In lengthy insolvency proceedings, interest accrued on existing claims during the “post-filing” period can represent a substantial portion of the debtor’s estate. In Re Nortel Networks Corporation et al2014 ONSC 4777, the Ontario Superior Court (the “Court”) ruled on whether the holders of unsecured bonds of the now-defunct Nortel group (“Nortel”) could assert a claim to post-filing interest in proceedings under the Companies’ Creditors Arrangement Act (Canada) (“CCAA”).

The ensuing decision, in which Justice Newbould of the Court rejected the post-filing interest claim on the basis of the Canadian “interest stops” rule, could be of consequence for future rulings under both the CCAA in Canada and Chapter 11 proceedings in the US.

BACKGROUND

Beginning in 1996, Nortel entities in Canada and the US issued unsecured pari passu notes under several bond indentures, all of which being payable by Nortel entities in Canada and the US as either principal borrowers or guarantors (the “Crossover Bonds”).

On January 14, 2009, Nortel entities in Canada filed for and were granted CCAA protection in Ontario. On the same date, Nortel entities in the US filed petitions for Chapter 11 bankruptcy protection in Delaware. The stated purpose of the CCAA and Chapter 11 filings was to stabilize Nortel’s business in order to maximize the chances of preserving all or a portion of the enterprise, but this hope soon evaporated; Nortel assets worldwide have since been sold piece-by-piece for a total of approximately US$7.3 billion. The allocation of the realizations of the sale is currently the subject of dispute between the estates located in Canada, the US, and Europe, the Middle East and Africa.

Under claims procedures in both the Canadian and US proceedings, claims by holders of the Crossover Bonds (the “Bondholders”) for principal and pre-filing interest amount to US$4.092 million. The Bondholders also claim to be entitled to post-filing interest and related claims under the terms of the Crossover Bonds which, as of December 31, 2013, amounts to approximately US$1.6 billion. Thus, the post-filing claim represents a significant portion of the total assets available for distribution to all creditors.

A joint hearing in Ontario and Delaware was scheduled to adjudicate on the issue of the post-filing interest claim. However, the US hearing was adjourned due to a last-minute settlement between the US entities and the US unsecured creditors’ committee.

With respect to the Canadian Nortel entities (the “Canadian Debtors”), apart from the Bondholders, the main claimants are Nortel disabled employees, former employees and retirees (the “Pensioners”).

ANALYSIS

The Bondholders’ main contention was that to deny them the right to post-filing interest would amount to a confiscation of a property right to interest, as they are contractually entitled to the interest under the terms of the Crossover Bonds, and that absent express statutory authority, the Court has no ability to interfere with their contractual right.

First, J. Newbould quickly dismissed the Bondholders’ claim that their right to interest is a property right, as the bonds were unsecured (see Thibodeau v. Thibodeau2011 ONCA 110. Nevertheless, the question remained as to whether the Bondholders’ contractual rights should prevail over the judge-made “interest stops” rule.

On this point, the Canadian Debtors argued that the “interest stops” rule is a common law rule corollary to the pari passu rule governing equitable and rateable payments of an insolvent’s debts and that while the CCAA is silent as to the right to post-filing interest, it does not rule out the “interest stops” rule.

  1. Newbould gave reason to the Canadian Debtors’ argument. The “interest stops” rule is based on the fundamental principles of fairness and equality that govern unsecured creditor recourses under insolvency law. An insolvency filing under the CCAA stays creditor enforcement and is meant to preserve the status quo (see Century Services Inc. v. Canada (Attorney General)2010 SCC 60. Accordingly, it would be unfair and detrimental to the status quo if one group of creditors, being the Bondholders, were permitted to obtain post-filing relief on the basis of their contracts, while another group, the Pensioners – having no contractual right to post-filing interest – were not. Allowing the Bondholders to include post-filing interest in their claim would significantly dilute the recovery rights of the Pensioners and other creditors.
  2. Newbould further cited cases where the “interest stops” rule has been applied to cases under the Bankruptcy and Insolvency Act (Canada) (“BIA”) and the Winding-up and Restructuring Act (Canada), despite the fact that the legislation did not provide for it. J. Newbould then drew on two recent Canadian Supreme Court cases, which state that the BIA and the CCAA should be interpreted to give creditors “analogous entitlements” as the two statutes are parts of “an integrated insolvency scheme” (see Century Services, precited, and Re Indalex2013 SCC 6.

Moreover, there are policy reasons in favour of applying the “interest stops” rule, since allowing the Bondholders’ claim to grow disproportionately to others during the post-filing period would be threatening to the objectives of the CCAA, i.e. to maintain the status quo.

Finally, J. Newbould also dismissed the Bondholders’ submission that it was premature for the Court to rule on the post-filing interest issue in the absence of a plan of arrangement or compromise, the latter which may include payment of post-filing interest, and that such plan could not yet be negotiated until the allocation dispute had been settled. J. Newbould disagreed; the Court was not compromising the Bondholders’ claim to post-filing interest in the absence of a plan, but rather determining whether the Bondholders have a claim to such interest pursuant to the claims procedure orders previously made on July 30, 2009.

APPEAL AND IMPLICATIONS

On September 9, 2014, the Bondholders filed a motion seeking leave for appeal with the Ontario Court of Appeal; it remains to be seen whether appeal will be granted. If J. Newbould’s decision is upheld, it could have lasting consequences on all future CCAA proceedings involving post-filing contractual rights.

On the US side of things, the settlement reached between the US debtor entities and unsecured creditors is subject to the approval of the Delaware Bankruptcy Court. While the US decision is to be decided on the basis of US bankruptcy law, it will be interesting to see what weight will be given to the Ontario decision in order to ensure fairness of treatment between the US and Canadian Bondholders.

Ziyi Shi