On December 29, 2011, the US Court of Appeals for the Third Circuit issued an opinion in the chapter 11 bankruptcy case In re Nortel Networks, Inc., holding that the "automatic stay" on creditor collection actions outside the bankruptcy applied to prevent the UK Pension Protection Fund and the Trustee of the UK Nortel Pension Plan from participating in UK pensions proceedings initiated by the UK Pensions Regulator. The decision turned narrowly on the Court's conclusion that neither the Pension Protection Fund nor the Trustee were exercising governmental police or regulatory powers in the UK proceedings. But the decision reinforces the extraterritorial reach of the US bankruptcy automatic stay and the hurdles that impact non-US entities asserting claims in a US bankruptcy proceeding. And it has broader implications for the ability to coordinate overlapping claims in multinational insolvency proceedings, and the limited role in those proceedings for comity—the recognition that one nation typically allows within its territory to the legislative, executive or judicial acts of another nation in light of international duty and convenience.
The Nortel Pension Plan and the UK Proceedings
The financial deterioration of the Nortel Group, due in part to pension obligations, triggered bankruptcy, administration, or insolvency proceedings in 2009 in three jurisdictions: Canada, for the ultimate parent, Nortel Networks Corporation, and other Canadian affiliates; the US, for US-based Nortel Networks, Inc. and other American affiliates; and the UK, for Nortel Networks UK Limited (NNUK) and other European affiliates.
The UK based pension scheme connected to NNUK (The Nortel Pension Plan) has a funding deficit of about £2.1bn (€2.5 bn or $3.2 bn). Prior to the bankruptcy, the Determinations Panel of the UK Pensions Regulator ("TPR") had concluded that the Nortel Pension Plan was "insufficiently resourced," activating its "moral hazard" or "anti-avoidance" powers under the UK Pensions Act to intervene to prevent companies from failing to fund their pension schemes. Those powers include contribution notices and financial support directions.
Contribution notices are effectively a demand for a specified sum of money to be paid to the relevant scheme within a specified period of time. Financial support directions (FSDs) require the recipient to put in place financial support for the scheme, which must remain in place while the scheme is in existence, but do not necessarily require an immediate cash payment to the scheme. Significantly, either a contribution notice or a financial support direction can be issued not only to the employer directly sponsoring the scheme, but to a person associated or connected to the employer, such as a non-UK corporate affiliate.
The Nortel insolvency also implicated the UK Pension Protection Fund (PPF). The PPF is a UK-government-established but privately funded entity that pays compensation at a prescribed level to members of defined benefit pension schemes where the sponsoring employer has experienced an insolvency event and the scheme is underfunded to a specified level. Upon an employer's insolvency, the PPF assesses whether it is required under the relevant statutory provisions to pay benefits, and can take action to recover the funding deficit from the sponsoring employer (and any other companies that may have a liability to the pension scheme in question).
Exercising its powers under the UK Pensions Act, TPR issued a "warning notice" to NNUK and its affiliates, including its US affiliates, in January 2010, to the effect that it was considering issuing a FSD, and that the companies had until March, 2010 to make their submissions.
The US Proceedings
Meanwhile, the US Nortel affiliates were debtors in Chapter 11 reorganization proceedings in Delaware. Under the US Bankruptcy Code, an "automatic stay" goes into effect upon the filing of the bankruptcy petition. The automatic stay generally prohibits anyone from beginning or continuing a judicial, administration, or other action or proceeding against the debtor, or any recovery of a pre-bankruptcy claim against the debtor, outside the bankruptcy proceeding without first obtaining relief from the Bankruptcy Court for cause shown. The automatic stay is intended to preserve the debtor's assets for the benefit of all creditors and prevent any one creditor from improving its position vis-à-vis the others once the bankruptcy petition is filed and to focus claims and litigation into the Bankruptcy Court forum.
The automatic stay is subject to exceptions, however. In particular, the "police power" exception allows the initiation or continuation of an action by a "governmental unit" or any organization exercising authority to enforce the governmental unit's police and regulatory power. Typically the exception is applied to allow continuing governmental action to stop or deter conduct that would seriously threaten the public welfare, such as a violation of environmental or consumer protection laws.
The PPF and the Trustee of the Nortel Pension Plan filed joint contingent and unliquidated claims against the US debtors in the Delaware bankruptcy court, predicated on the outcome of the UK proceedings. In apparent reaction to the TPR "warning notice," the US debtors filed a motion to enforce the automatic stay, essentially asking the bankruptcy court to prevent PPF and the Trustee from participating in the UK proceedings with respect to the US debtors' liability for the NNUK plan deficit. The bankruptcy court found that the police power exception did not apply and granted the motion. The bankruptcy court's decision was affirmed by the US district court, and has now been affirmed by the US Court of Appeals.
The Court's View of the Police Power Exception
The Nortel Court interpreted the police power exception to require first that the action be taken by a governmental unit, and second that it be in furtherance of public policy and not just the pecuniary purpose of the governmental unit.
Which relevant entities were governmental units? To the Court, the Trustee was just a private party responsible for administering the plan and ensuring that its members receive their benefits. And although the PPF was government-created, the Court viewed it as merely standing in the shoes of as private party during the assessment period.
The Court allowed that TPR might be a governmental unit. But TPR was not a party to the US bankruptcy proceedings, did not file a claim, and therefore, according to the Court, it could not assert the police power exception. (The Court observed that TPR, as well as the Trustee and the PPF, was a party to the Canadian insolvency proceedings, but that the Canadian court had nevertheless similarly determined that the actions taken by TPR were null and void in Canada for purposes of the Canadian proceedings, and that decision had been upheld in Canadian appeals.)
In any event, the PPF's and the Trustee's participation in the UK proceedings failed the pecuniary purpose and public policy test. The Court described TPR's role as primarily seeking to determine the liability for a financial shortfall in a private pension plan. Even if the broader goal of protecting pension plans protected the public welfare, the narrower function of allocating liability did not. It instead adjudicated private rights, and focused on the pecuniary interest of PPF in reducing its own exposure by maximizing the NNUK Nortel Pension Plan's recovery from other responsible parties. Although the Court described the issue as "close," it held that PPF and the Trustee failed this component of the police power exception as well.
For either or both those reasons, the police power exception did not apply. The Court noted that a creditor had the right under the US Bankruptcy Code to seek relief from the automatic stay for good cause, but that the Trustee and PPF had not sought that relief.
The Court declined to consider comity in reaching its conclusions, saying only that the extraterritorial application of the US automatic stay was well established under US law, and that (as it had concluded) neither the Trustee nor PPF were governmental units within the scope of the police power exception.
During the course of these proceedings, the Determinations Panel of the TPR held a hearing to determine whether FSDs should issue. In light of the US automatic stay, the US debtors did not participate in these proceedings, and the Trustee participated only with respect to potential FSDs against Nortel units that were not the subject of the automatic stay order. TPR eventually issued an FSD against 25 companies, including the US debtors, on the basis that the data to support the FSD indicated that Nortel operated as a single global entity and the US entities benefited indirectly from the UK entities' failure to fund the Nortel Pension Plan.
But those findings will have no binding effect, and perhaps will have no effect at all, in the US bankruptcy (nor, apparently, in the Canadian insolvency proceedings). The Nortel Court pointed out that there was nothing currently pending before the US bankruptcy court that required it to determine what effect it should accord to the TPR estimates, or even whether they would be admissible, in light of the fact that none of the parties in the US bankruptcy participated in the UK proceedings with respect to the US parties. And there were no estimates before the court of the total claims filed in the US and Canadian bankruptcies. The issues of competing claims would be left for the allocation stage of the US bankruptcy proceedings.
But the Nortel Court seems to have realized that this result was not truly a practical solution for the real issues. It observed:
The Court suggested that mediation might be appropriate. It noted that a protocol had been agreed to appoint the Ontario, Canada, Chief Justice to resolve the allocation issues. The Nortel Court "hoped,"—since it had no power to order—that the parties could devise a process by which all conflicting claims were put in his hands for resolution.
The Nortel decision in the Court of Appeals is significant not only for its interpretation of the police power exception (though its opinion can be read to construe the public policy and pecuniary purpose test more strictly than prior precedent might have required), but because it underscores the reach of the US bankruptcy automatic stay. It also conveys the reluctance of the US bankruptcy court to let the cross-border allocation issues of whether and to what extent NNUK affiliates should be responsible for NNUK's obligations be decided by single jurisdiction's administrative body with a single constituency. Non-US creditors, and even non-US governmental entities, must remain mindful that their actions that might affect US affiliates of non-US companies are subject to second-guessing, or worse, in the US bankruptcy courts, and take the impact of US bankruptcy law and procedure into consideration in structuring their strategy to deal with their part of multinational insolvencies.
Meanwhile, only time will tell if there can be fulfillment of the hopes of the Nortel Court—and no doubt of the pensioners also—that some single proceeding can somehow resolve the issues raised, not uniquely, by the Nortel cross-border insolvency.
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