On May 12, 2015, more than six years after Nortel’s bankruptcy filing, four years after liquidations of all of its assets, and six months after an unprecedented joint trial before one U.S. court and one Canadian court, two judges simultaneously, but independently, reached an important decision regarding the allocation of Nortel’s $7.3 billion liquidation proceeds among its creditors.
Both decisions call for an allocation of the proceeds largely proportional to Nortel’s global creditor claims. This pro rata allocation is a modified mechanism that was proposed by Dr. Coleman Bazelon, a principal at The Brattle Group (Brattle), as an economically-rational allocation that, in the absence of an ex ante agreement among Nortel’s legal entities prior to its bankruptcy, reflected the financial and management realities of Nortel’s business operations.
As the Courts acknowledged, the core issue at dispute is the interpretation of an internal transfer pricing agreement, the Master Research and Development Agreement (MRDA), which allocated, for tax purposes, Nortel’s operating income or losses between 2001 and 2008 across Nortel’s worldwide legal entities. After bankruptcy, three debtors (Canada, the United States, and EMEA) and various creditor groups disagreed about the meaning and applicability of the MRDA, and, as a result, proposed different allocation methodologies. Both Dr. Bazelon and Dr. Steve Felgran, a transfer pricing expert supported by Brattle, concluded that the purpose of the MRDA was to allocate Nortel’s group operating profits and losses for tax compliance purposes, and did not apply to the allocation of bankruptcy proceeds.
The Courts’ decisions endorse the opinions of both Drs. Bazelon and Felgran. Justice Frank Newbould of Canada’s Ontario Superior Court of Justice ruled that the MRDA “was an operating agreement and was not intended to, nor did it, deal with the disposal of all of Nortel’s assets in situation in which no revenue was being earned and no profit or losses were occurring.” Similarly, Judge Kevin Gross of the U.S. Bankruptcy Court for Delaware determined that “the MRDA, a tax document, was clearly not meant to, nor does it even purport to, govern inter-company allocation of the proceeds from liquidated Nortel assets. … The evidence at trial was overwhelming and undisputed that the MRDA was not intended to address that contingency [global insolvency or liquidation of the Nortel Group].”
Of particular interest in the case and for future bankruptcy cases is the allocation of the $4.5 billion Nortel received in an auction of its 6,000 plus patent portfolio. Using analyses on Nortel’s patents, the Brattle team and Dr. Bazelon found that Nortel’s technologies and R&D activities were too entangled across both lines of business and international borders to be reasonably allocated across the bankruptcy estates. This conclusion was echoed by both Courts. For instance, the Canadian court observed,
“The intangible assets … were not separately located in any one jurisdiction or owned separately in different jurisdictions… R&D took place in various labs around the world in a collaborative fashion. R&D was organized around a particular project, not particular geographical locations or legal entities, and was managed on a global basis. The fact that Nortel ensured that legal entities were property created and advised in the various countries …does not mean that Nortel operated a separate business in each country. It did not.”
Dr. Bazelon’s recommended pro rata allocation method, with some modifications by the Courts, was accepted by the Canadian court as “doing what is just in the unique circumstances” of Nortel’s case, and by the U.S. court as “a fair and equitable mechanism.”
Brattle was retained in this case by Nortel’s UK pension claimants, represented by Willkie Farr & Gallagher, Thornton Grout Finnigan, and Hogan Lovells. The Brattle consulting team was led by principals Mr. William Zarakas and Dr. Bin Zhou.
Dr. Bazelon’s expert reports, as well as the Courts’ decisions, can be accessed using the links below.