On August 19, 2014, the Ontario Superior Court of Justice [Commercial List] (Ontario Court) released an important decision regarding the ability of unsecured bondholders to assert a claim for "post-filing" interest in proceedings under the Companies' Creditors Arrangement Act (Canada) (CCAA). The CCAA is Canada's principal statute for the restructuring of large insolvent corporations and is similar in effect to Chapter 11 of the United States Bankruptcy Code (Bankruptcy Code). The issue arose in the context of the liquidating CCAA proceedings of Nortel Networks Corporation and its Canadian affiliates (collectively, the Canadian Debtors). In determining the quantum of claims of unsecured bondholders to the proceeds of the liquidation of the Canadian Debtors' assets, Justice Frank Newbould held that the "interest stops" rule applies in CCAA proceedings and, accordingly, unsecured bondholders were not entitled to assert claims for post-filing interest. The interest stops rule requires that, for the purposes of claim quantification, contractual interest stops accruing on unsecured debt as of the date the insolvency proceeding is filed.
Beginning in 1996, U.S. and Canadian Nortel entities issued and/or guaranteed unsecured pari passu notes (Crossover Bonds). All of the Crossover Bonds were payable by U.S. and Canadian Nortel entities, either as principal borrower or guarantor. Under the terms of the relevant indentures, the holders of the Crossover Bonds (collectively, the Bondholders) are entitled to interest on their principal debt until such time as the debt owing to them is paid in full.
CCAA Proceedings, Chapter 11 Proceedings and U.K. Administration
On January 14, 2009, the Canadian Debtors filed for and were granted protection from creditors under the CCAA by the Ontario Court. On that same date, Nortel Networks Inc. and its U.S. affiliates (collectively, the U.S. Debtors) filed petitions under Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware (Delaware Court). Affiliated entities in Europe (including in the U.K.), the Middle East and Africa (collectively, the EMEA Debtors) also filed for administration in the U.K. (the Canadian Debtors, the U.S. Debtors and the EMEA Debtors are collectively referred to as Nortel). The stated purposes of the filings were to stabilize the business in order to maximize the opportunity to restructure and continue Nortel as a going concern enterprise. That hope, however, would not be realized. Nortel's assets have been sold on a piecemeal basis and at this stage the primary role of the courts supervising the proceedings is to determine the appropriate allocation of proceeds among the three Nortel estates and facilitate an orderly distribution of the proceeds, whether through a plan or otherwise.
The sale of Nortel's assets, including a large patent portfolio, generated approximately US$7.3 billion in realizations, which are currently the subject of a larger dispute over their proper allocation (Allocation Dispute) among the Canadian Debtors, the U.S. Debtors and the EMEA Debtors. The Allocation Dispute has been argued in joint hearings in the Ontario Court and the Delaware Court, and closing arguments were heard on September 22-24, 2014. The presiding U.S. and Canadian judges have reserved judgment. The determination of each estate's entitlement to the aggregate proceeds of liquidation is, however, only one step towards finally determining creditor distributions. The validity and quantum any disputed claims asserted by creditors against each estate must also be determined. The determination of the Bondholders' entitlement to post-filing interest is a critical part of that process, given the magnitude of the claim (discussed below).
As the CCAA does not expressly prohibit asserting a claim for post-filing interest, the Bondholders took the position that contractual interest continues to accrue from and after the CCAA filing date and that a claim for such interest can be asserted against the Canadian Debtors. Pursuant to the terms of the Bankruptcy Code, the Bondholders also asserted that they were entitled to post-petition interest payable by the U.S. Debtors in the Chapter 11 proceedings. The Bondholders' claims as at the filing date totalled approximately US$4.092 billion in principal and pre-filing interest; the post-filing interest claim added an additional US$1.6 billion to their claims.
If successful, the post-filing interest claim by the Bondholders would represent a substantial portion of the claims asserted against the approximately US$7.3 billion available to creditors of all three Nortel estates, substantially reducing the recovery of other unsecured creditors (the Canadian Debtors have no secured creditors). The claim for post-filing interest was referred to by the monitor appointed by the Ontario Court (Monitor) as the "elephant in the room" with respect to negotiations regarding the Allocation Dispute.
In addition to the Bondholders, the other principal creditors of the Canadian Debtors are disabled employees, former employees and retirees with pension claims (collectively, the Employee Creditors). Although the Allocation Dispute has not been resolved, it is anticipated that creditors of the Canadian Debtors will suffer a shortfall and will only receive a pro-rata share of their unsecured claims. To the extent that the Bondholders are entitled to submit claims for post-filing interest in Canada, the recoveries of the Employee Creditors and other creditors (who do not have contracts entitling them to interest) will be diluted. Consequently, the Monitor, the Canadian Debtors, the Employee Creditors and other parties of aligned interest took the position that the Bondholders could not make a claim for post-filing interest under the CCAA.
Joint Motion Regarding Post-Filing Interest
A joint hearing in the Ontario and Delaware Courts was scheduled for July 25, 2014 to adjudicate the dispute. The hearing in the Delaware Court was adjourned because of a settlement between the U.S. Debtors and the U.S. unsecured creditors' committee (UCC), of which the Bondholders are by far the largest constituency. The settlement provides that the Bondholders will be entitled to claim post-filing interest (called "post-petition interest" in the U.S.) in the amount of US$876 million plus an additional amount equal to 3.5 per cent per annum times the principal balance of the Crossover Bonds outstanding at the time of distribution, up to a maximum of US$134 million, for a total potential entitlement of US$1.01 billion out of the US$1.6 billion in post-petition interest claims that were asserted. The U.S. Debtors have requested that the Delaware Court approve the settlement, which they have asserted is well within the "range of reasonableness" – the standard for approving settlements under U.S. bankruptcy law.
No such settlement was reached in Canada and the hearing proceeded in the Ontario Court before Justice Newbould.
ONTARIO COURT DECISION
In his reasons, Justice Newbould addressed two separate arguments raised by the Bondholders in the Ontario Court: (i) that the interest stops rule does not apply to CCAA proceedings and (ii) that it was inappropriate for the Ontario Court to determine the issue of post-filing interest prior to the filing of a plan of arrangement or compromise.
Interest Stops Rule
The Canadian Debtors, the Monitor, the Canadian creditors' committee (primarily composed of Employee Creditors and their representatives), U.K. pension claimants, the EMEA Debtors and the successor indenture trustee for certain notes that do not include the Crossover Bonds took the position that since the CCAA is silent as to the right to post-filing interest, the common law interest stops rule – which applies in bankruptcies under the Bankruptcy and Insolvency Act (Canada) (BIA) (i.e., liquidation proceedings akin to Chapter 7 proceedings under the Bankruptcy Code) – should also apply in a liquidating CCAA proceeding. Further, they asserted that provisions in the BIA, including provisions that provide that claims are to be calculated as at the date of bankruptcy, are consistent with this overriding common law principle.
These parties argued that the CCAA stay of proceedings, which prevents all creditors from taking any action to collect their debts, is intended to preserve the status quo as at the date of filing as between similar situated stakeholders. If contractual interest were to accrue to the benefit of one unsecured creditor constituency while other unsecured creditor constituencies that are not entitled to contractual interest are stayed, the filing date status quo would be altered, which would be fundamentally unfair to creditors in the same unsecured class.
The Bondholders, supported by the UCC and the indenture trustee for the Crossover Bonds, argued that unlike the BIA, which contains express statutory provisions that have the effect of stopping interest as at the date of bankruptcy, there is no such interest stops rule under the CCAA. The fact that Parliament included an interest stops rule in the BIA and not in the CCAA, they submitted, evidences that Parliament did not intend such a rule to apply in CCAA proceedings. This lack of statutory authority was critical to the Bondholders' argument. They asserted that denying the Bondholders the right to post-filing interest would amount to confiscating a property right and that absent express statutory authority, the Ontario Court had no ability to interfere with the Bondholders' contractual entitlement to interest. The Bondholders also cited appellate level decisions which, they submitted, supported the contention that the interest stops rule is inapplicable in CCAA proceedings.
In ruling against the Bondholders, Justice Newbould held that the status quo with respect to unsecured creditors should be maintained as at the date of filing and accepted the argument that to permit some creditor claims to grow disproportionately to others during the CCAA stay period would not maintain the status quo. Justice Newbould concluded that as the Bondholders were unsecured creditors, their contractual claim to interest did not amount to a property right, express statutory authority stopping interest was not required and the overriding common law principle that interest stops on the bankruptcy filing date applied to CCAA cases.
Citing the Supreme Court of Canada's decisions in Century Services Inc. v. Canada (Attorney General) and Sun Indalex Finance, LLC v. United Steelworkers, Justice Newbould favoured an interpretation of the CCAA that would avoid incentivizing debtors and other stakeholders to pursue a liquidation proceeding under the BIA over a potential restructuring proceeding under the CCAA in order to achieve a different treatment of post-filing interest. Accordingly, Justice Newbould favoured a more uniform treatment across insolvency regimes and concluded that as the common law interest stops rule applies to liquidation proceedings under the BIA, there was "no reason not to apply the interest stops rule" to a liquidating CCAA proceeding.
In addition, Justice Newbould distinguished the earlier appellate level cases cited by the Bondholders on the basis that they dealt with substantially different fact scenarios. He also noted that those earlier cases must be understood in the context of the more recent Supreme Court of Canada case law which, in his view, favoured applying a common standard to BIA and CCAA cases.
Need for a CCAA Plan
The Bondholders submitted that the Canadian Debtors' and Monitor's motion to determine the Bondholders' entitlement to claim for post-filing interest was premature. It was their position that: (i) distributions to unsecured creditors could not be made in the absence of a CCAA plan; (ii) it is well-settled law (as acknowledged by Justice Newbould) that a CCAA plan can provide for post-filing interest; (iii) whether or not post-filing interest would be provided for in a plan should be the subject of negotiations between the interested parties not pre-determination by the court; and (iv) therefore, it was "entirely premature and inappropriate" for the Ontario Court to insert itself into the process at this stage of the proceedings and to dictate in advance what the parties' CCAA plan negotiations should or should not include. Further, the Bondholders asserted that such negotiations cannot meaningfully take place until the Allocation Dispute is settled and each of the Canadian, U.S. and EMEA Debtors determine what proceeds they have for distribution to their particular creditors.
Justice Newbould disagreed and noted that the Ontario Court was not being asked to compromise the Bondholders' claims for post-filing interest in the absence of a CCAA plan; rather, the Ontario Court was being asked to determine whether the Bondholders had a right to claim for such interest pursuant to the claims procedure order dated July 30, 2009 (Claims Procedure Order). The Claims Procedure Order provided for claims to be proven for the purposes of voting and distribution, and the determination of the Bondholders' claims for post-filing interest is consistent with the process of determining whether these claims are finally proven. Moreover, determinations of creditor claims and distributions to creditors have been ordered prior to CCAA plans in numerous CCAA proceedings. Therefore, Justice Newbould was not persuaded that it was premature for the Ontario Court to determine the post-filing interest issue.
The Bondholders filed a motion seeking leave to appeal Justice Newbould's decision on September 9, 2014 to the Court of Appeal for Ontario (Court of Appeal). If leave is granted, the Court of Appeal will then hear submissions by the parties as to whether Justice Newbould's decision should be upheld. An appeal from a decision of the Court of Appeal lies, with leave, with the Supreme Court of Canada.
Justice Newbould concluded that the overriding common law principle that interest stops on the filing date applies to CCAA proceedings as well as bankruptcies. However, Justice Newbould reaffirmed that although unsecured creditors have no legal entitlement to post-filing interest (unless all principal indebtedness is paid in full), a plan of arrangement can provide for post-filing interest on a negotiated basis. Justice Newbould also stated, in non-binding obiter, that he was not persuaded that in a liquidating CCAA a plan was needed prior to distributing proceeds of sale to unsecured creditors. That issue may have to be revisited if and when the Canadian Debtors seek to distribute the proceeds ultimately allocated to them.
It remains to be seen whether leave to appeal will be granted and what further guidance may be provided on these matters, should the Court of Appeal wish to hear this matter.
An update will be provided following the determination on the leave to appeal motion.
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