Nortel: The Courts’ Creative Cross-Border Solution

"The Court is convinced that where, as here, operating entities in an integrated, multi-national enterprise developed assets in common, there is nothing in the law or facts giving any of those entities certain and calculable claims to the proceeds from the liquidation of those assets in an enterprise-wide insolvency, adopting a pro rata allocation approach, which recognizes inter-company and settlement related claims and cash in hand, yields the most acceptable result.” [Judge Gross, In Re Nortel Networks, p. 64][1]

"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…. Nortel was organized along global product lines … pursuant to a horizontally organized matrix structure and no one entity or region was able to provide the full line of Nortel products and services." [Justice Newbould, Nortel, par. 202.][2]

An unprecedented filing leads to an unprecedented joint solution from the both the U.S. Bankruptcy Court for the District of Delaware and the Ontario Superior Court of Justice -Commercial List supervising the Nortel liquidation in Canada and the U.S. Namely, the courts decided to allocate the sale proceeds on a modified pro rata basis determined by the ratio of the claims against each of the estates. This conclusion was reached after a unique 21-day cross-border trial conducted simultaneously in Wilmington, Del., and Toronto.

The trial itself was a unique collaboration. Technically, there were two simultaneous trials proceeding in the two countries with a joint record of proceedings. The courts were joined in a dedicated video link specially created for this trial. Witnesses gave testimony in either court. Canadian lawyers appeared in Wilmington. American lawyers appeared in Toronto (but were excused from needing to follow the Canadian practice of wearing gowns for trial!). Justice Newbould, the Canadian supervising judge, would ask questions of witnesses and counsel in Wilmington. Judge Gross, the American supervising judge, could do the same of those in Toronto.

More than 2,000 exhibits and designations from depositions conducted in the U.S., Canada, U.K., France and Hong Kong were entered into evidence. Post-trial briefs and proposed findings of fact and law in excess of over 1,000 pages were submitted. Then there were two days of closing arguments. And after all was said and done, the courts ended up denigrating all the principal parties’ positions. Instead, the courts jointly adopted a result derived from an approach that only three parties (none of whom were the principal estates) put forward.

At issue in the trial was the allocation of about $7.3 billion in sale proceeds from Nortel assets. The sale of business lines generated about $2.85 billion. The $4.6 billion balance resulted from the sale of the residual Nortel IP (i.e., IP that wasn’t directly or mostly linked to a particular line of business).

Nortel’s parent company, Nortel Networks Corporation (NNC), was incorporated in Canada. NNC was a publicly traded company with more than 130 direct and indirect subsidiaries in over 100 countries. NNC was always based in Canada (and was originally the Bell Telephone Company of Canada, established in 1883). NNC’s immediate subsidiary was Nortel Networks Limited (NNL), another Canadian company.

NNL was the principal Canadian operating company. Nortel’s principal research and development (R&D) was conducted by NNL, along with Nortel Networks, Inc. (NNI), based in the U.S., and Nortel Networks UK Limited (NNUK), Nortel Networks SA (NNSA) and Nortel Networks Ireland (NN Ireland). NNUK, NNSA and NN Ireland were all based in Europe (collectively, the “EMEA debtors”). Although there were additional debtors in Canada, the U.S. and EMEA, the principal dispute was over to how to allocate the sale proceeds amongst NNI and the other U.S. chapter 11 debtors (the “U.S. interests”), NNL, NNC and other Canadian debtors (the “Canadian interests”), and the various EMEA debtors (the “EMEA interests”).

In addition to the Canadian interests, the U.S. interests and the EMEA interests, several additional parties were able to participate in the allocation trial as “core parties.” These additional parties were the UCC; an ad hoc bondholder group that held bonds that were issued by either NNC or NNL and guaranteed by NNC (or another U.S. debtor), or issued by a U.S. debtor but guaranteed by a Canadian debtor; the Canadian creditors’ committee (CCC); a group of U.K. pension claimants (UKPC); and the three indenture trustees for the series of bonds that Nortel had issued (Wilmington Trust, National Association, Law Debenture and BNY Mellon). Of three indenture trustees, Law Debenture and BNY Mellon represented holders of the bonds issued to the ad hoc bondholders. Wilmington Trust’s bonds were issued by NNL and had no claim over to NNI or other U.S. interests. Only the UKPC, as its principal argument, and the CCC and Wilmington Trust as an alternative argument to that put forward by the Canadian interests, promoted the concept of a pro rata allocation as a way for the courts to achieve a fair and equitable result.

The evidence was unequivocal that Nortel was an integrated enterprise that focused its business around lines of business and operated across geographies. Nortel operated as a classic “matrix structure.” Virtually all patents were registered in the name of NNL. There were some 8,800 patents registered, most of them in the U.S. only. Nortel, as a group, spent billions on R&D, but there was no way to trace which R&D investment produced which IP.

Given its multinational structure, Nortel had transfer-pricing arrangements to govern how it reported income to the various taxing authorities in the U.S., Canada and the UK. While the process changed over time, the method in place in January 2009 (when the worldwide insolvency proceedings commenced) was a residual profit-sharing method (RPSM). The RPSM was set out in a master research and distribution agreement (MRDA). The goal of this approach was to minimize the taxes that Nortel paid on a global basis. The parties argued over who really owned the IP and whether the MRDA determined beneficial ownership of the IP.

The courts disagreed over how to interpret the MRDA. The Canadian court ruled that NNL held both legal and beneficial ownership in the IP. The U.S. court (interpreting an Ontario law document) ruled that NNL held legal title only. Notwithstanding this disagreement, the courts did agree that the MRDA did not apply to allocate proceeds from the sale of Nortel’s assets.

Instead, the courts held that as this was an unprecedented situation, an equitable remedy had to be applied to do justice. Claims against each of the estates were to be determined, then the proceeds were to be allocated proportionate to the claims against each estate. The courts emphasized that their pro rata allocation approach was neither substantive consolidation nor a pro rata distribution.

In their decisions, the courts acknowledged the great harm caused by the parties’ inability to reach a compromise solution (including three failed mediation attempts over several years). The parties were admonished to accept the decisions and to move on toward finally distributing the proceeds. Notwithstanding this admonition, appeals have been filed in both countries. Perhaps Nortel will result in yet another innovation, a joint cross-border appeal hearing? For a company that in its prime was a focus for innovation, the irony should be apparent. In any event, the Nortel saga continues.