In a nutshell

The recent ruling by US and Canadian courts on the allocation of the US$7.3B proceeds from the Nortel asset sales was the first piece of good news for Nortel’s Canadian pensioners since the 2009 bankruptcy. The initially tabled equitable 71% recovery raised expectations for both a quick resolution and a better (than previously expected) outcome. But the road ahead might still be long and treacherous given the remaining uncertainties: the appeals in progress and perhaps more to come, the claims that will be accepted by the regions/courts and how the ‘modified’ pro rata will actually work, the final cost of the legal and professional services, etc. As to the pension plan windup, its timing and outcome are fuzzy at best given the opacity of the current state of plan assets/liabilities relative deemed 2010 windup assumptions, and the apparent Ontario regulator/administrator plan to offer CVs of substantially lower value than cost of buying annuities. As a Canadian pensioner I am cautiously optimistic (naive>) about a possible improved outcome.

The details

Many Nortel Canadian pensioners had smiles on their faces over the past couple of months with the US and Canadian court decisions on the allocation of the $7.3B in the JPMorgan lockbox in the US, and accompanying optimistic announcements on percentage recoveries by creditors in various jurisdictions/regions. While the Justices’ decisions were welcome, it is far from clear what the various creditors’ recoveries will be and when that will occur.

Almost 6 ½ years after the Nortel’s entered bankruptcy protection (actually liquidation, using CCAA, rather than BIA, procedures intended for reorganization rather than liquidation; see “Target’s retreat tactics raise questions about CCAA”) on May 12 when Justice Gross (U.S.) and Justice Newbould (Canada) have essentially reached the same conclusion/decision, what they call a “modified pro rata” distribution of the $7.3B cash sitting in the (JPMorgan) lockbox, as reported by Peg Brickley in the WSJ’s “Canadian, U.S. courts rule on Nortel’ $7’3 billion cash fight”. (If I recall correctly, at the time of the bankruptcy declaration there was an additional $2.5B or so cash sitting in Nortel accounts, presumably mainly in Canada/US/UK; as it turned out little of that was in Canada, with likely 2/3 and 1/3 split between US and UK regions.)

The Canadian judge was quoted in the article that “…insolvency practitioners, academics, international bodies, and others have watched as Nortel’s early success in maximizing the value of its global assets through cooperation has disintegrated into value-erosive adversarial and territorial litigation described by many as scorched earth litigation…” The U.S. judge Gross called the ruling “an extraordinary result…It rests on equitable principles, and spurns the legalistic theories…No international law or agreement sets out guidelines for how to divide money raised in the liquidation of a company that, when it operated, sprawled across the globe and prided itself on the international cooperation that built its businesses… It is now the parties who have to make a decision: accept the court’s rulings and give them effect, take appeals and thereby prolong the hardship and deplete the remaining estate”.  ”.

The article also noted that the next critical step in the process is for the judges to sift through the claims.

The bondholders asked the judges to reconsider their decisions, but upon reflection the judges stood by their earlier conclusions when they announced on July 6 and reported by Peg Brickley in the WSJ’s  “Nortel U.S., Bondholders Lose Bid to Upset $7.3 Billion Ruling”. They furthermore indicated that bondholders must claim against the Canadian estate and funds from lockbox will be allocated to each region in proportion to the claims in those regions.

At Koskie Minsky’s Nortel Networks Corporation Allocation Litigation page updated on July 7 K-M calls the pro rata approach of allocating the lockbox funds ‘proportionately based on the aggregated claims in each of the three jurisdictions. All creditors, including Canadian pensioners and disabled employees, are to receive a fair and equitable payment of their claims (while that is highly desirable, that’s not actually clear upon further reflection as we shall see below). The decisions take an unprecedented approach, and are a major breakthrough in the cross-border litigation. “ For those of you who need to go to the sources you can find the May 12 decisions at Justice Newbould decision and Justice Gross decision and the result s of the July 6 “clarification and/or reconsideration” at Newbould and Gross. K-M notes that “The parties now have 10 days to appeal the allocation decisions in Canada and 14 days in the U.S.” (Presumably that means July 16 in Canada and July 20 in the U.S.)

The UK perspective was expressed in Lexology’s “Lessons from Nortel: what do the recent allocation decisions mean” which indicates that “The courts held that a pro rata allocation of the sale proceeds would yield the most acceptable and equitable result. Each Nortel entity will therefore be allocated a pro rata share of the sale proceeds based on the proportion that the allowable claims against that entity bears to the total allowable claims against all Nortel entities.  The courts stressed that this did not constitute a global substantive consolidation.  Separate legal entities will not be treated as if they and their assets have been merged into a single entity which is responsible for all external liabilities and where intra-group claims have been cancelled out.  Instead, each entity’s rights to cash in hand and intra-group claims, settlements and guarantees will continue to be recognised. Each entity will still be required to distribute the funds allocated to it in accordance with its own insolvency procedure and with local insolvency laws.” (i.e. each region will hold on to the cash in hand, which sounds certainly less than “equitable”, which is somewhat strange given the intent to have an equitable treatment of all creditors.)

The Star’s “Pressure mounting on creditors to accept ruling” opines that the “odds of any of the three competing Nortel creditor entities being granted leave to appeal are “minuscule” in light of fees”. “While lawyers representing Nortel in the U.S. submitted fees for court approval monthly… The issue of professional fees has been controversial, with Justice Morawetz of the Ontario Court of Justice Geoffrey Morawetz demanding a costing in 2013 of the Canadian action, saying the court here “has been in the dark.””

In the Globe and Mail’s “How two judges came to the same surprising decision in Nortel case” Adrian Myers, shortly after the May 12^th decision, takes readers through the reasons why after spending >$1B on legal fees, the judges concluded that the only sensible approach is pro rata because Nortel despite its tax driven structure, in reality operated s a single entity and therefore the only sensible conclusion is the pro rata approach. (That’s true but the prospects are for ‘modified’ pro rata, i.e. some are more equal than others.)

In another couple of Globe and Mail articles “Judges rip into squabbling Nortel lawyers”  and  “Nortel fight pits Canada against the world” McFarland and Grey discuss how low the legal arguments and personal attacks have descended during the trial.

Opinions on differences in creditor recoveries by region

In the days following the May decision, upon reflection, the equitable pro rata 71% started to unravel.

While I can’t claim to understand the arguments presented in Distressed Debt Investing (a bondholder advocate website) it seems to suggest that U.S. debtors’ calculate recoveries based on the court’s pro rata allocation would result in: 40% for U.S., 49% for Canadian, and 65% for EMEA unsecured creditors and 89% for guaranteed bondholders. (The article also includes irrelevant and incorrect information about Canadian pensioners’ recoveries.)

In The Toronto Star’s “Nortel decision may finally stop the legal gravy train” David Olive commenting on the May 12 ruling writes that lockbox assets are to be distributed according “time-honoured principles of proportionality and equity”. “It is estimated that the Canadian unit will get about 55 per cent of what it sought, the U.S. group gets 93 per cent of what it claimed, and the European unit obtains 64 per cent of what it wanted.”

S&P Capital IQ’s “Nortel high yield bonds plunge 20-30 points after asset-distribution rulings” Matthew Fuller writes following May 12 judgements that “$7.3 billion raised by the company through sales of intellectual property, pitted creditors of the company’s U.S. units, who had been seeking a larger proportional distribution of the assets, against the company’s pensioners and European creditors. According to a report in the Toronto Globe and Mail, the ruling by U.S. Bankruptcy Court Judge Kevin Gross said creditors would be receiving about 71 cents on the dollar. The report noted, however, that the math might change because the rulings allow for a $2 billion (pre-filing claim) payment to the U.S. unit, and not all of the assets held by the company’s subsidiaries are subject to the ruling

But McFarland and Grey in the Globe and Mail’s “Unusual rulings on Nortel assets provide some solace to pensioners” reports that “Lawyers for the pensioners had argued for just such a “pro rata” distribution of Nortel assets. But Mark Zigler, a lawyer for the pensioners, said his group should not expect to receive 71 per cent of what they are owed once the dust settles. That’s because the rulings still allow for a $2-billion payment owed by Nortel’s Canadian parent to its U.S. arm, he said, and certain Nortel assets held by its subsidiaries are not part of the pro-rata distribution. “There’s some twists and turns on it but we’re very pleased with a result that upheld the approach that our clients were taking,” Mr. Zigler said late Tuesday. “…The math changes. It will not be 71 per cent. I don’t think it will be anywhere near there.”” “The rulings divide Nortel’s assets only by region and do not actually allocate funds to specific creditor groups, such as pensioners or bondholders.”

And this elusive $2B Nortel US claim in Nortel Canada assets is repeated in the “Judges make decision on the fate of the remaining US$7.3B of Nortel assets”  David Friend of the Canadian Press reports that “The filings say the proportional distribution would wind up giving all the creditors about 71 per cent of the return on their claims. Within the decisions, the courts acknowledged that intercompany claims will be recognized, including a $2-billion claim made by Nortel’s U.S. operations against the Canadian parent company. Those claims will ultimately impact the amount of money distributed to other creditors.”

After the July 6^th review of their May 12^th ruling Investment & Pensions Europe’s “US, Canadian courts throw out Nortel appeal over ‘misleading’ figures” reports that “Facing a £2.1bn (€2.9bn) hole in the UK pension scheme, the trustees, alongside the regulator and PPF, began legal proceedings against the remaining estate to seek funding. However, proceedings were then challenged by the company over the right of the UK regulator to issue demands across borders.” (The Canadian court accepted about $450M claim against the Canadian estate, with a further $100M in the appeal process.)

It would be reasonable to be wondering why 6 ½ years after bankruptcy we still don’t have a good handle on various creditors’ claims against different regions. According to a May 7, 2015 Nortel Networks CCAA applicants overall claims status on the E&Y Document Centre (all figures in CAD) suggests that much work remains before it is possible to really have an idea on what the overall percent asset coverage exists relative to the claims submitted by various creditors. So while Justices Gross and Newbould took a major step in independently coming to the same conclusion on how the $7.3B resulting from asset sales are to be allocated to the various geographical regions, the overall accepted size of the claims appears to be still an indeterminate. Looking at this table, duplicates will have to be eliminated, claims have to be validated, sized and accepted by affected regions and a determination of how exactly cross jurisdictional guarantees will be handled, if at all. If an agreement on claims is going to take anything comparable to the 6 ½ years to reach the decision on asset allocation, this might not be settled until a significant proportion of the pensioners will in fact have died.

My take on the modified pro rata allocation

The June 2015 NRPC newsletter suggests that pensioners can expect more than 25% but less than 71%; but as a result of this latest ruling, even the low end of this range is still higher than my post-bankruptcy guesstimated range of 10-15%. That is good news! So I decided to try some scenarios based on my limited understanding of the existing assets and claims once lawyers and other bankruptcy professional are paid at 100%, and making some assumptions about cross regional puts/takes on claims, after assuming that all claim duplicates are eliminated.

I have created an Excel spreadsheet accessible at this link so you can change the permissible input values shown in red to explore alternate scenarios; you can do this in Excel online or by downloading it into Excel on your computer. Scenarios were explored with various: cash-in hand, recoveries from asset sales, trade claims and with/without US vs. Canada pre-filing $2B claim (this also assumes that the face value of the bonds were to be included as part of the claims of the Canadian estate). My (PB) guesstimated ranges are shown in the table below together estimates from other sources mentioned above:

Recoveries	US (bondhldrs)	US (others)	Canada	UK
Distressed Debt	89%	40%	49%	65%
Toronto Star	93%	93%	55%	64%
Cap  IQ/pro rata	71%	71%	71%	71%
Koskie Minsky			25%<x<71%
PB:With interest Face value	61%-72% 76%-90%	70-100%	44%-51%	62%-70%

As you’ll note Justice Gross’s equitable pro rata recovery is 71%. Canadian creditors, including pensioners) are expected to receive much worse than pro rata recovery (~47%), UK close to pro rata (~65%), while US bondholders relative to face value+ interest close to pro rata (~65%) but relative to face value only a much better than pro rata (~83%); US non-bondholders might do even better than bondholders, depending on how the calculations are done. Clearly all these numbers must be taken with a large grain of salt, but there you have it and you can change the (somewhat cryptic) spreadsheet as you wish.

Unless the US and Canadian courts stick by the originally suggested intent of equitable pro rata distribution of 71% to all claimants, we have no idea where this may lead to. In fact, if I was a betting man (which I am not), I would still say that Canadian pensioners should assume that the recovery will be closer to the 25% than the 71%.

At 40% (a level substantially less than the equitable 71% noted by the judges) recovery on the 41% pension plan shortfall established on the deemed windup date of October 1, 2010, would add about 16% points to the 59% funded level for a total pension level of 75%, while at the equitable 71% recovery level a more respectable 88% funded level would be achieved!

I must concede that I am more optimistic than before, and will raise my Canadian pensioners’ recovery guesstimate from my previous 10-15% to 30-45%; but until we know better, to be safe and minimize disappointment, I would assume no additional recovery beyond present level of pensions for retirement planning purposes.

Bottom line

From an overall Nortel bankruptcy court distribution/recovery perspective:

-the two judges to have independently concluded that a (modified) pro rata approach to the $7.3 B sales proceeds is the only fair allocation of the lockbox is a significant step forward, even if the equitable 71% for all creditors is only approximately maintained;  but the matter of specific percentage recoveries by creditors in various countries far from resolved.

-the first obstacle to be cleared in the next week or so is the 10 (in Canada) and 14 (in the US) day periods during which the bondholders have the right to appeal the judges’ recent allocation decision; will they appeal the Justices’ decisions? If they do, the corrosive erosion of the still remaining assets available for distribution will continue unabated, even after $1.5B was spent so far on legal/professional fees.

-how specifically will the ‘modified’ pro rata asset distribution be calculated? How are other non-lockbox assets in existence in various regions to be allocated, after all at the time of bankruptcy Nortel was in the possession of about $2.5B in cash alone, with probably the vast majority of that being in the US and at least $700M in the UK (as demanded by the UK pension regulator just prior to bankruptcy being declared (with NTL obliging); this has at least in part contributed to Nortel management’s decision to shortly thereafter seek bankruptcy protection.)

-the claims must still be validated, sized, duplicates eliminated and then accepted by (presumably) each affected estate/jurisdiction; there is still much jurisdictional judicial discretion that remains which can radically affect the outcomes of the Canadian pensioners (who are the only pensioners, unlike those in the US and UK who had no/minimal government run pension guarantees that kicked in when their employer declares bankruptcy with a substantially underfunded pension plan). The outcome of the bankruptcy courts’ deliberations may dramatically impact the remaining lives of the Canadian pensioners, whereas in the US and UK the pension protection funds will be the primary beneficiaries

From a Canadian pensioners’ perspective the other remaining issues are windup related:

-the total lack of transparency associated with the pension plan assets (and liabilities) since the last published financial statement in December 2009 and the assumed 59% funded status of the plan on October 1, 2010 (the deemed though not actual) windup date. How will the Canadian pensioners’ claim be determined given a very dynamic interest rate environment? Did the (supposedly) immunized pension plan at least protect the funded status from being affected by interest rate changes (even though it prevented participation in the massive stock market advance)?

-will the CV formula designed to be used for situations where a couple of months might separate deemed from actual windup be forcibly applied even when more than five years separate deemed and actual windup dates, typically resulting in 10-50%+difference between calculated CV and cost of buying corresponding annuity? In fact it is difficult to see how the pension claim calculation will be done without an iterative process factoring in the (changing) cost of annuities, the proportion of those taking CV over annuities and the substantial difference between the cost of annuities and the proposed CV calculation (is this even legal?)

-there must be a uniform formula to calculate CV and corresponding annuity costs acceptable to all provincial regulators where plan members belong; in fact for claims purposes the only credible assumption that can be made is that 100% of pensioners will take an annuity. This is the only credible approach to the claims process

So given continued level of unknowns and opacity of the process even after over 6 1/2 years, I continue to be cautious on my expectations (but a little less so) about both the timing and level of the pensioners’ recoveries. I hope to be proven wrong, but given the history of the process so far, to be an outright optimist would be naive.

P.S. This interesting Forbes article came to my attention since writing the post A Brave Newbould World: How a Last-Minute Switch May Have Altered Nortel’s $7.3B Asset Split