The Continuing Saga of Nortel: Ontario Court of Appeal Confirms Bondholders Not Entitled to Post-Petition Interest

The Ontario Court of Appeal[1] recently affirmed the decision of the Ontario Superior Court of Justice in Nortel Networks Corporation (Re)[2] that the common law “Interest Stops Rule” applies in proceedings under Canada’s Companies’ Creditors Arrangement Act (CCAA).[3] In the context of the joint allocation trial conducted between the Ontario court and the Delaware bankruptcy court, Justice Newbould of the Ontario Superior Court of Justice directed that two discrete issues be argued:[4]

1. whether the holders of the crossover bond claims are legally entitled … to claim or receive any amounts under the relevant indentures above and beyond the outstanding principal debt and pre-petition interest (namely, above and beyond US$4.092 billion); and
2. if it is determined that the crossover bondholders are so entitled, what additional amounts are such holders entitled to so claim and receive.

Ultimately, Justice Newbould answered the first question in the negative, so he did not need to answer the second question. In reaching that conclusion, he accepted that the common law Interest Stops Rule, which has been held to be a fundamental tenet of insolvency law, applies in the CCAA context. The court upheld this ruling, although the parties retain the right to provide for the payment of post-filing interest in a CCAA plan of reorganization.

The Interest Stops Rule requires that creditors’ claims stop accruing interest as of the date of the CCAA filing. Accordingly, the appellant bondholders were not entitled to claim interest that had accrued post-filing. This decision is yet another chapter in the ongoing saga of the Nortel multijurisdictional insolvency proceedings, which were commenced in January 2009.

Background

The appeal was brought by the ad hoc group of bondholders, which represented a substantial number of unsecured “crossover bonds,” payable by both U.S. and Canadian Nortel entities, as either principal debtors or guarantors. The CCAA is silent on the treatment of post-filing interest. As a result, the crossover bondholders took the position that, pursuant to the terms of the relevant indentures under which their bonds were issued, which provided for the continuing accrual of interest until payment, they were entitled to claim post-filing interest.

Holders of the crossover bonds filed claims for principal and pre-filing interest in the amount of US$4.092 billion against the applicable Canadian and U.S. Nortel debtors. They also claimed an entitlement to post-filing interest, which, as of Dec. 13, 2013, amounted to approximately US$1.6 billion. These amounts represent a substantial portion of the total proceeds available for distribution to all of Nortel’s creditors, which were generated from the worldwide sale of Nortel’s businesses in the approximate amount of $7.3 billion. A successful claim for post-filing interest by the ad hoc group of bondholders would have reduced the amount of proceeds available to distribution to Nortel’s other creditors, notably pensioners and former employees, who do not have any contractual right to post-filing interest.

The Decision

Before the release of the decision of the Superior Court of Justice, Canadian law had been unclear as to whether unsecured creditors could assert proper claims for post-filing interest in CCAA proceedings. In clear contrast, Canada’s Bankruptcy and Insolvency Act (BIA)[5] does not allow unsecured creditors to assert claims for post-filing interest unless there is a surplus of funds remaining after payment of all creditors. In that rare case, the BIA prescribes the applicable interest rate for all such claims. Should the Interest Stops Rule, which applies in BIA proceedings, have no application to CCAA proceedings, the two statutes governing Canada’s insolvency regimes would provide for different recoveries to creditors with a contractual right to post-filing interest.

The court in Nortel affirmed that the Interest Stops Rule applies in CCAA proceedings. However, the court expressly clarified that its ruling does not prevent a CCAA plan of reorganization from providing for the payment of post-filing interest, which is common practice.

In support of its analysis for the application of the Interest Stops Rule in CCAA proceedings, the court noted that the rule is a necessary corollary of the pari passu principle (i.e., ratable distributions). This principle, which is a governing principle of insolvency law in Canada, the United States and virtually all jurisdictions, provides that the assets of an insolvent debtor are to be distributed ratably amongst the debtor’s unsecured creditors (subject to the claims of prior-ranking creditors). Absent the application of the Interest Stops Rule, the court held, the fairness and orderly distribution sought to be obtained by the pari passu principle cannot be achieved.

The court cited various additional reasons for imposing the Interest Stops Rule in CCAA proceedings, including (1) harmonizing the CCAA with the BIA, (2) ensuring creditors without a contractual right to post-filing interest would not be incentivized to prefer liquidation proceedings over a CCAA reorganization, (3) the need to preserve the status quo post-filing and (4) the principle of fairness.

Previous judicial decisions[6] had permitted claims for interest post-filing in CCAA proceedings. However, the court in Nortel limited both the Stelco and Canada 3000 cases to their specific facts. In addition, the court noted that the older cases should be read in light of the Supreme Court of Canada’s more recent decisions,[7] which emphasize the need to harmonize the two statutory schemes under the BIA and CCAA. Therefore, the court confirmed that as a fundamental tenet of insolvency law, the Interest Stops Rule is applicable to CCAA proceedings, and that confirmation of the rule was necessary to preserve the status quo, post-filing, amongst unsecured creditors.[8]