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A man walks past a company sign at a Nortel Networks office tower in TorontoNATHAN DENETTE/The Canadian Press

Efforts to cap the amount of interest due to U.S. bondholders of Nortel Networks Ltd. are a "blatant attempt" to "subvert" the priority of debtholders in bankruptcy cases, Nortel's U.S. bondholders argue in new legal filings.

An ad hoc group of U.S. bondholders and debenture trustees filed court submissions Tuesday, arguing they deserve to be paid the contractual amount of interest that has accrued on $4.1-billion (U.S.) of outstanding bonds since Nortel filed for bankruptcy protection in 2009 -- an amount estimated to be worth $1.6-billion and climbing.

The bondholders argue they have a legal priority on Nortel's assets, and the the Canadian parent company has a junior claim in bankruptcy, so the Canadian court-appointed monitor cannot assert that the parent is owed funds before bondholders are fully paid all unpaid interest.

"The monitor's request is a blatant attempt to subvert the absolute priority rule," the bondholders said in court documents, arguing the claim "is directly at odds with both the letter and spirit of the absolute priority rule."

Nortel's Canadian bankruptcy monitor, Ernst & Young, filed written submissions in court arguing in favour of capping possible interest payments on Nortel's bonds, arguing interest payments made to U.S. bondholders will "come at the expense of creditors in the Canadian proceeding," including pensioners and former employees.

"The primary objective of these liquidation cases should be to distribute available funds to all stakeholders in accordance with established liquidation priorities," the monitor said.

The latest court filings were ordered by two judges presiding over the unprecedented cross-border trial to determine the division of Nortel's assets. They will hold a hearing next week to consider whether interest should be paid on Nortel's outstanding bonds and how it should be calculated, and ordered all the groups in the case to submit written arguments in advance of the hearing.

The trial -- which is being conducted simultaneously in courtrooms in Toronto and Wilmington, Del., using video links – has been hearing evidence since May on how to divide $7.3-billion in cash raised from the sale of Nortel's assets among the Canadian parent and its subsidiaries in Britain and the United States.

U.S. bondholders contend any owed interest should accrue at a contractual rate that would be worth at least $1.6-billion, while the Canadian monitor and other creditors argue any interest paid should be calculated at a modest fixed U.S. federal judgment rate, which would cap payments at just $90-million.

The dispute over interest has become a key issue in the Nortel bankruptcy because of the wide gap between both sides' claims. The Canadian monitor said in court filings last month that the interest issue has become a "logjam," preventing a negotiated settlement in the case.

Nortel's U.S. debtholders dispute that claim, but said the Canadian monitor breached confidentiality agreements by even discussing the existence of settlement talks.

A new court filing Tuesday by a group representing Nortel's U.S. division and affiliated companies says the judges should disregard the Canadian monitor's comments about settlement talks because the U.S. parties cannot respond to the claim without also breaching confidentiality rules.

"Confidentiality restrictions prevent the U.S. debtors from meaningfully responding to this assertion, including explaining to the court their view on why settlement discussions to date have not yet succeeded."

Separately, the ad hoc committee of U.S. bondholders said in their filing that the monitor was "factually incorrect" to say the interest issue was preventing a settlement.

"As this court is aware, the issues in these cases are numerous and complex; simply singling out on particular issue and trying to resolve it in isolation is a recipe for wasteful litigation and appeal, not settlement," the bondholders said.