Canada: Nortel's Environmental Obligations Don't Withstand CCAA Restructuring Proceedings

Since Nortel Networks Corporation and a number of related companies (together, "Nortel"), initiated a reorganization under the Companies' Creditors Arrangement Act ("CCAA") over two years ago, the Ontario Ministry of the Environment (the "MOE") has sought to hold Nortel responsible to remediate environmental contamination remaining on properties once or currently owned by Nortel. Nortel has maintained that its responsibility for the environmental contamination should not be prioritized ahead of its other obligations. On March 9, 2012, the Ontario Superior Court of Justice released its reasons in a number of motions relating to these environmental matters, brought together before Justice Morawetz. Finding for Nortel, the court determined that, where operations have ceased on a particular property and a company can only comply with the Environmental Protection Act  (the "EPA") or orders of the MOE by expending funds, the environmental liabilities involved amount to financial obligations to pay and are, as such, prohibited by the CCAA-related stay of proceedings and are more properly addressed as claims in the CCAA process.

Background

In January, 2009, the insolvent Nortel initiated a restructuring of its businesses under the CCAA. At this time Nortel was granted the typical stay of proceedings prohibiting its creditors from taking legal action in an effort to collect on debts (the "Stay"). Specifically, the Stay provided that, while it was in effect:

This type of stay is intended, in theory, to ensure that the insolvent company, in this case Nortel, has an opportunity to develop a Plan of Arrangement that is in the best interests of all stakeholders, free from interference by its creditors and other parties. Often, as was the case for Nortel, the court allows the debtor to use the CCAA process, including the stay, to facilitate an orderly liquidation of its assets and to distribute the proceeds in accordance with the established priorities under the CCAA.

Subsequent to the granting of the Stay, orders were granted by the court setting out the process for stakeholders in Nortel to submit their claims and for these claims to be evaluated and ultimately accepted or rejected. The Amended and Restated Claims Procedure Order was granted on July 30, 2009 and the Claims Resolution Order on September 16, 2010 (the "Claims Orders"). The MOE chose not to file a claim.

Historically, Nortel had owned and conducted manufacturing business on several sites using processes that involved hazardous substances. Many years prior to the CCAA filing, Nortel had disposed of almost all of its interest in the manufacturing sites, retaining only a partial interest in one location. Nortel had, notwithstanding that it no longer owned the sites, conducted certain remediation activities in connection with these sites and was continuing to conduct such activities even after the CCAA filing. Nortel estimated that, at the time of the CCAA filing, it had spent approximately $30.2 million on remediation subsequent to selling the sites.

Under the EPA, orders requiring remediation work can be issued against any current or former owner of, or person responsible for, the subject property, among other parties. When the Stay was granted, Nortel was not subject to any such orders under the EPA.

After the Stay was granted, the MOE, under the powers provided in the EPA relating to remediation orders, issued an order against Nortel requiring it to conduct certain work on a property in which Nortel retained some interest. Subsequently, the MOE prepared draft orders relating to three other sites once owned by Nortel, which it intended to serve formally upon Nortel depending on the outcome of the motion before Justice Morawetz (all formal and draft orders together, the "MOE Orders"). The MOE did not demand any payments from Nortel. Nortel estimated that the work required by the MOE Orders would cost at least $18 million.

Issues and Arguments in the Motion

Nortel sought a number of declarations and orders, which all turned on the issue of whether the MOE Orders were subject to the Stay or otherwise constituted 'claims' which could be compromised in an insolvency proceeding and should thus be stayed. Specifically, Nortel sought the following:

1. an authorization and direction that it cease performing any remediation at or in relation to the sites named in the MOE Orders (the "Sites");
2. a declaration that any claims in relation to remediation requirements by the MOE or any other person against Nortel or its current or former directors or officers in relation to the Sites be subject to resolution and determination in accordance with the terms of the Claims Orders;
3. an order repudiating or disclaiming any contractual obligations to carry out remediation requirements on the Sites;
4. an order declaring that the relief sought by the MOE Orders is financial and monetary in nature and that the MOE Orders are stayed by the general Stay already ordered by the court at the time of the CCAA filing;
5. a declaration that related proceedings before the Environmental Review Tribunal in relation to the MOE Orders be stayed; and
6. advice and direction with respect to certain contaminated lands still owned by Nortel.

Nortel argued that the MOE Orders were fundamentally attempts to enforce financial obligations and, as such, were disallowed by the Stay. The MOE argued that the activities required by the MOE Orders were performance-based regulatory obligations, which were specifically exempted from the Stay, and that the obligations did not otherwise amount to 'claims' and thus operated despite the Stay.

Although the Stay explicitly does not exempt Nortel from meeting regulatory environmental requirements, Nortel argued that since it no longer owns most of the Sites and conducts no operations on any of them, there was no operational performance element of the MOE Orders and the Stay exemption should not apply. Referencing the AbitibiBowater Inc. CCAA proceeding (a decision of the Quebec Superior Court, an appeal of which was heard by the Supreme Court of Canada on November 16, 2011 and we await its decision), Nortel noted that the court determined that MOE Orders which are "truly financial and monetary in nature can be qualified as claims under the CCAA".

Furthermore, Nortel pointed out that the CCAA already addresses the priority of environmental liabilities in the context of an insolvent company and provides avenues for recovering costs associated with remediation work. Section 11.8(8) of the CCAA gives the Crown a first priority charge on the debtor's real property to secure the costs of remedying environmental damage to that real property. Nortel argued that allowing the provincial EPA to operate in the manner put forward by the MOE would have the effect of prioritizing all environmental liabilities over all other unsecured claims. The end result would be requiring payment of a debt outside of the federal CCAA framework, which is intended to operate as a complete framework for assessing and prioritizing claims according to the "single proceeding model".

The MOE challenged Nortel's interpretation of the provisions of the CCAA dealing with environmental liabilities, arguing that they only applied to the MOE when acting as a creditor, not a regulator. More particularly, it argued that the MOE only becomes a creditor upon an exercise of Ministerial discretion not exercised in this case.

The MOE set out a continuum of activities undertaken under the EPA, for which it can be characterised from a pure regulator to a pure creditor. The MOE argued that it is properly characterised as a true creditor only where the Crown has carried out work on a site and seeks to reclaim those costs directly from the owner or former owner. Given this understanding, the MOE argued that, on the facts of the instant case, its activities did not amount to those of a creditor, unlike certain of the activities of the provincial ministry involved in the AbitibiBowater case, and that Nortel's obligations under the EPA and to the MOE did not properly fit under any of the provisions within the CCAA.

It was further argued by the MOE that there is a sharp distinction between direct financial obligations owed to the Crown itself, which would not be exempt from the Stay, and those obligations accrued to third parties in the course of Nortel performing the obligations required by the MOE Orders. The fact that performance of the obligations set out in the MOE Orders would require Nortel to spend money, the MOE argued, does not make the MOE Orders orders to pay claims which could be compromised by an insolvency proceeding.

The MOE also argued that there was a constitutional conflict between the federal power of "bankruptcy and insolvency" and the provincial regulatory power over the environment, which could and should be resolved by limiting the impact of the insolvency legislation to monetary obligations and leaving performance obligation unaffected. In response, Nortel argued that there was no real distinction between the MOE issuing an order that required Nortel to expend money on remediation and the MOE issuing an order seeking reimbursement from Nortel for the costs of remediation. As such, these orders were monetary in nature and clearly under the federal purview in insolvency situations.

The Court's Reasons

The court begins its analysis by noting that it is "necessary to emphasize: insolvency statutes such as the CCAA and the Bankruptcy and Insolvency Act ("BIA") do not mesh very well with environmental legislation. The environmental legislation and its regulatory framework functions more effectively when insolvency is not present." The court accepts that the MOE will not always be acting as a creditor when issuing remediation orders, but ultimately rejects the significance of the MOE's distinction between debts owed to the Crown directly and those incurred to third parties in the performance of obligations required by the Crown. The court concludes that the realities of Nortel's insolvency mean the MOE Orders can amount to nothing but an attempt to enforce a financial obligation:

If the result of the issuance of the MOE Orders is that Nortel is required to react in a certain way, it follows, in the present circumstances, that Nortel will be required to incur a financial obligation to comply. It is not a question of altering its operational activities in order to comply with the EPA on a going forward basis. There is no going forward business. Nortel is in a position where it has no real option but to pay money to comply with any environmental issue. In my view, if the MOE moves from draft orders to issued orders, the result is clear. The MOE would be, in reality, enforcing a payment obligation, which step is prohibited by the Stay.

The court goes on to explain that the MOE Orders do constitute a claim under the CCAA, determining that the environmental liabilities become a claim at the time the damage occurs, not when the Minister decides to exercise discretion in transforming the obligation to perform into an obligation to pay, as the MOE had argued. The court concludes that the intent of the CCAA and the BIA is that, while companies with on-going operations must comply with environmental legislation, the environmental liabilities of those no longer in operation are to be dealt with by way of a charge over the property in favour of the MOE under section 11.8(8) of the CCAA. In this case, since Nortel had sold its interest in most of the Sites prior to filing under the CCAA, there was no property to charge, and the MOE is left to file a claim primarily as an unsecured creditor.

Implications

It will be interesting to see if the Supreme Court of Canada agrees with Mr. Justice Morawetz when it issues its decision in AbitibiBowater matter. In the meantime, the Nortel decision stands for the proposition that:

1. any orders by regulators (such as orders under the EPA) that go beyond regulating on going operations are likely to be treated as 'claims' in insolvency proceedings that are subject to a stay and compromise in any resulting plan or distribution as unsecured claims, unless the relevant legislation provides a charge of some sort in favour of the regulator; and
2. the MOE and any other entities with potential claims against debtor companies in insolvency proceedings arising from environmental damage should be filing proofs of claim in the insolvency proceeding for as much money as can be reasonably supported by the circumstances.

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