling that Nortel’s bondholders were not entitled to US$1.6 billion in post-filing interest on their unsecured claims against Nortel.⁴  Between 1996 and 2008, certain of Nortel’s Canadian and U.S. entities issued and/or guaranteed a number of unsecured bonds (referred to in Nortel’s CCAA proceedings as the “Crossover Bonds”).  The Crossover Bonds were payable by Nortel’s Canadian and U.S. entities either as principal borrower/issuer or as guarantor.  Under the contractual terms of the applicable bond indentures, the holders of the Crossover Bonds are entitled to interest on the principal amount owing under the bonds until the principal amounts are paid in full.

A motion to determine whether post-filing interest could be claimed against the insolvent issuer in Canada was heard by the CCAA Court on July 25, 2014. Applying the common-law “interest stops rule” normally applied in Bankruptcy and Insolvency Act proceedings, Justice Newbould ruled that post-filing interest was not payable on the Crossover Bonds.⁵  Justice Newbould began his reasons with reference to the “fundamental tenet of insolvency law that all debts shall be pari passu and all unsecured creditors [shall] receive equal treatment”.⁶  Justice Newbould found that the status quo with respect to unsecured creditors should be maintained as at the date of Nortel’s filing and that to permit certain claims to grow disproportionately to others during the CCAA stay period would violate the status quo.

Leave to appeal to the Ontario Court of Appeal was sought by the holders of the Crossover Bonds and was later granted.  On appeal, the Court of Appeal upheld Justice Newbould’s ruling and held that the common-law interest stops rule applies in CCAA proceedings.⁷

Consistent with its practice on application for leave to appeal, the Supreme Court of Canada did not issue written reasons in support of its decision to deny leave.

Conclusion

As noted above, the Court of Appeal and Supreme Court’s denials of leave to appeal on each of the Allocation Decision and entitlement to post-filing interest are significant positive developments in Nortel’s longstanding CCAA proceeding.  It is expected that these decisions will go a long way in drawing the proceeding closer to a final resolution and distributions to creditors on their claims.

If you would like to discuss the potential implications of this decision in any particular situation, please do not hesitate to contact any member of TGF’s restructuring team: www.tgf.ca/restructuring .

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