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On October 13, 2015, the Ontario Court of Appeal released its decision in Re Nortel Networks Corporation,[1] regarding the application of the common law “interest stops rule” in insolvency proceedings under the Companies’ Creditors Arrangement Act (“CCAA”).[2] 

The appeal was brought by the Ad Hoc Group of Bondholders (the “Bondholders”) which held claims against certain of the Canadian Nortel entities that were the issuer or guarantor of the bonds.  The Bondholders appealed the decision of the Honourable Justice Newbould[3] that the common law “interest stops rule” applies in a CCAA proceeding, thereby preventing the Bondholders from accruing post-filing interest on their claims filed in the Nortel CCAA proceeding. 

The Ontario Court of Appeal denied the appeal of the Bondholders and upheld the decision of Justice Newbould.  The Court of Appeal found that there were sound legal and policy reasons for applying the interest stops rule in the CCAA context.[4]  Further, the Court of Appeal found that the decisions in Re Stelco and Re Canada 3000 that were relied on by the Bondholders did not preclude the application of the interest stops rule.[5]

Background

On January 14, 2009, Nortel’s Canadian restructuring proceedings were commenced under the CCAA.  Concurrent with the Canadian filing, Nortel’s international entities commenced proceedings in the United States and in the United Kingdom for its Europe, Middle East and Africa entities.  In the Initial Order granted in the Canadian CCAA proceedings, the Canadian Debtors[6] were directed, subject to certain exceptions, to make no payments of principal or interest on account of amounts owing by the Canadian Debtors to any of their creditors as of the filing date, unless approved by the Monitor.  Further, all proceedings and enforcement processes, and all rights and remedies of any person against the Canadian Debtors were stayed absent consent of the Canadian Debtors and the Monitor, or leave of the Court.[7]

As part of the claims procedure in the CCAA proceeding, the Bondholders filed proofs of claim that included the principal amount of the debt, interest that accrued to the date of the insolvency filing and contractual interest and other post-filing amounts accruing after the date of filing.[8]

On June 24, 2014, Justice Newbould released a decision that the common law “interest stops rule” applied in the CCAA and, as such, the Bondholders were not entitled to post-filing interest on their claims in the Nortel CCAA proceeding.  The Bondholders appealed this decision, which appeal was heard on April 29, 2015.

Issues on Appeal

There were two related issues raised by the Bondholders on the appeal:

1.   whether the CCAA judge erred in concluding that an interest stops rule applies in CCAA proceedings; and

2.   if not, whether he erred in concluding that the Bondholders are not legally entitled to claim or receive any amounts under the relevant indentures above and beyond the outstanding principal debt and pre-filing interest.[9]

Analysis

In upholding Justice Newbould’s decision, the Court of Appeal reviewed the origin and scope of the interest stops rule.  The Court of Appeal found that it is well settled that the pari passu principle applies in insolvency proceedings.[10]  The pari passu principle has been said to be the foremost principle in the law of insolvency not just in Canada, but around the world.[11]  It is this principle that creates the requirement to treat all unsecured creditors fairly and ensures an orderly distribution of the assets of a bankrupt company.  In finding the pari passu rule applies, the Court found the necessary corollary was the interest stops rule.  Absent the interest stops rule, the fairness and orderly distribution sought by the pari passu rule could not be achieved.[12]  The court found that to allow some creditors to accrue interest as a result of contractual provisions, while other creditors’ claims do not include such a right, would create prejudice for those parties who are not able to accrue interest as a result of the commencement of the proceedings, which the court referred to as “accidental delay”.[13]  The underlying purposes for the interest stops rule is fairness to creditors and to achieve an orderly administration.[14]

Following its review of the origin and scope of the principles, the Court of Appeal examined if the interest stops rule should apply in CCAA proceedings.  The court found that while there are differences between the CCAA and the other Canadian insolvency schemes,[15] the “principles that underpin the conclusion that the interest stops rule is necessary in bankruptcy and winding-up proceedings – namely, the fair treatment of creditors and the orderly administration of an insolvent debtor’s estate - apply with equal force to CCAA proceedings.”[16]  In making this finding the Court of Appeal reviewed the various factors it considered. 

First, the Court of Appeal commented that the CCAA is part of an integrated insolvency regime, including the Bankruptcy and Insolvency Act (Canada) (the “BIA”) and the Winding Up and Restructuring Act.  The court found that the application of the interest stops rule was consistent with the position set out by the Supreme Court of Canada in Century Services[17] that the BIA and the CCAA should be interpreted in a harmonious manner.[18]  The court commented that the interest stops rule should apply in the CCAA, unless the rule is expressly ousted by the CCAA.[19]  The Court of Appeal went on to find that the CCAA does not address entitlement to claim post-filing interest let alone oust the common law rule with clear wording.

Second, the Court of Appeal found that if the interest stops rule did not apply in the CCAA, the creditors who did not have a contractual right to post-filing interest would have “skewed incentives against reorganizing under the CCAA” and this would “only undermine that statute’s remedial objectives and risk inviting the very social ills that it was enacted to avert.”[20]  This same position was adopted in Re Indalex, where the Supreme Court of Canada further commented that to “avoid a race to liquidation under the BIA, courts will favour an interpretation of the CCAA that affords creditors analogous entitlements” to those that they would receive under the BIA.[21]  Without the interest stops rule under the CCAA, the creditors with no claim to post-filing interest would have an incentive to proceed under the BIA as opposed to allowing a company to restructure under the CCAA.

Third, the Court of Appeal found the interest stops rule is consistent with maintaining the status quo while the company attempts to restructure under the CCAA.[22]

Fourth, the Court of Appeal found “if the interest stops rule were not to apply in CCAA proceedings, the key objective of that statute – to facilitate the restructuring of corporations through flexibility and creativity – may be undermined” as a result of the asymmetrical entitlement to interest.[23]  In short, creditors who have an entitlement to interest may be less motivated to compromise than those who have no entitlement.

Fifth, the Court of Appeal found that the principle of fairness supports the application of the interest stops rule.  In Nortel, the delay in liquidating the assets allowed for significant recoveries to be made and the Court of Appeal found that that benefit should be for all creditors equally, not disproportionately to those who continued to accrue post-filing interest.[24]

Finally, the appellant raised concerns that as a result of past practices, the Bondholders had a reasonable expectation to receive post-filing interest.  The Court of Appeal responded by finding that the interest stops rule is not contrary to established CCAA practices nor would it prevent a Plan of Arrangement (in which all creditors would have a statutory right to vote) from providing for post-filing interest.[25]  The Court of Appeal did not accept the appellant’s submission that the application of the “interest stops rule” would be a disincentive to participating in CCAA proceedings.[26]  Further, the Court of Appeal could not accept the concern that a debtor company could obtain a permanent interest holiday resulting in unfairness given the oversight of CCAA judges in administration of CCAA proceedings.[27]

As a result of the foregoing factors, the Court of Appeal found that there are sound reasons for adopting an interest stops rule in CCAA proceedings.  The Court of Appeal then went on to review the facts and decisions from the SCC’s decision in Re Canada 3000[28] and the Ontario Court of Appeal’s decision in Re Stelco.[29]

In Re Canada 3000, the Supreme Court of Canada (the “SCC”) made the comment “[w]hile a CCAA filing does not stop the accrual of interest...” in relation to interest accruing under certain aviation acts[30].  In the Nortel decision, the Court of Appeal reviewed this comment and found it to be of limited application, dealing only with interest accruing under the specific aviation acts in that case.[31]  Further, the Ontario Court of Appeal found that the SCC was not deciding whether, absent the rights under the aviation acts, the interest would have accrued or been stopped by the common law interest stops rule.[32]  As a result, the Court of Appeal concluded that the SCC comment did not preclude the application of the interest stops rule in CCAA proceedings.

In Re Stelco, the Ontario Court of Appeal was called upon to decide an inter-creditor dispute between the senior debenture holders (the “Seniors”) and the junior note holders (the “Juniors”) of Stelco Inc. (“Stelco”).  At the time of its filing for protection under the CCAA, Stelco had two principal debt obligations: (i) debts owing to the Seniors pursuant to senior debentures, and (ii) debts owing to the Juniors pursuant to junior notes.  Pursuant to the note indenture governing the Juniors, the Juniors agreed to subordinate their entitlement to repayment until the Seniors were repaid in full (the “Turnover Provisions”).  Disputes arose between the Juniors and Seniors as a result of the Plan of Arrangement of Stelco (the “Plan”).  The Plan provided for payments to both the Seniors and the Juniors, however, the claims of Stelco’s creditors were limited to amounts in existence on the filing date.  As a result, the Seniors were only able to claim interest to the date of filing against Stelco.  The Seniors claimed the accrued post-filing interest against the Juniors, amongst other things, pursuant to the Turnover Provisions.  The Ontario Court of Appeal in Re Stelco ultimately found that the Plan did not extinguish the rights as between the Seniors and the Juniors[33] nor did it extinguish the accrual of post-filing interest by the Seniors.[34] 

In Nortel, the Court of Appeal examined the comments from Re Stelco and found that the Court in that case was dealing with rights between two creditors, rather than making broad statements about CCAA proceedings generally. The Court of Appeal in Nortel found that the interest stops rule relates to claims by creditors against the debtor but does not deal with arrangements as between creditors. [35]  The ability for one creditor to recover interest from another creditor does not affect the application of the interest stops rule in a CCAA proceeding.[36]  The Court of Appeal found the other comments made in Re Stelco with respect to the interest stops rule to be obiter and not binding on its current decision.[37] 

In light of its analysis, the Court of Appeal found that these two decisions did not preclude the application of the interest stops rule in CCAA proceedings.  As such, the Court of Appeal upheld the decision of Justice Newbould that the Bondholders could not claim or receive post-filing interest at this time and dismissed the appeal by the Bondholders.

Comments

This decision is just another step in the ongoing litigation in the Nortel restructuring.  With each decision in this proceeding, the creditors of the various Nortel entities get closer to receiving a potential distribution of the proceeds of the sale of the global Nortel enterprise.

It will be interesting to see the scope for the application of this decision in future cases.  While the decision leaves open the ability for unsecured creditors to receive post-filing interest as part of a Plan of Arrangement in a CCAA proceeding, this decision will certainly have implications for unsecured creditors in the future.

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 .