TRANSFERS & RENEWALS
Transposing the Music
2003 NATOA Regional Workshop
The Loews Vanderbilt Hotel
Brian T. Grogan, Esq.
Moss & Barnett, A Professional Association
Telephone: (612) 347-0340 Facsimile: (612) 339-6686
Web site: www.municipalcommunicationslaw.com
FRANCHISE RENEWAL: Industry Consolidation
Creates New Challenges for Franchise Negotiations
According to the FCC’s most recent report on competition,
the 10 largest providers of multichannel video programming (“MVP”) serve nearly
85% of all cable subscribers in the
The problem with the regionalization of cable operators is the difficulty for competition to take hold. Regional clusters in excess of 100,000 cable subscribers are very difficult for small competitors to penetrate. As a result, most of the wired competition in the country is found in smaller jurisdictions where regional clusters are not feasible and where independent telephone companies or small start-ups are able to compete.
By way of example, there are just over 33,000 community units identified by the FCC in the United States. A community unit is a city, town, county or other jurisdiction where a cable operator has sought permission from the FCC to provide cable service. Of those 33,000 community units only 617 have effective competition from another wired cable operator. This means just 2% of communities in the country face competition from another wired cable operator. The cable industry argues that competition is present from DBS providers nationwide and, therefore, the presence of another wired competitor does not mean competition is not present. However, given that 35% of all cable programming is affiliated with one of the major cable operators such as Comcast, AOL Time Warner and others, it is not difficult to understand the concern of consumer groups regarding the horizontal and vertical concentration within the cable industry.
This paper will review some of the problems franchising authorities are experiencing as a result of this industry consolidation and ways in which franchising authorities are attempting to address the ever-changing cable industry. The paper will also provide a detailed description of the Charter v. Santa Cruz cases which have served to clarify the authority of local franchising authorities (LFAs) in a transfer proceeding.
1. Regionalization = No Local Presence
As cable operators create large regional clusters often the first thing to be eliminated is the local office. Cable operators are attempting to address years of poor customer service by creating large regional call centers to handle telephone inquiries. Cable operators then attempt to eliminate local offices because such offices no longer handle telephone traffic and walk-in traffic can be handled with a drop box or by contracting with another local retailer. The result is that cable subscribers may be forced to drive 30 miles or more to actually speak face-to-face with a cable operator representative.
This lack of local presence extends beyond customer service issues and also impacts the relationship between the franchising authority and the cable operator. Previously, franchising authorities were are able to maintain a direct line of communication with the local office and local general manager to address citizen complaints, deal with outages and maintain positive communications between the franchising authority and the cable operator. Once the local office is gone so too is the local presence of staff to maintain contact with the franchising authority.
Regionalized call centers also bring with them a whole new set of problems for franchising authorities. When operating correctly and under normal conditions, regional call centers can process customer calls in an efficient manner. These call centers can track telephone calls using sophisticated computer systems to provide reports to verify compliance with franchise standards. Unfortunately, the larger the regional call center the more likely it is to be impacted by outages, line cuts, weather conditions and related issues virtually every day. This results in unusually high call volume from various portions of the region thereby affecting an entire region.
If a fiber is cut on the north side of an operating region knocking out service to 10,000 customers, phone lines will be flooded with calls from that portion of the region. In the southern portion of the region service may be operating fine and customers may simply be calling in with billing questions or routine service issues. Because of the unusually high call volume associated with the issues in the northern part of the region, all customers will be impacted and will be unable to reach a customer service representative. The larger the region the more often abnormal operating conditions will exist resulting in significant down time for the entire call center.
An additional frustration of franchising authorities is the inability for such regional call centers to provide system specific data. Many franchises will require that a cable operator respond to telephone inquiries within 30 seconds and that customers receive a busy signal less than 3% of the time. Generally, these standards are measured on a quarterly basis and must be complied with at least 90% of the time. Cable operators argue that they can only provide a region-wide report and cannot break out numbers for each individual jurisdiction. Moreover, many cable operators will argue that abnormal operating conditions throughout the region should relieve them of franchise compliance regardless of whether such conditions ever existed within a given jurisdiction.
The ultimate goal of all franchising authorities is to ensure quality customer service for cable subscribers. The ability to verify compliance, however, is significantly more complex with the advent of regional call centers and the unique problems they present. The key to resolving some of these issues is to address them upfront during franchise renewal negotiations to ensure that objective standards are included within the franchise document and that accurate reports are submitted by the cable operator to verify compliance.
When cable operators serve regional clusters the desire is to operate the entire region as one large system irrespective of jurisdictional boundaries. In order to do so, the cable operator must endeavor to have the same franchise obligations and requirements within all cable franchises. It is not uncommon for large regional clusters to serve as many as 100 different jurisdictions each with a separate franchise. The result for franchising authorities is a cable operator that may pursue negotiation positions that have little or nothing to do with your community, but rather are meant to establish a region-wide precedent to minimize the burdens on the cable operator.
For example, one of the items often negotiated by franchising authorities in renewal negotiations is channel capacity for local public, educational or governmental (“PEG”) programming. The number of PEG channels which a franchising authority may seek will be based upon the need in that community. It is not uncommon for franchising authorities to seek up to three channels solely for educational purposes which may serve school districts, community colleges and universities. This same community may also seek a channel for public access programming and one or more channels for governmental access programming.
The cable operator, however, may have set aside only three PEG channels for use in the region. The cable operator will endeavor to have the same channel line-up throughout the region to aid in its advertising sales and communication with cable subscribers. Thus, only three channels will be set aside in the line-up for community programming setting up a difficult negotiation process for a franchising authority which may have a local need for greater local capacity. In such negotiations, the cable operator may argue that if additional channel capacity is to be allocated it will result in a reduction of satellite delivered programming that cable subscribers may otherwise benefit from. This presents elected officials with a difficult dilemma and ultimately may have very little to do with the local cable-related community needs and interests but rather the cable operator’s regional plans and desires.
A cable operator will use the same arguments with respect to funding for community programming, institutional networks, security funds, letters of credit and related franchise requirements. The cable operator will no doubt seek the lowest common denominator of previously granted franchises arguing that it cannot agree to requirements above those in other communities. Some cable operators have included provisions within franchises stating that if future franchises are agreed to within the region containing more favorable provisions, the cable operator will provide such benefits to that community. When the next negotiation is conducted with a neighboring community the cable operator will argue that it cannot agree to more favorable terms because it would result in an undue financial burden on the cable operator as it would be forced to give other jurisdictions similar benefits.
3. Limited Local Authority
As cable operators have consolidated, the authority given to the regional system managers or state directors of franchising has diminished. Generally, local cable managers have little authority to commit to obligations without first seeking approval from corporate. The centralization of franchising has resulted in protracted renewal negotiations and significant backtracking in the renewal process.
Franchising authorities will often begin renewal negotiations with the local general manager and/or director of franchising. As this process unfolds the statement will often be made by the local cable manager’s representatives that the issue appears acceptable although they will have to run it by corporate first. The corporate legal counsel located in Denver, St. Louis or on the east coast may not be completely familiar with the franchising authority, its needs, or the negotiation process that is unfolding. Yet corporate will be used as the bad cop in the negotiation process in an attempt to limit or reduce franchise commitments to be made by the local cable manager.
The result for the franchising authority is a delay in the negotiation process and, on frequent occasions, the need to retract agreed upon positions as the cable operator may be forced to back away from prior commitments made during negotiations.
4. Company Policy
As cable operators have grown in size so too has their negotiation strength. More and more frequently cable operators are attempting to establish nationwide policy for franchise negotiations. Most recently, cable operators have attempted to take the position that bonds, security funds and letters of credit should no longer be mandated in the franchise as it presents an undue financial burden on the cable operator and a waste of limited financial resources. The cable operators will argue that because they have never been found in violation of their existing franchise and have otherwise been a good corporate citizen they should no longer be forced to provide financial security to the franchising authority. Unfortunately, this argument completely ignores the possibility that the cable operator may go bankrupt (i.e. Adelphia) or may transfer the system to a less financially secure cable operator. In addition, absent some form of security fund or bond the franchising authority will have no enforcement mechanism available to it other than termination of the franchise.
Cable operators have also recently attempted similar negotiation tactics with respect to the transfer of ownership provisions, financial support for PEG access channels, scope of authority to be contained in the franchise, definition for gross revenues on which franchise fee payments are based and institutional network services.
Historically, cable operators have negotiated the above-requirements franchise by franchise based on the local community needs and interests. As the cable operators have become larger and more focused on regional clusters it has become more important for franchising authorities to clearly document all of their local needs and interests during the renewal process. If informal negotiations prove unsuccessful, the franchising authority is then prepared to enter into formal renewal procedures to protect its rights and interests.
5. Debt Load High, Cash Flow Low
As the major cable operators have consolidated and grown in size so too has their accumulated debt. In late 2002, Charter Communications announced to shareholders that it would attempt to reduce its swelling $18 billion of debt to improve its 2003 cash flow. One of the main strategies for reducing debt is to cut back on capital expenditures. This means that system upgrades not already mandated within local franchises may be impacted by a reduction in capital expenditures. In addition, the rollout of new services such as high-speed data, video-on-demand, interactive television and related product offerings may be delayed as cable operators attempt to grapple with the high debt carried on the systems. In a 2002 Forbes article, James Chanos identified the per subscriber debt of cable operators, including 1) Cox $1,100 debt per subscriber, 2) Comcast $1,352 debt per subscriber, 3) Cablevision $2,404 debt per subscriber, and 4) Charter $2,497 debt per subscriber. Bankrupt Adelphia’s debt was $2,508 per subscriber (numbers were not available for AT&T and AOL Time Warner). With cable industry stocks trading at a fraction of their 52-week high, 2003 is not expected to be a strong year for capital spending as a percentage of revenue.
Further evidence of this trend can be seen from the information available in the FCC’s report on competition. Through June of 2002, the National average dollar value per subscriber for system transactions was $2,196. What this means is that for cable systems that were purchased last year, the average price was $2,196 per subscriber. Compare this number with the average 2001 cost/subscriber of $4,872 and the 2000 cost/subscriber of $5,755. It is not surprising given the extraordinarily high purchase price paid in 2000 and prior years that some cable operators are struggling with debt maintenance and limiting capital expenditures for their systems.
Charter Communications, Inc. v. County of Santa Cruz, 133 F. Supp. 2d 1184 (N.D.Cal. 2001).
While the facts of this case are likely distinguishable from the actions of many cities in reviewing a transfer request, the district court’s findings served as a wake-up call in the cable industry and among LFAs around the country. Finally, it is worth noting that the district court ultimately awarded Charter its attorneys’ fees in the case adding a rather unfortunate punctuation mark on the case, at least from a municipal perspective.
Ninth Circuit Decision
On September 20, 2002, a three judge panel of the Ninth Circuit Court of Appeals overturned the district court’s decision in Charter v. Santa Cruz. The Ninth Circuit decision vacates the district court opinion, Charter Comms. Inc. v. County of Santa Cruz, 133 F.Supp.2d 1184, 1187-1200 (N.D. Cal. 2001), which had been widely cited by the entire cable industry for the proposition that transfer approval cannot be unreasonably conditioned by a franchising authority. The industry had also cited the district court decision for the proposition that a cable operator cannot be compelled to reimburse the costs and expenses associated with a transfer review.
The Ninth Circuit panel focused on one key issue in reviewing the district court decision. Was the County’s denial of consent unreasonable? The court held that “when reviewing disputes emerging from [a] franchise agreement, a court must determine whether the county could have deemed it reasonable to deny consent; this is a much more forgiving standard than whether the district court judge would have denied consent himself if he were acting as the County’s agent.”
The Ninth Circuit held that it was reviewing a discretionary decision of the County Board of Supervisors, a legislative body. The court noted that review of a transfer of control is a “legislative act” entitled to deferential treatment by the court. Thus, whether the County denied consent reasonably is a question “governed not by a preponderance of evidence standard, but rather a substantial evidence test.” Under such a deferential standard, the “County’s denial of consent should be upheld as long as there is substantial evidence for any one sufficient reason for denial.”
The Ninth Circuit found that the ability of the cable operator to adequately service the franchise throughout its term is a legitimate concern. It was not unreasonable for the County to be concerned about Paul Allen’s (the key individual behind Charter) true net worth and about the relationship of that wealth to the viability of the enterprise. The court also held that district court erred by failing to give deference to the County’s articulated concern for keeping stable the subscriber rates in the future. It was not unreasonable for the County to be worried about the long-term viability of the Allen purchase and its effects on the County’s responsibility to assure a stable cable franchise for its citizens.
The Court also held that “even if we thought the County had acted unreasonably, our view would be deferential not only because precedent so commands, but also because methods exist to promote self-correction in the future: citizens can vote out their local representatives and cable operators can refuse to enter into franchise agreements with notoriously difficult local franchising authorities.”
Therefore, the Ninth Circuit held that “since the County’s judgment was reasonable, it necessarily follows that its decision to deny the transfer on the basis of that judgment was supported by a legitimate governmental interest.” Charter voluntarily entered into an agreement under which the County had to approve any transfer of the franchise and thus, to that extent, waived its right to claim that a denial of the transfer violated its First Amendment rights. The Ninth Circuit cited multiple decisions arguing that First Amendment rights may be waived upon clear and convincing evidence that the waiver is “knowing, voluntary and intelligent.”
As a result of the Ninth Circuit’s decision, the district court’s decision, including a companion case mandating the reimbursement of attorney’s fees to Charter, were vacated.
Cable Industry Reaction to Ninth Circuit Decision
The reaction of the cable industry to the Ninth Circuit’s Santa Cruz decision has been swift. In some cases, state cable associations are approaching state legislatures seeking clarification regarding the scope of authority for LFA review of a proposed transfer. In all cases, cable operators are approaching renewal negotiations with an eye toward clarifying the scope of transfer review. Historically, the cable industry and LFAs have often disagreed regarding the precise wording for a transfer provision in a local cable television franchise. However, today cable operators are now attempting to obtain “pre-approval” for certain transfers thereby excluding LFA review. In the past, cable operators often sought a franchise exemption from a transfer review if the franchise was pledged as collateral for financing or in cases of internal restructuring where no change of control takes place. As a result of Santa Cruz, however, LFAs should be on guard with respect to the language proposed by cable operators in draft renewal franchises. In many cases, cable operators are now attempting to craft transfer language which will prevent LFA review of certain mergers such as the AT&T Comcast merger, and/or the acquisition of Time Warner by AOL.
Sample Franchise Language for Transfers
Federal law provides LFAs no guidance regarding the scope of a transfer provision in a cable television franchise and in most cases state law is silent on the issue. Generally speaking, LFAs should consider including the following language in the local cable television franchise:
This Franchise shall not be sold, assigned or transferred, either in whole or in part, or leased or sublet in any manner, nor shall title thereto, either legal or equitable, or any right, interest or properly therein, pass to or vest in any Person without full compliance with the procedure set forth in this section.
The provisions of this section shall only apply to the sale or transfer of all or a majority of Grantee’s assets, merger (including any parent and its subsidiary corporation), consolidation, or sale or transfer of stock in Grantee so as to create a new controlling interest. The term “controlling interest” as used herein is not limited to majority stock ownership, but includes actual working control in whatever manner exercised. The parties to the sale or transfer shall make a written request to the City for its approval of a sale or transfer. (Procedural language omitted)
Transfer Procedural Concerns
In addition, LFAs should be leery of imposing any burdensome procedural requirements on their review. Many cable operators seek to limit municipal review to “legal, technical and financial” qualifications despite the fact that there is no such statutory limitation on the issues which an LFA may consider at the time of a transfer review. Further, LFAs should not include any limitation on the applicable timeframe for review. Cable operators argue that the federal 120 day time limit is applicable and this should be set forth in the local franchise. However, this 120 day time limit may not be final depending upon the cable operator’s responsiveness to information requests which may be submitted by the LFA. At most, the LFA should simply agree to comply with applicable federal laws regarding the timing for any review of a proposed transfer and interpret the applicable time frames under the federal statutes and applicable case law at the time of the proposed transfer. See 47 C.F.R. § 76.502 and 47 U.S.C. § 537 for the federal statutory timing requirements.
Transfer Review Qualifications
In reviewing the qualifications of a proposed transferee inquiries should, at a minimum, be made into the following items:
(1) Current cable franchises;
(2) Cable franchise violations;
(3) Other cable systems sold; and
(4) Revocations, suspensions, non-renewals of any franchise or business license held by the transferee.
In addition, the LFA should investigate the technical qualifications of the proposed transferee by inquiring about any proposed changes to the system, changes in operating personnel, or any requested changes to the franchise itself. Most importantly, however, is the LFA’s review of the financial qualifications of the proposed transferee.
The financial capability of the proposed transferee will impact directly on the quality of cable service and the ability of the transferee to live up to its commitments under the franchise. The LFA should demand all documentation necessary to enable it to evaluate the transferee’s financial qualifications. At a minimum, the LFA should receive the following information:
(1) A full and complete copy of the transfer agreement by and between the buyer and seller;
(2) Corporate or business formation documents, such as articles of incorporation, partnership and limited partnership agreements and management agreements;
(3) Financing documents, such as bank loan agreements or commitment letter; for limited partnerships, a proposed prospectus agreement or offering circular, terms and conditions of the limited partnership agreement; for a public corporation, registration statements S-1 and other forms filed with the Securities and Exchange Commission; and
(4) Current and historical financial statements of the transferee including gross revenue projections, income statements, sources and uses of funds, anticipated capital expenditures, justifications, depreciation schedules, charges for services, expenditures, other system new-build commitments, cash flow analysis, balance sheets and proposed penetration rates.
This financial information and other documentation will help the LFA assess the financial impact of the proposed transfer on the system and its subscribers. When reviewing the financial qualifications the LFA should, at a minimum, review the following:
a. operating ratio = operating expense/revenue
b. operating margin = operating profit/revenue
c. operating expenses
d. pre-tax profit margin = income before taxes/revenue
(2) Market factors - should be addressed in proforma financial statements and include information regarding revenue per subscriber and household density.
(3) Capital expenditures - which should include plant distribution costs, pre-operating expense, headend costs, converter costs, connection costs, and building costs or leasehold improvements.
(4) Debt equity ratio - this measurement shows long-term debt as a percentage of overall capitalization.
(5) Cash flow - debt service. The proforma financials should include a cash flow or source of funds schedule indicating projected annual income or depreciation which in turn would indicate projected cash flow, i.e., net income plus depreciation.
Many cable operators are attempting to limit LFA review of a proposed transfer in the local cable television franchise. The battle may take place in renewal negotiations or before your state legislature. Regardless, LFAs should take extra precautions to ensure that their rights are not waived and that the LFA retains maximum authority to review a proposed transfer. Therefore, even though an LFA may not currently be in the midst of a transfer proceeding, it is time to think about your transfer approval rights. The provisions contained in the local franchise will often dictate whether LFA approval is required and will establish the scope, timing and conditions which may be imposed during such a review.
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Brian T. Grogan is a shareholder with the Minneapolis law firm of Moss & Barnett. Brian represents municipalities throughout the country on franchise renewals, transfers of ownership, telecommunications planning, right of way issues, First Amendment issues, litigation and other related communication matters. Brian is a member of the American Bar Association (Forum Committee on Communications Law), National Association of Telecommunications Officers and Advisors, International Municipal Lawyers Association (Contracts, Franchises and Technology Section), and is Chair of the Communications Law Section of the Minnesota State Bar Association.