COURT FILE AND PARTIES

COURT FILE NO.: 09-CL-7950
DATE: 20121116

SUPERIOR COURT OF JUSTICE – ONTARIO
(COMMERCIAL LIST)

RE: IN THE MATTER OF THE COMPANIES’ CREDITORS ARRANGEMENT ACT , R.S.C. 1985, c. C-36, AS AMENDED

AND IN THE MATTER OF A PLAN OF COMPROMISE OR ARRANGEMENT OF NORTEL NETWORKS CORPORATION, NORTEL NETWORKS LIMITED, NORTEL NETWORKS GLOBAL CORPORATION, NORTEL NETWORKS INTERNATIONAL CORPORATION AND NORTEL NETWORKS TECHNOLOGY CORPORATION, Applicants

BEFORE: MORAWETZ J.

COUNSEL: Alan Merskey, for the Applicants

Lyndon Barnes and Adam Hirsch, for the Directors of Nortel Networks Corporation

Gavin Finlayson, for the Noteholders Group

Joseph Pasquariello, for the Monitor, Ernst & Young Inc.

Shayne Kukulowicz, for the Unsecured Creditors Committee

Andrea McKinnon, for the Former Employees

Robin B. Schwill, for Nortel Networks UK Limited

Thomas McCrae, for Nortel Canadian Continuing Employees

Scott Bomhof, for Nortel Networks Inc. and the U.S. Debtors

Sean Dewart and Tim Gleason, for Chartis Insurance Co.

ENDORSEMENT

OVERVIEW

[ 1 ] Nortel Networks Corporation (“NNC”), Nortel Networks Limited (“NNL”), Nortel Networks Technology Corporation, Nortel Networks International Corporation and Nortel Networks Global Corporation (collectively, the “Applicants”) bring this motion for advice and directions regarding the obligations of Chartis, Inc. (“Chartis”), as provider of the Executive and Organization Liability Insurance Policy (the “D&O Policy”), to the Applicants and their subsidiaries. The Applicants also seek a declaration that the retention provisions specified in the D&O Policy are not applicable in the circumstances.

[ 2 ] NNC entered into the D&O Policy with AIG Commercial Insurance Company of Canada (“AIG”), now carrying on business as Chartis, which holds the Policy No. 01-335-76-98.

[ 3 ] The D&O Policy coverage period was December 1, 2008 to December 1, 2009.

[ 4 ] The D&O Policy provides coverage for various claims made against NNC, its subsidiaries, or their executives or employees (the “Executives”). The coverage also extends to reasonable and necessary fees, costs and expenses that result from defending a claim made against Executives.

[ 5 ] The D&O Policy provides for a total retention amount of U.S. $10 million (the “Retention”).

[ 6 ] Under the D&O Policy, the Retention does not apply in certain circumstances, including in the event that NNC, or its relevant subsidiary has not indemnified nor is permitted or required to indemnify an Executive due to law.

[ 7 ] The D&O Policy contains two relevant forms of coverage:

(a) Coverage B, or organizational coverage (“Coverage B”) for NNC and its subsidiaries; and

(b) Coverage A, or individual coverage (“Coverage A”) for protection directly to the Executives.

[ 8 ] Under Coverage B, Chartis is required to pay the loss of NNC for indemnifying its Executives.

[ 9 ] Under Coverage A, Chartis is required to pay the loss of the executives where NNC has not indemnified the Executives.

[ 10 ] The Retention is not applicable to a non-indemnifiable loss under Coverage A. This includes a loss for which NNC is not permitted or required by law to indemnify the executives.

[ 11 ] An issue has arisen as to whether Chartis is permitted or required to provide coverage to the Executives until the Retention is exhausted and paid by NNC.

FACTS

[ 12 ] On January 14, 2009, an order (the “Initial Order”) granting a stay of proceedings against the Applicants (the “Stay”) pursuant to the Companies’ Creditors Arrangement Act (“CCAA”) was granted. The Initial Order appointed Ernst & Young Inc. as Monitor (the “Monitor”). The portions of the Initial Order which are relevant to the disposition of this motion are set out in Schedule “A”.

[ 13 ] The Initial Order contains a broad Stay against the Applicants in paragraphs 10, 14, and 15.

[ 14 ] The Stay period has been continuously extended during the course of these proceedings.

[ 15 ] Shortly before Nortel filed for CCAA protection, the insurance broker asked Chartis how the indemnification language in the policy would be applied if Nortel became insolvent. Chartis responded by letter dated December 1, 2008 (the “December Letter”) and advised that “if” Nortel and its subsidiaries file for creditor protection “and the court prohibits indemnification of officers and directors “because of higher bankruptcy law priorities”, then “generally, the Insurer would not consider indemnification…to be permitted or required”.

[ 16 ] Immediately prior to the commencement of the CCAA proceedings, NNC established a trust fund for the benefit of individuals serving as Executives (the “D&O Trust”), in the amount of approximately CDN $12 million.

[ 17 ] Paragraphs 21 – 22 of the Initial Order specifies particular circumstances in which the Applicants are entitled to indemnify the Executives.

[ 18 ] On May 18, 2009, Mr. David Lucescu commenced an intended class proceeding in New York against Mr. Michael Zafirodski and Mr. Pavi Binning (the “Lucescu Class Action”). Mr. Zafirodski was the chief executive officer and a director of NNC and Mr. Binning was the chief financial officer.

[ 19 ] The Lucescu Class Action alleges that various statements made or permitted by Messrs. Zafirodski and Binning in 2008 regarding Nortel’s performance and prospects were false and materially misleading.

[ 20 ] The Lucescu Class Action is currently affected by the Stay.

[ 21 ] Messrs. Zafirodski and Binning incurred costs in responding to the proceedings which the directors and Nortel assert are recoverable under the D&O Policy, even though the amounts in issue (less than $100,000) are within the Retention.

[ 22 ] NNC takes the position that, because of the Stay, NNC has not provided indemnification to Messrs. Zafirodski and Binning for the defence-related costs incurred.

[ 23 ] Chartis has refused to pay the legal accounts and related fees that have accrued with regard to the Lucescu Class Action.

[ 24 ] In 2011, the Administrator of approximately of 20 of Nortel’s overseas subsidiaries (the “EMEA Entities”) filed a proof of claim against various Executives in the claims process (the “EMEA Claims”).

INSURANCE COVERAGE STRUCTURE

[ 25 ] The D&O Policy defines loss to include the costs of damages, settlements, judgments and reasonable and necessary defence-related fees, costs and expenses.

[ 26 ] In the Applicants’ factum, counsel set out that in the normal course, in the event of a claim against an Executive, NNC would indemnify an Executive for losses arising from their status as an Executive. The obligation to indemnify the Executives is set out in Article 9.2 of NNC’s Bylaw No. 1

[ 27 ] NNC would, either subsequently or contemporaneously, seek coverage from Chartis for such losses in excess of the Retention as provided by Coverage B. Coverage B applies to losses incurred by NNC beyond the Retention, if it is applicable, as a consequence of claims made directly against it or as a result of its indemnification of an Executive.

[ 28 ] In the event of losses by an Executive for which the Executive is not indemnified, coverage applies under Coverage A.

[ 29 ] Coverage A is non-rescindable and cannot be deemed void.

[ 30 ] The D&O Policy further defines non-indemnifiable loss as follows:

Loss for which an organization has neither indemnified nor is permitted or required to indemnify an Insured Person pursuant to law or contract or memorandum, articles, bylaws, charter, operating agreement or similar documents of an Organization. [emphasis added]

[ 31 ] If the Retention is applicable, Chartis is only obliged to respond to a claim once the Retention has been exhausted.

[ 32 ] The Retention is defined as follows:

For each Claim, the Insurer shall only be liable for the amount of Loss arising from a Claim which is in excess of the applicable Retention amounts stated in items 4(a) through 4(e) of the Declarations, such Retention amounts to be borne by an Organization and/or the Insured Person and remain uninsured, with regard to all Loss other than Non-Indemnifiable Loss .

The Retention amount specified in

(i) Item 4(a) applies to Loss that arises out of a Securities Claim;

(ii) Item 4(b) applies to loss that arises out of an Employment Practices Claim; and ….

No Retention Amount is applicable to Crisis Loss or Non-Indemnifiable Loss … [emphasis added]

[ 33 ] NNC takes the position that the Stay and related laws preclude NNC from indemnifying legal and related costs incurred by the Executives in connection with, among other things, claims based upon pre-filing actions. As such, NNC submits, Coverage A and the non-indemnifiable loss provisions of the D&O Policy are triggered.

[ 34 ] NNC takes the position that the EMEA Claims are based upon pre-filing actions.

[ 35 ] The Applicants anticipate that Chartis’s position will be to not respond to eligible losses (including defence costs) arising from these claims until the Retention is exhausted.

[ 36 ] Chartis takes the position that Nortel and the directors incorrectly equate a procedural order restraining creditors’ remedies against Nortel, with the extinguishment of Nortel’s substantive obligations, where, in fact, Nortel’s substantive obligation to indemnify its directors for the matters in issue on this motion continues to exist, notwithstanding the Stay. Accordingly, Chartis takes the position that the losses Nortel seeks to recover from Chartis are uninsured.

[ 37 ] Counsel to the Applicants emphasized it was AIG’s position in December 2008 that the Retention would not apply in the event of insolvency (Exhibit B to the Supplemental Ventresca Affidavit). Further, the D&O Policy makes other direct statements as to Chartis’s obligations in the event of NNC’s insolvency. Endorsement 8 to the D&O Policy provides:

Bankruptcy or insolvency of any Organization or any Insured Person shall not relieve the Insurer of any of its obligations hereunder.

The coverage provided under this policy is intended as a matter of priority to protect and benefit the Insured Persons such that, in the event of bankruptcy of the Organization, the insurer shall first pay Loss under Coverages A and C prior to paying Loss under Coverage B.

THE D&O TRUST

[ 38 ] Chartis has also taken the position that the D&O Trust should provide indemnity to the Executives up to the amount of the Retention.

[ 39 ] The Trust Indenture identifies “Liability Claims” as any claim that can be asserted against a D&O or for which a D&O can be held personally liable arising from his status as a D&O. A “D&O Qualifying Claim” is defined as the Liability Claim that qualifies for coverage under Nortel’s D&O insurance policies’ scheme.

[ 40 ] The Trustee has full discretion as to whether or not to provide funds from D&O Trust in the case of liability claims that are so eligible.

[ 41 ] The Applicants submit that the D&O Trust was established in recognition of the fact that the laws of various jurisdictions in which Nortel operated provide that directors and officers of companies may become personally liable for certain liability claims. Accordingly, the intended purpose of the D&O Trust is to provide payment for, inter alia , the defence costs incurred by a D&O in responding to claims made against them personally and payment of liabilities found on such claims to the extent that the D&O insurance policies does not do so, and NNC is unable to do so itself. The D&O Trust may also be used for the maintenance of existing D&O insurance policies by NNC, including renewals or restatements, through the payment of premiums or other necessary costs, to the extent that NNC is unable to do so itself.

[ 42 ] Counsel to the Applicants submits that the D&O Trust does not constitute insurance and “shall not be available to provide financial support for the defence of Liability claims which are D&O Qualifying Claims or to pay Liability Claims which are D&O Qualifying Claims”.

(Decision continues with the full reasoning and disposition exactly as in the source.)

MORAWETZ J.
Date: November 16, 2012