Nortel: The CBI Case of the Century (So Far)

There can be little doubt Nortel wins the title for the cross-border insolvency case of the young century. Not only is it a huge case (US$7B or so), but as I noted in my last post it has established several milestones, including a joint televised trial in Toronto and New York and a common result in the two courts. Even more important are the substantive results in the universalist mode: the initial agreement on a global sale of assets without reference to territorial or corporate boundaries and the new ruling that orders global distribution on a quasi pro rata basis. The ruling is also notable for what it is not. It is not an acceptance of substantive consolidation. It is not territorialist; the result was unrelated to the situs of assets or creditors. It is also not fully universalist, although it does represent a species of modified universalism.

The key to the global distribution ruling, discussed below, is a finding that ownership of the sold assets could not be attributed to any one corporation in the corporate group and thus the proceeds should be distributed globally. I refer the reader to the opinions for the details, especially paragraph 250 of Judge Newburgh’s opinion. In summary, the proceeds of the sales are distributed pro rata among the estates. That result differs from a pure pro rata among all creditors of the corporate group primarily for three reasons. First, some cash stays in place. Second, intra-group claims share in the distribution from each estate, including an established $2B claim by the US sub against the Canadian parent. Third, an intra-group guarantee is potentially recognized.

The fundamental issue presented was entitlement to the proceeds of the sale of various assets. The first step necessarily was to determine ownership of those assets, primarily IP. The two judges agreed that the highly integrated nature of Nortel made it impossible to arrive at a fair and accurate determination of ownership within the Nortel group. By contrast, they obviously felt that the intra-group claim ($2B) against the parent and the parent’s guarantees were firmly attached to the US sub. No doubt they were also keenly aware of the Third Circuit precedent limiting substantive consolidation. Given a decision to avoid a result equivalent to substantive consolidation, and therefore to honor the corporate form as to claims, they were stuck with the problem of allocating the sale proceeds, a problem that substantive consolidation would have enabled them to avoid as discussed below.

The courts allocated on the basis of the claims against each estate. In the case of indeterminate ownership between two unrelated companies, surely an allocation on the basis of each company’s total debt would be quite odd, but the relationship between the two companies in this case justifies allocation on the basis of debt. Absent the intra-group claim, the cash, and the guarantee, the courts’ allocation in this case by amount of claims would produce a perfectly pro rata distribution to group creditors on a global basis—the universalist result for a highly integrated multinational debtor group and the same result as with substantive consolidation. However, adding in the intra-group claim, the cash, and the guarantee modifies the universalist result and yields a great advantage to the US sub’s creditors.

Two factors have contributed to confusion about the case. One is that corporate-form concerns overlap to some extent with territorialist claims. In this case, advantages for the US sub seem to be advantages for the US “side,” when in fact its creditors no doubt include holders from around the world and the result is unrelated to the situs of the assets or the claims. The second is that lack of clarity about asset ownership as between entities suggests substantive consolidation, but in this case was an independent ownership problem derived from the internal arrangements of a highly integrated company.

The core of the correct universalist analysis of the case would be respect for the corporate form until it was shown (as it was here) that the corporate group was highly integrated. On that showing, there would be imposed a strong burden on any party seeking to show creditor reliance on corporate distinctions within the group. The courts here declined to impose that burden. For example, the two courts apparently accepted that cash should remain where it ended up despite a system of global cash management that moved cash around the world on a regular basis.

There are other interesting wrinkles, including the calculation of total debt, but we leave those for another day.

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