Nortel Networks Corporation was a telecommunications firm that filed for protection under the Companies’ Creditors Arrangement Act (“CCAA”) in 2009. At the time, a large number of interrelated companies representing the global business operations of Nortel also filed for protection, including Nortel Networks Limited (“NNL”), its direct Canadian subsidiary and legal owner of the Nortel Group’s worldwide patent portfolio.
Shortly after making a proposal under the CCAA, a decision was made to liquidate the assets of all Nortel companies. This included approximately 10,000 patents, most of which were sold to a consortium of technology firms operating as Rockstar Bidco LP for $4.5 billion dollars. Sales of Nortel business lines, including patents necessary to operate those business lines, generated an additional $3.285 billion.
In order to secure the earliest and highest value for the liquidation of assets, the Nortel group agreed to resolve entitlement to the proceeds after the sales had been completed. The Ontario Superior Court – Commercial List, in a joint trial with the US Bankruptcy Court for the District of Delaware in the USA, determined how to allocate the remaining $7.3 billion in proceeds to debtors in Canada, the USA, Europe, the Middle East and Africa.
Structure of the Nortel Group and Ownership of IP
Nortel Group operated as a “matrix structure”, in which transfer payments based on research and development expenditure determined the extent to which a subsidiary shared in Nortel’s global profits.
Payments were distributed throughout the Nortel matrix in large part through residual profits governed by a Master Research and Development Agreement (“MRDA”), where the amount of payment was based on each Residual Profit Entity’s (“RPE”) expenditure on R&D relative to the total R&D expenditure of all RPEs.
NNC’s direct subsidiary NNL was the legal owner of all intellectual property, and other RPEs were granted an exclusive licence to make and sell Nortel products in their respective territories, and a non-exclusive licence to sell Nortel products in territories which were not exclusive to an RPE. The nature of these ownership rights and the role of the MRDA were highly contested.
The MRDA and the Allocation of Assets
A number of arguments concerning the appropriate method of allocation were advance by the parties, including Nortel’s American subsidiary (“NNI”), the Court appointed Monitor, and entities incorporated in Europe, the Middle East and Africa (“EMEA”). These arguments focused on the beneficial ownership of the patent portfolio, and the extent to which existing agreements were relevant for determining each entity’s share in the sale proceeds.
The Monitor argued that under the MRDA, it was always understood that NNL was the owner of all Nortel IP. The global subsidiaries merely had exclusive or non-exclusive licences to sell Nortel technology as embodied in Nortel Products and services. Since the patents were sold to the Rockstar Consortium for monetization through licensing, and participants in the MRDA distribution scheme were not in the business of sublicensing Nortel technology, the Monitor argued that substantially all of the property sold to Rockstar was owned by NNL, which should therefore get the lion’s share of the assets.
The US Debtors argued that the MRDA should govern the distribution of assets, as each entity was granted beneficial ownership pursuant to this Agreement. Therefore, allocation of assets should be based in large part on the research and development expenditures where a larger R&D expenditure entitles a Debtor to a larger share of the sale proceeds of the IP. This approach heavily favoured the US Debtors and NNI.
Finally, the EMEA Debtors argued that all participants in the MRDA had joint ownership of the IP, and this joint ownership should be the basis for allocating proceeds from the sale of the residual IP.
Pro rata Allocation of Assets Based on the Court’s Equitable Jurisdiction
Ultimately, the Court found that, in order to avoid unjust enrichment, the funds should be allocated on a pro rata basis according to the percentage of the total of allowed claims against the total allowed claims against all Debtor Estates. The Court declined to order an allocation based on the various arguments about legal and beneficial ownership, as Nortel was a highly integrated multi-national enterprise with all entities performing research and development.
The Court found support for its jurisdiction to order this method of allocation based on the test for unjust enrichment in both the USA and Canada as well as the broad inherent jurisdiction granted to the Court to make orders as required “to fill in gaps or lacunae not covered by specific provisions of the CCAA”.
In the Court’s opinion, distributing the proceeds of the residual IP sales on a pro-rata basis did not amount to a “substantive consolidation”, in which a series of separate legal entities belong to a corporate group were treated as one. For one thing, the distribution of sale proceeds did not extinguish any inter-company debts, one effect of consolidation. In the Court’s opinion, the method of allocation simply reflected the fact that despite the structure of organization for the Nortel Group, these entities were heavily integrated in terms of employee mobility, collaborative research and development and the division of products and services.
This unique case shows a flexible and equitable approach to distribution of sale proceeds under the CCAA. According to the Court, the situation at issue in these proceedings had not been faced before and “will by its nature involve innovation”. This innovation was achieved through the exercise of wide equitable jurisdiction and the inter-jurisdictional cooperation, in particular between Justice Newbould of the Ontario Superior Court – Commercial List and Judge Kevin Gross and the US Bankruptcy Court for the District of Delaware.