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

A last minute settlement has been reached in a key dispute in the Nortel Networks Ltd. bankruptcy case – over how much interest should be paid on Nortel's outstanding bonds.

The settlement, which would see U.S. bondholders collect up to $1-billion (U.S.) in interest payments on outstanding bonds, was reached Thursday evening, the day before the matter was set to go before a U.S. bankruptcy judge in Wilmington, Delaware.

The settlement, between Nortel's U.S. arm and the bondholders, still has to be approved by the court at a hearing set for mid-September.

Nortel, which filed for bankruptcy protection in 2009, has $4.1-billion in outstanding bonds.

U.S. bondholders had made written submissions to the court saying that interest should accrue at a contractual rate that would add up to at least $1.6-billion.

But Nortel's Canadian monitor Ernst & Young and other creditors argued that any interest should have been calculated at a much more modest U.S. federal judgment rate, which would have capped payments at around $90-million. That would leave more for other creditors, including pensioners and former employees.

The monitor is not part of the settlement agreement, and a source said it will object to the settlement the other parties have reached, at the September hearing.

The settlement would see bondholders receive $876-million, plus as much as $134-million more if they have not been repaid by the middle of next year, according to the settlement agreement filed in court documents.

In earlier court filings, the parties expressed sharply divergent views on the interest issue.

In their filings, the U.S. bondholders described efforts to cap the amount of interest as a "blatant attempt" to "subvert" the priority of debt holders in bankruptcy cases.

The bondholders also accused the monitor and Canadian creditors of conducting a "smear campaign" against them, and said their opponents were indulging in "name calling and finger pointing."

The Canadian monitor said in its court filings that the interest issue had become a "logjam," preventing a negotiated settlement in the overall case.

The broader Nortel trial heard evidence for five weeks starting in May, on how to divide $7.3-billion in cash raised from the sale of Nortel's assets. A ruling has not yet been made on how that money will be distributed among the Canadian parent and its subsidiaries in Britain and the United States.