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Judge Gross Issues Decision on Allocation of $7.3 Billion in Sale Proceeds Among Nortel Network Debtors Worldwide

By Charlene D. Davis

On May 12. 2015,  one year to the day after the start of a 21 day trial conducted jointly by the United States Bankruptcy Court for the District of Delaware (the “US Court”) and the Ontario Superior Court of Justice, Commercial List ( the “Canadian Court”), Judge Kevin Gross issued an order and 130 page opinion concluding that the allocation of the sale proceeds realized from sales of virtually all of the Nortel assets worldwide should be made on a modified pro-rata basis to all Nortel Debtors worldwide.  At the same time, the Canadian Court issued a judgment and reasons for judgment directing the same result, although with some differing analysis.

In arriving at its decision, the US Court noted that Nortel worldwide had been organized such that each entity was integrated into national and product line management structures to perform R&D, sales and other common functions across geographic boundaries and legal entities.  It also noted that, effective January 1, 2001, the Nortel entities worldwide operated pursuant to a Master Research and Development Agreement (“MRDA”), which memorialized the group’s internal transfer pricing policy and was intended for approval by various taxing authorities.  The Court found that the MRDA did not dictate how to allocate  sale proceeds in an insolvency since it did not address valuation of assets upon a sale or insolvency.  Since the MRDA did not apply and no other agreement governed, the US Court evaluated and ultimately rejected approaches advocated by the U.S. Nortel Debtors, the Canadian Nortel Debtors and the Nortel Debtors in Europe, the Middle East and Africa (the “EMEA Debtors).

Specifically, the US Court concluded that 1) the U.S. Nortel Debtors’ revenue based approach was not valid as it was not based on the valuation of specific assets and rights sold by each estate or on a discounted cash flow analysis of the value of each Debtors’ business; 2) the Canadian Nortel Debtors’ ownership based approach was not supportable as the Canadian Nortel Debtors did not own all of the Nortel intellectual property but held only “bare” legal title with other Nortel entities holding beneficial interests in it; and 3) the EMEA Nortel Debtors proposed contribution approach (as opposed to their support for the U.S. Nortel Debtors approach with modifications) erroneously equated the cost of development of an asset with its value.

Judge Gross found authority for adopting a modified pro-rata allocation approach in section 105 of the Bankruptcy Code as interpreted by the United States Court of Appeals for the Third Circuit.   His Honor distinguished the modified pro-rata approach from substantive consolidation based on its preservation and acknowledgement of the corporate separateness of the Nortel Debtors.  The modified pro-rata approach will 1) allocate proceeds to each Nortel estate for distribution to its creditors in accord with law applicable in its jurisdiction; 2) recognize claims only once, with the exception of  holders of guarantees who will be permitted to satisfy any deficiency, resulting from the allocation to the primary Nortel obligors, from the allocation to the Nortel guarantors; and 3) include intercompany claims and settlements approved by the US Court and the Canadian Court in calculating any allocation.

A copy of the Court’s opinion is available here.

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