FCC Licenses and Insolvency

March 19, 1999

This outline is a summary review of the issues and the development of answers to insolvency questions relating to FCC licenses as developed over the recent years. Among the questions relevant to an insolvency case are what is a FCC license, what (or whose) rules apply to the determination of the answers, and why are we talking about this.

Since the enactment of the Bankruptcy Code, the evolution of the treatment of FCC broadcast licenses has been rapid, and, while confusing, has moved consistently in the direction of accommodating financial and economic reality in carving out legal recognition for issues that were not contemplated by the Communications Act of 1934 (47 U.S.C., § 151 et. seq.). That act by its terms applies to radio broadcasting. It clearly now applies to television broadcasting and other forms of radio communication such as licenses for broadcasting on the personal communication system spectrum.

Simplifying the discussion for our purposes, the government through the FCC controls the use of public air rights and without exception has the ability to issue and revoke licenses granted to licensees for the use of radio frequencies. Just as the act in 1934 did not anticipate television, it did not anticipate personal communication systems or the expense of operating a licensee.

It is an area where the law, the technology and the finance issues have converged from different eras; recently they have been harmonized in ways that only lawyers (and those who think like lawyers) could create or understand.

The questions that have been litigated are:

Is the FCC license property of the estate?;

May a security interest be taken in the license?;

How may a licensee obtain financing?; and

Who gets the proceeds from a disposition of a broadcasting business as a going concern?

Note, any time there is a transfer of the license, the transferee must be approved by the FCC to be able to utilize the license - a sometimes time consuming process.

The usual context for the issues as they have evolved is a radio or television station is insolvent and the estate, whether through a trustee or a debtor in possession seeks to sell the business as a going concern including a transfer of the license (subject to FCC approval). Increasingly, the debtor licensee is the holder of a Personal Communications System license ("PCS").

Starting in 1983, with D.H. Overmyer Telecasting v. Lake Erie Communications 35 B.R. 400 (Bankr. ND Ohio, 1983), the issue of whether a license is property of the estate was raised. The court concluded the FCC license was not "property of the estate". It was a "right" granted by the government subject to the government rules. Even though a licensee may transfer the license, the court observed, the transfer required government approval. The FCC license revocation proceeding was not subject to the automatic stay and there was no right to realize value from the sale of the business

Stephens Industries, Inc. vs. McClung, 789 F. 2d. 386 (6th Cir., 1986), continued the tendency of the courts to rule that the license was, in essence, a public privilege and that a creditor could not obtain a security interest in the license. Relying on the FCC decision of In Re Merkley, 94 F.C.C. 2d. 829 (1983), the Stephens court held that the broadcast license was not an owned asset or a vested property interest that could be subject to a mortgage, lien, pledge, attachment, seizure or similar right. The court, however, authorized the § 363 sale of all assets of the debtor, including whatever rights attached to the license. The trend continued in the case of In Re Smith 94 B.R. 220 (Bankr., M.D. Ga., 1988) which similarly cited the Merkley decision as to the policy of the FCC, which clearly prohibited a security interest in the license. This court, however, said the license was property of the estate (no one questioned this conclusion).

While the negative security interest rulings were continuing, the issue whether the license was property of the debtor's bankruptcy estate evolved into consistent holdings that it was (see Smith, supra). In the Matter of Fugazy Express, Inc., 124 B.R. 426 (U.S.D.C., S.D.N.Y., 1991) actually analyzes the property of the estate question and concludes that 11 U.S.C., § 541 includes any conceivable tangible or intangible property or cause of action. While the FCC has revocation and regulatory power, but, unlike the Overmyer court, Fugazy concluded the 11 U.S.C., § 362 automatic stay applied and the public health and safety exception did not.

In 1992, the trend continued to find that not only were licenses property of the estate, but that security interests may be enforceable, not in the license but in the proceeds of a disposition of a license. The first step in that direction is represented by In Re Ridgely Communications, Inc., 139 B.R. 374 (Bankr., D. Md., 1992) which relied upon the 1988 FCC ruling in In Re Bill Welch, 3 F.C.C.R. 6502 (1988) to determine that FCC had previously acknowledged that a license confers certain private rights upon the licensee which may be sold for a profit to a private party subject to FCC approval of the transferee. The private rights were distinguished from the public rights of the FCC to regulate. The court discusses the distinction between the public right and the private right clarifying that the secured creditor, while not entitled to a security interest in the license, was entitled to enforce its security interests as a general intangible, in the proceeds of the sale of the license and the business. The court also quotes Fugazy, supra, at length on the property of the estate question.

The Seventh Circuit took on Ridgely, supra, on the security interest issue In Re Tak Communications 985 F. 2d 916 (7th Cir., 1993) which affirmed the District Court decision which may be found at In Re Tak Communications, 138 B.R. 568, (D.C., Wisc., 1992). The circuit adopted the District Court's decision which affirmed the Bankruptcy's Court's decision prohibiting a security interest from attaching to the license or its proceeds. Both the District Court and the Circuit specifically rejected Ridgely.2/ Of note, the Seventh Circuit did observe that the District assumed the license was property of the estate, while relying on Stephens, supra, Smith, supra, and In Re Bill Welch, supra,(the same FCC opinion relied on by Ridgely) to reject a security interest in the license or its proceeds.

Subsequently, In Re: Atlantic Business and Community Development Corporation, Internal Revenue Service v. Subranni, 994 F. 2d. 1069 (3d. Cir.asoning, rejected Tak Communications, and held that a creditor may have a security interest in the proceeds of the disposition of the license subject to the approval of the FCC of the transferee. The FCC hearing officer stated in rejecting the Tak decision, "The Court in Tak held that the Commission has a policy prohibiting a licensee from granting a security interest to a creditor in the proceeds of the sale of the license. It expressly declined to adopt the rational of Ridgely, 139 B.R. 374. We respectively conclude that the court erred in Tak. Moreover, we [the FCC] were not a party to that action. The Court's ruling cannot bind the Commission to a policy it does not have."

The opinion emphasized the difference between a prohibited security interest in the broadcast license and a permitted security interest in the proceeds of the license. (Be sure of your collateral description.)

Subsequently, the FCC in a review of the Mobile Services Division opinion in Cheskey, supra, ruled in In Re Walter O'Cheskey,/4 13 F.C.C.R. 10656 (1998), that the prior opinion (Cheskey - 1) got it right - no security interest in the license, but a security interest in the proceeds is okay. Furthermore, they observe this has always been their view as Ridgely, supra, observed in relying on In Re Bill Welch, supra. (This clear position seemed to have been missed at several stops along the way including the Seventh Circuit who relied on Bill Welch as well.)

Finally, the Ninth Circuit ruled in July, 1998 in MLQ Investors, L.P. v. Pacific Quadracasting, Inc. et al., 146 F. 3d. 746 (9th Cir., 1998) 5/ that a security interest in proceeds of the sale of the broadcasting license was enforceful, as such a security interest in proceeds constituted a general intangible under state law that could be perfected prior to the sale pursuant to the applicable state UCC provisions for perfection of security interests in general intangibles. Consequently, the perfection dates from the date of filing. The secured creditor in that case defeated the IRS tax lien and any claim of the equity holder. (They stipulated to follow bankruptcy priorities). The 9th Circuit relied upon In Re: Bill Welch, supra and cited both Ridgely, supra and Cheskey, #1 supra with approval that the proprietary right in proceeds from the sale of the license is what the security interest attaches to.

Where this leaves us is that a creditor may have a security interest in the value of the broadcast entity particularly as a going concern (note: if a facility is shut down for any length of time the license is subject to termination, which would have a destructive effect on value). With the 1998 rulings secured creditors may now sleep somewhat easier. In order to assure that the security interest is enforceable, however, the security agreement and the financing statements must clearly include general intangibles, usually reference the license as an item of collateral to the extent permitted by law, and be duly perfected prior to the filing of a bankruptcy.

Indications from Pacific Quadracasting is that the Ninth Circuit will recognize the security interest as perfected from the date of filing avoiding the question whether it is a springing security interest that arises upon the sale in a bankruptcy proceeding or otherwise springs into existence at some point of trouble.

Obviously, to realize the value from the license the sale must be on a going concern basis prior to termination of the license and subject to the FCC approval of the buyer. A number of the early bankruptcy cases as well as the subsequent ones relied upon a Bankruptcy Act case, LaRose v. Federal Communications Commission, 494 F. 2d 1145 (D.C., 1974). La Rose has a direct impact upon the question of the valuation of the collateral and how it may be preserved and sold by an involuntary assignee (a bankruptcy fiduciary). LaRose was misinterpreted by some of the cases that tried to indicate that the license would not be property of the estate. But as a bankruptcy fiduciary was allowed to sell the rights of a licensee, there had to be something to sell and the FCC had to deal with the sale in good faith.

In LaRose, a receiver appointed under the Bankruptcy Act attempted to sell a broadcaster together with its license. The FCC rejected the purported sale and then rejected another purported sale because of the finality of the prior rejection. Disposing of the finality questions, the Court determined that the FCC abused its discretion by not considering the second sale. The Second Circuit sent the matter back to be considered in light of what is termed the "Second Thursday" doctrine. In essence, the "Second Thursday" doctrine, is an FCC policy designed to protect the public interest of innocent creditors and allows the Commission to approve a sale and assignment of a bankrupt's license in a transaction that will not unduly interfere with the FCC mandate to ensure that broadcast licenses are used and transferred consistently with the Communications Act. Basically, they require that the wrongdoers derive no benefit, directly or indirectly, from the sale or only a minor benefit which is outweighed by the equities in favor of innocent creditors. This doctrine persists and becomes extremely relevant in the context of PCS licenses.6/

The FCC opened a series of frequencies for PCS bidding with reduced down payment and up front low interest financing arrangements. The FCC functions both as secured creditor and regulator. The dual position of the FCC as a regulator and secured creditor will lead to a further evolution of the rights in and to licenses and the financing thereof. Because of the evolution of the bankruptcy standards, it may also lead to the expansion of the use of bankruptcy as a forum for sales.

Today, the license is property of the estate in which a security interest may not be granted but the proceeds of the license are subject to a security interest. There remains the policy to preserve value for innocent creditors subject to the regulatory power to control.

The FCC is subject to the automatic stay as to revocation hearings and the bankruptcy fiduciary or nonbankruptcy receiver as an involuntary transferee may operate while seeking a sale which will benefit innocent creditors (a licensee may reorganize but only if not in the FCC dog house).

Without the going concern value, the hard assets will not support the modern financing requirements of a broadcast licensee. The bankruptcy sale may be a better way to realize the value given the current mix of FCC rules and decision based bankruptcy rules.

Another important feature of the FCC powers and the issues that effects value will be the inability of a seller to retain a reversionary interest. This is a material effect as the FCC will not preapprove a potential buyer at a Bankruptcy Court sale, and there is no assurance that approval will follow in ordinary course. This is an area with which Bieally Walter O'Cheskey.

4/ Same guy, but they have the apostrophe this time.

5/ The case was argued before O'Cheskey #2 was issued in April, 1998, which is not cited in the case.

6/ For an excellent discussion of PCS licenses and the FCC in bankruptcy see Personal Communication System Licenses and the 'Specter' of Bankruptcy, Carolyn Hochstadter Dicker, 6 Commlaw Conspectus 59 (1998).

* a co-panelist at the program.

Prentice O'Leary, Sheppard, Mullin, Richter & Hampton LLP © 1999

* This article was drafted for the American Bankruptcy Institute program materials for Bankruptcy Battleground West, March 19, 1999. Mr. O'Leary was a panelist on the panel discussing "High-Tech Reorganization Issues, Security Interests, Regulatory Concerns, License Considerations, etc., Concerning Computer, Telecommunications and Intellectual Property Assets."