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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Comments

[Adam Levitin]

Jay, How important of a precedent do you think Nortel is? My initial read is that while fascinating it isn't not a situation that will readily arise again. The reason the court(s) had to engage in the allocation issue was because the DIP financing agreement required the proceeds of the IP asset sale to be escrowed pending resolution of their allocation.

I would think in most cases the IP would be clearly held by one corporate entity, which would receive the proceeds of the sale. Alternatively, the DIP financing agreement might just specify how asset sale proceeds have to be awarded.

[Jay Lawrence Westbrook]

Adam, you make two excellent points. Ultimately the question is empirical and I don't think anyone has done the study. My sense is that many multinationals are highly integrated, especially as to cash and IP development and ownership. Except for allocation agreements for tax purposes, to which the courts in Nortel correctly gave little credence for ownership purposes, companies often pay little attention to ownership allocation of assets generally, thinking instead of divisions that cut across corporate and geographical lines. That may be especially true for IP.

I think that Nortel will encourage global sales for maximum returns. As long as the DIP loan has first priority in the proceeds, I think a delayed decision on allocation will often be a good idea because arguing re allocation up front will delay the sales and perhaps torpedo the global appoach.

[Adam Levitin]

Jay, I don't see this as being an issue that depends on a company being a multinational. Instead, upon more thought, I'm surprised it is a problem more frequently in domestic bankruptcies. Imagine that substantially all of the assets of a multi-entity debtor were sold--basically a going concern sale done as an asset sale Wouldn't there have to be some allocation of the sale proceeds? It would have to cover more than the liquidation value of the assets, but also the going concern value. That would seem to tee up the Nortel problem, and I don't think it's escapable with consensual plan confirmation because it affects the best interest analysis. This leaves me puzzled why we don't see this issue more often. For example, why wasn't this an issue in Chrysler or GM?

[JAEP]

Adam, the issue is muted when you have only one substantive bankruptcy law governing. And when you're all in one country, it strikes me as empirically more likely that a random shell set up to hold the IP assets would be sub-con-able.

Jay, the cash thing might just be laziness/inertia? Otherwise it strikes me as odd for the very reasons you say -- surely cash management is one of the most entangled/interrelated aspects of a multinational corporate web?!