I think we should all take a moment to appreciate that the Nortel Networks Corp. decisions of the Ontario Commercial List and the Delaware Bankruptcy Court represent the kind of Bay Street drama more regularly found at Ben McNally or the Canadian Opera Company.
Really, the plot summary is the stuff of Homer. A great house rapidly rises and then spectacularly falls, leaving three different countries to fight over the remains of the estate. They employ "scorched earth" tactics in their battle, hiring a cadre of mercenaries ( lawyers) to do their bidding. Finally, after two grand confrontations in two of the most powerful jurisdictions in North America, the crane lowers two great gods – Justice Newbould of the Commercial List and Judge Gross in Delaware – deus ex machina, to scold the combatants and to mete out justice in a most unexpected way.
The practical details of this epic are here, and the core of the decision is that both Justice Newbould and Judge Gross independently came to the same conclusion – that Nortel's creditors should share in Nortel's $7.3-billion estate pro-rata.
I know, you doth protest – creditors sharing pro-rata is a pretty typical bankruptcy result and hardly sounds like a conclusion that merits $1-billion in legal fees. I hear you, but then it's not exactly a surprise when Odysseus slays the suitors and gets Penelope either. Like with The Odyssey, the most compelling tales are the stories within the stories – and my favourite story in the Nortel decisions isn't about bankruptcy or legal fees, it's that the Nortel decision is a seminal case in contract interpretation.
One of the core maxims of commercial law is that tax drives structure. In essence, that means that companies and transactions are set up in a way to minimize the amount of tax that companies pay. This makes companies less like hydras with many heads and one body, but armies, composed of varying battalions with slightly different tasks, working towards a common goal.
Political controversies aside, this is good business sense. For tech companies like Nortel, intellectual property proves to be an efficient way to do this. By way of a crude example, a company could sell a phone that costs $100 but costs $10 to make and pay tax on the $90 of profit. Or it could license the IP from a related entity in a low tax jurisdiction and pay a $90 licensing fee to that related entity (which then pays tax on the income from the licensing fee, but at that jurisdiction's much lower rate).
Tax authorities like the Canada Revenue Agency and the Internal Revenue Service are hip to this (admit it, you've never seen the words "hip" and "tax authority" in the same sentence before) and require that these internal transactions be priced at their fair market value. This is called transfer pricing.
To document its internal transactions, all of Nortel's subsidiaries and related companies entered into something called the Master Research and Development Agreement (MRDA) which set out the licensing rights to Nortel's IP. The MRDA was a tax document, drafted by tax lawyers, for tax purposes. But it is also the major document setting out who owns what IP, and Nortel's IP turned out to be worth over $4-billion.
So, while Nortel looked like one big "Nortel" to you and me, from a legal perspective, Nortel was a bunch of smaller Nortels working in tandem because smaller Nortels meant less tax. Critically, each Nortel had obligations to the other Nortels, and each Nortel had its own creditors. You can see where this is going – the creditors of the Nortel that gets the IP, as well as the proceeds of the sale of Nortel's other assets, are the creditors that make out the best. (Unsurprisingly, the judges were presented with positions from each of the creditors that they found "self serving.") And the only document that could set this out wasn't designed to apportion assets between creditors; it was designed to minimize tax.
Thus, the key question for both Justice Newbould and Justice Gross was, does the MRDA govern the allocation of proceeds among the creditors?
What follows is a little bit amazing. Since the MRDA specified Ontario law as the governing law for the agreement, both the Delaware and Ontario courts had to analyze the agreement using Ontario law, and both came to the same conclusion, but the two courts differed in how they reached that conclusion.
Justice Newbould found that the MRDA vested IP rights in Nortel's Canadian entity distinguishing between the economic right to the income stream generated by the IP, and the legal rights to the IP reserved by the Canadian entity and licensed to the other entities. Nonetheless, Justice Newbould found that "the agreement in its application was intended to apply only to Nortel while it operated and not to deal with rights after Nortel and its subsidiaries stopped operating its businesses." This allowed Justice Newbould to use the court's broad authority to insist on a pro-rata allocation among creditors in bankruptcy.
(As an aside, paragraph 93 of the Ontario decision should put to rest the debate over who gives a fuddle duddle about the Oxford comma? The answer is Justice Newbould and, at the risk of overreaching, it provides persuasive evidence that all Ontario law firms should mandate that all independent clauses be separated by commas, Oxford or otherwise.)
Judge Gross reached a different conclusion, finding that the MRDA finding that the economic reality of the agreement was one that conferred actual legal rights to each of the entities in their respective territories. Nonetheless, it was clear from the face of the document that it did not allocate rights in a liquidation scenario, leaving the Delaware Court in the same place as the Ontario one; to allocate the proceeds among the creditors in the fairest way possible – pro-rata.
This is a somewhat remarkable place to land. Ontario law in Delaware now looks different than Ontario law in Ontario when it comes to determining property rights under MRDA contracts. If the issue ever comes up again, there's now good reason to believe that a lawsuit over an Ontario contract in Delaware will have a different result than a lawsuit over the same contract in Ontario.
I'd go on, but the fire draws down. Still, these things are Homeric, and I get the impression that, much like The Odyssey and The Iliad, those of us in the business will be reading them for a long time to come.
Adrian Myers is a lawyer at Torkin Manes LLP.