Filling the gaps in Nortel creditors’ rights

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When you line up to buy your iPhone 6 in a few weeks you would like to think that you know what you're buying. You will see the phone, turn on the phone, and be almost entirely certain that you have indeed bought a tiny computer that you can use to communicate with friends and family.

Bonds are not like this. Sure, you know the principal amount of the bond and the interest it pays, and yeah, you can read the indenture, but even after all of that, even if you know what the gaps and the questions in the indenture are, you can't know the answers to those questions until a court answers them first.

No indenture or statutory regime anticipates every situation, which is where the courts come in. Justice Frank Newbould's recent decision in the Nortel bankruptcy uses common law reasoning to clarify the fundamental bankruptcy concept of the equitable treatment of creditors – a concept left surprisingly ambiguous by both the bonds and the Creditors Companies Arrangement Act.

Beginning in 1996, Nortel issued unsecured notes under three separate bond indentures payable in both Canada and the U.S. Under the CCAA, these notes ranked pari passu with Nortel's other unsecured creditors: namely, other unsecured bondholders in Canada and elsewhere, and Nortel's disabled employees, former employees and retirees. In plain English, pari passu simply means that all unsecured bondholders were entitled to recover at the same time under a CCAA proceeding – after secured creditors but before shareholders.

In 2009, Nortel filed for CCAA protection. In general, all unsecured claims share pro rata in the company's assets, after secured creditors have been paid out. The size of each pari passu creditor's claim determines the proportion of the debtor's estate that each creditor will receive. Therefore, one way to increase your recovery in bankruptcy is to find a way to grow the size of your claim relative to other unsecured creditors. In other words, to paraphrase Animal Farm, while all unsecured creditors may be entitled to equitable treatment, some creditors want to make themselves more equal than others.

Playing the role of Napoleon the Pig in this drama is a group of U.S. bondholders who argued that they were entitled to $1.4-billion in post-CCAA petition interest on their claim – that is, interest for the five-year period between when Nortel filed and the hearing date.

The rest of the animals objected to the U.S. bondholders' theory, suggesting that the intuitively named "interest stops rule" applies to post-petition interest in CCAA proceedings. Interest stops accruing once a company files for CCAA protection and creditors are stayed from enforcing their rights.

While the CCAA doesn't mention the "interest stops rule," Justice Newbould found, after a convincing argument, that it does apply. Justice Newbould found that the purpose of the stay against creditor enforcement is to preserve the status quo between pari passu creditors and prevent creditors from rushing to enforce their rights, thereby crippling the company. Failure to apply the interest stops rule to the CCAA would violate the principle of equality between creditors, as it unjustly compensates bondholders for the delay between the 2009 stay and when whole matter is eventually settled.

Furthermore, because the "interest stops rules" applies to Canada's other bankruptcy statute, the Bankruptcy and Insolvency Act, that rule should apply across the two statutes in order to make sure that claims stay consistent between the CCAA and the BIA and don't disappear when moving from a CCAA restructuring proceeding to a full-on bankruptcy proceeding under the BIA.

Justice Newbould's opinion is a great example of how what's often derided as "legislating from the bench" can be useful and necessary. The CCAA is silent as to whether creditors are entitled to post-petition interest. No amount of parsing of the words of the statute gives an answer one way or the other. It's up to judges, taking legal and policy considerations together, to try and fill the gap.

Still, one can't help but feel a touch, if only just a touch, of sympathy for the U.S. bondholders. In their heart of hearts, maybe they truly believed that post-petition interest was allowable under the CCAA. Maybe they really thought that they were more equal than the other unsecured creditors and that Justice Newbould's decision was a big surprise.

But this is the way the common law works. And really, despite what you may be thinking when you head over to the Apple store in a few weeks, this is actually kind of like buying an iPhone. When you unwrap that iPhone 6, you're almost certain to discover something that you don't like about the operating system. It could be worse – at least you're not $1.4-billion worth of unhappy.