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UPDATE ON RECENT FCC AND COURT DECISIONS IMPACTING CITIES

1. Supreme Court Denies Cert. in Landmark Transfer Case - On Monday, January 12, 2004, the Supreme Court denied the Cert. Petition in Charter Communications, Inc. v. County of Santa Cruz, 2004 WL 47372. As a result, the Ninth Circuit’s decision in this cable franchise transfer case will stand. Below is a description of the case.

Santa Cruz Case

On September 20, 2002, a three judge panel of the Ninth Circuit Court of Appeals overturned the leading case regarding cable television transfers of ownership. Charter Communications, Inc. v. County of Santa Cruz, 304 F.3d 927 (9th Cir. 2002). 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 (see www.municipalcommunicationslaw.com - click Presentations - then click Key Legal Decisions Regarding Franchise Renewals and Transfers - for a complete discussion of the district court decision).

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.

2. Open Video System – On July 1, 2003, the Minnesota Court of Appeals affirmed the City of Otsego’s decision to require WH Link, LLC (“WHL”) to obtain a cable franchise and provide cable service throughout the entire city as a condition of that franchise. See WH Link, LLC v. City of Otsego, 664 N.W.2d 360 (Minn. App. July 1, 2003).

Otsego Case

In 2000, WHL received authority from the MPUC to provide local telephone service in a number of communities including the City of Otsego. WHL installed facilities and began providing local telephone and Internet services within the City. The system also had the capacity to carry video signals. In 2001, WHL filed an application with the FCC for certification to operate an open video system (“OVS”). The FCC approved the application and thereafter WHL met with the city to discuss its plans to provide video programming. The city took the position that WHL would have to obtain a cable franchise to provide OVS service. WHL disagreed arguing that the state law franchise requirement in Chapter 238 was preempted by federal laws establishing the OVS regulatory framework.

In 2002, WHL agreed to apply for a cable franchise under state law and the incumbent cable operator, Charter Communications, also participated in the franchising procedure due to the impending expiration of its local authorization. After following the state statutory procedure for granting a cable television franchise, the city approved granting a franchise to Charter Communications. The city also conditionally approved WHL’s application subject to WHL providing service to the entire city within seven (7) years and agreeing to a density requirement of nine (9) homes per quarter mile, identical to the requirements imposed upon Charter Communications. WHL rejected the service area requirement and informed the city that it viewed the imposition of the requirement as effectively denying its franchise application. WHL then challenged the city’s decision before the Court of Appeals.

The issues before the Court of Appeals were as follows:

i. Does the cable franchise requirement of Minn. Stat. § 238.08 apply to an OVS operated by a local exchange carrier?

ii. Does federal law preempt the application of a cable-franchise requirement to an OVS or the imposition of a service-area requirement on an OVS operator?

With respect to the first issue the court concluded that WHL’s OVS system is a “cable communications system” under Chapter 238 and therefore not exempt from municipal right-of-way franchise authority. Thus the court held that the city did not error in requiring WHL to obtain a cable franchise for its OVS.

With respect to the federal preemption issues WHL argued that Congress excluded OVS systems from the definition of “cable system” under federal law and that therefore state and local governmental units are barred from requiring OVS operators to obtain a cable franchise. The court, relying on a decision from the United States Court of Appeals for the Fifth Circuit in City of Dallas v. FCC, 165 F.3d 341 (5th Cir. 1999), disagreed. The court found that the Dallas case stood for the proposition that local franchising authorities have the right to determine whether or not to impose a franchise on an OVS provider. The court held that Federal law does not “eviscerate the ability of local authorities to impose franchise requirements.”

The Otsego case was a resounding victory for municipalities faced with requests from competitive cable television operators seeking to circumvent local franchising authority. However, the case also has highlighted a significant issue in existing Minnesota statutes regarding the level playing field provisions of Minn. Stat. § 238.08. In particular, competitive providers affiliated with competitive local exchange carriers have expressed concerns that the statute serves to limit or restrict the delivery of competitive video services to customers around the state. It is likely that this issue will be further debated at this year’s session and also possible that amendments may be made to Chapter 238 to address the limited service area issue raised by the competitive providers.

3. Ninth Circuit Rules That Cable Modem Service Is a “Cable Service” - The United States Court of Appeals for the Ninth Circuit has held that cable modem service is not a “cable service” but instead part “telecommunications service” and part “information service.” Brand X Internet Services v. Federal Communications Commission, 345 F.3d 1120 (9th Cir. 2003).

Background of Case

When Congress adopted the Telecommunications Act of 1996 it sought to provide a “pro-competitive, de-regulatory national policy framework” designed to promote the deployment of advanced telecommunications and information technologies to all Americans by opening all telecommunications markets to competition.” H.R. Conf. Rep. No. 104-458, at 113 (1996). As result, the Act maintained significant common carrier obligations on providers of “telecommunications services” but left providers of “information services” subject to much less stringent regulation. The Act raised the question of whether new broadband Internet technologies, such as cable modem service, qualified as telecommunications services, information services, cable services or a combination of these.

The FCC did not initially take a position on the regulatory classification of cable modem service. The Ninth Circuit was the first to tackle the issue in AT&T v. City of Portland, 216 F.3d 871 (9th Cir. 2000) where the court held that cable modem service did not qualify as a “cable service” but rather contained both information service and telecommunications service components.

Thereafter, the FCC on September 28, 2000 issued a Notice of Inquiry, In The Matter of Inquiry Concerning High-Speed Access to the Internet over Cable and Other Facilities. 15 F.C.C.R. 19287. (NOI) In the NOI the FCC sought to determine the regulatory treatment to be accorded to cable modem service. After reviewing over 250 comments the FCC, on March 15, 2002, issued a Declaratory Ruling in which it concluded that “cable modem service, as it is currently offered, is properly classified as an interstate information service, not as a cable service, and that there is no separate offering of telecommunications service.” As a result of the FCC’s Declaratory Ruling operators providing cable modem service were no longer subject to regulation as a cable service provider under Title VI of the Act nor as a telecommunications service provider (i.e. common carrier) under Title II of the Act but rather as a provider of information service under the less stringent provisions of Title I of the Act.

Multiple parties sought review of the Declaratory Ruling and all of the related petitions were transferred to the Ninth Circuit for consideration. The fact that the Ninth Circuit received the case is significant because the Ninth Circuit had previously ruled on the issue in the Portland case. Typically, when reviewing an agency’s interpretation of a statute the court will apply a two-step formula set forth by the Supreme Court. The reviewing court must look first to the language of the statute and if the intent of Congress is clear the court, as well as the agency, must give effect to the unambiguously expressed intent of Congress. If the statute is silent or ambiguous, “the question for the court is whether the agency’s answer is based on a permissible construction of the statute.” Where the agency’s interpretation of the statute is reasonable, the court must defer.

What is the Difference Between a Cable, Telephone and Information Service?

In its analysis the Ninth Circuit utilized the following federal definitions.

“Cable service” is “(A) the one-way transmission to subscribers of (i) video programming, or (ii) other programming service and (B) subscriber interaction, if any, which is required for the selection or use of such video programming or other programming service.” 47 U.S.C. § 522(6).

“Telecommunications service” is “the offering of telecommunications for a fee directly to the public, or to such classes of users as to be effectively available directly to the public, regardless of the facilities used.” 47 U.S.C. § 153(46).

“Information services” is “the offering of a capability for generating, acquiring, storing, transforming, processing, retrieving, utilizing, or making available information via telecommunications, and includes electronic publishing, but does not include any use of any such capability for the management, control or operation of a telecommunications system or the management of the telecommunications service.” 47 U.S.C. § 153(20).

The Ninth Circuit’s Analysis

Because the Ninth Circuit had previously ruled on the matter the court looked to its decision in Portland for guidance. In Portland the Ninth Circuit held that “the essence of cable service [as defined in the Act]…. is one-way transmission of programming to subscribers generally,” and concluded that “the definition does not fit” cable modem service, whose salient characteristics are “not one-way and general, but interactive and individual.” Having determined that a cable operator may provide cable broadband Internet access without a cable service franchise the court in Portland then sought to determine how the Act defines cable modem service. In Portland the Ninth Circuit held that cable modem service consists of two elements: a pipeline and the Internet service transmitted through that pipeline. It further held that a cable modem service provider controls all of the transmission facilities between its subscribers and the Internet. Thus to the extent a cable modem service provider is a conventional ISP its activities are that of an information service. However, to the extent a cable operator provides its subscribers Internet transmission over its cable broadband facility, it is providing a telecommunications service as defined in the Act.

As a result of the Portland decision the Ninth Circuit, in the present case, held that because the FCC’s Declaratory Ruling “agreed with our conclusion that cable broadband service is not “cable service,” but disagreed with our conclusion that it is in part “telecommunications service,” we must affirm in part, vacate in part, and remand for further proceedings not inconsistent with this opinion.” Thus the FCC is instructed to review its rules to classify cable modem service as not only an “information service” but also a “telecommunications service.”

What Now?

A petition for rehearing en banc was filed with the Ninth Circuit Court of Appeals. On December 16, 2003, the Ninth Circuit established a January 6, 2004 deadline for 1) responses be filed to the FCC and National Cable Television Association rehearing petitions, and 2) the FCC’s a response to the municipal association’s rehearing petition. In addition, several lawsuits have arisen throughout the country involving cities attempting to collect franchise fees on cable modem service.

In Time Warner Cable v. City of Rochester, No. 6:03-CV-06257-DGL (W.D. N.Y.) the court, on December 22, 2003, granted Time Warner’s Motion for Summary Judgment enjoining Rochester and other New York towns from collecting franchise fees on anything other than Time Warner’s provision of “cable service” which does not include cable modem service. A similar case occurred between Jefferson Parish and Cox Communications in Louisiana, although the case was dismissed on November 21, 2003. This case also involved the Parish’s attempt to impose franchise fees on cable modem service. Locally, a case involving the city of St. Paul and Comcast Communications was recently settled. The case resulted from the City’s challenge of Comcast’s failure to remit franchise fees on cable modem service. The settlement of this case involved a number of issues including the City agreeing not to pursue cable modem franchise fees for several years, but thereafter reserving its right to pursue such a collection should it be permissible under applicable laws. To date there are no reported cases of cities successfully collecting franchise fees on cable modem service in the country.

For now it appears franchising authorities will be unable to mandate the payment of cable service franchise fees on cable modem revenues. However, if the Ninth Circuit decision stands, issues regarding common carrier regulation of cable modem service, including open access for competing ISPs, will be debated in states across the country.

TELEPHONE OVER THE INTERNET (VOIP) CAN IT BE REGULATED?

On September 11, 2003, the Minnesota Public Utilities Commission (“MPUC”) issued a nine- page order requiring Vonage Holdings Corporation (“Vonage”) to comply with Minnesota statutes and rules regarding the offering of telephone service. See In the Matter of the Complaint of the Minnesota Department of Commerce against Vonage Holdings Corporation regarding Lack of Authority to Operate in Minnesota, Docket No. P-6214/C-03-108 (Minn. Pub. Utils. Comm’n Sept. 11, 2003).

On October 16, 2003, the U.S. District Court in Minnesota released a decision enjoining the MPUC from regulating Vonage concluding that state regulation of Vonage’s services is not permissible because of the recognizable congressional intent to the leave the Internet and “information services” largely unregulated. Vonage Holdings Corporation v. The Minnesota Public Utilities Commission, 290 F. Supp. 2d 993 (8^th Cir. 2003).

Vonage markets and sells the service that permits voice communication via a high-speed (“broadband”) Internet connection. The broadband connection can be accessed via cable or DSL service. Vonage’s services use a technology called Voice Over Internet Protocol (“VoIP”) which allows customers to place and receive voice transmissions routed over the Internet. Traditional phone companies use circuit-switch technology which uses the public switched telephone network. VoIP does not utilize circuit switching, but rather “packet switching” a process of breaking down data into packets of digital bits and transmitting them over the Internet. Vonage utilizes a third party Internet Service Provider (“ISP”) and does not serve as an ISP for its customers.

The Minnesota Department of Commerce initially filed a complaint with the MPUC alleging that Vonage had failed to 1) obtain a proper certificate of authority required to provide telephone service in Minnesota; 2) submit a required 911 service plan; 3) pay 911 fees; and 4) file a tariff. The MPUC, in its September 11, 2003 order, required Vonage to comply with Minnesota statutes and rules regarding the offering of telephone service. Vonage filed a complaint in U.S. District Court where the court considered whether Vonage may be regulated by Minnesota law that requires telephone companies to obtain certification authorizing them to provide telephone service. Vonage argued that federal law preempts state authority and that its services are “information services,” which are not subject to regulation, rather than “telecommunications services” which may be regulated.

The District Court concluded that Congress had distinguished telecommunications services from information services and Congress had clearly stated that it did not intend to regulate the Internet and information services. Because the court concluded that the VoIP service provided by Vonage was an information service, attempts by the MPUC to regulate Vonage’s service offerings were in conflict with federal law and therefore preempted.

Why is VoIP Important to Cities?

This issue is important to local units of government not only due to the public safety issues but also the advanced services which may be provided by local cable operators in their communities.

Many large cable operators have announced plans to introduce VoIP telephone service utilizing their high-speed cable modem products. Some operators are pursuing certificates of need and convenience from state public utilities commissions, others are awaiting the outcome of the FCC proceedings and others are simply moving to offer the service. Since local units of government in Minnesota do not regulate any telecommunications service offerings the issue is not one of potential lost revenue from franchise fees to be paid to a city. Rather, the concern arises if a cable operator were to bundle voice, video and data services for one price to a consumer.

If, for example, the operator were to offer unlimited high-speed cable modem service, unlimited VoIP telephone service and 80 channels of video programming all for $120. What amount of that price is subject to the local cable television franchise fee? What if the operator argues that it is discounting or giving away for free the video services and allocating $60 to the cable modem and $60 to the VoIP service? Under that scenario, the operator may argue that it is not required to remit any franchise fee to the local jurisdiction under its cable service franchise. Cities no doubt would view this issue differently and would likely impute the fair market rate for the cable services and expect that a franchise fee would be remitted for that amount.

This issue should be carefully monitored by cities when reviewing quarterly or annual franchise fee payments received from their cable operator. Moreover, for those jurisdictions considering renewal of a cable television franchise, provisions should be added regarding bundled services and the impact on franchise fee payments by the cable operator.

UPDATE ON THE STATUS OF

TELECOMMUNICATIONS STATE LEGISLATIVE PROPOSALS

At the end of the 2003 session three telecommunications bills had been introduced. Each of these bills was introduced for a specific purpose. First, Senator Kelley introduced SF 1556 which would overhaul all current legislation related to telecommunications providers (telephone, television, internet and data) and create new law which would dramatically reduce local regulatory authority over cable services and shifting such authority to the Minnesota Public Utilities Commission. Second, the telephone industry introduced a bill (SF 1311 & HF 1498) in which the telephone industry would be able to provide cable TV services in a community but would be classified as an OVS (Open Video System) provider and would be subject to limited local regulatory authority. The OVS providers would have to comply with federal guidelines and provide franchise fees, PEG (Public, Educational and Government) access facilities and channels and the provider would have to open up two-thirds of its network capacity for lease to competitors. Third, MACTA introduced a chapter 238 (cable TV) rewrite bill (HF 1633) which was intended to clean up Chapter 238 and modernize it. (Legislative summary prepared with assistance from MACTA President, Jeff Lueders)

ARE CABLE OPERATORS PAYING ALL

THE FRANCHISE FEES THEY OWE CITIES?

Over the past several years, cable franchises have been transferred numerous times. Many cities throughout the State of Minnesota have had as many as three different cable operators during the last six years. During these transfers hundreds of franchises trade hands and the new cable operator then attempts to comply with numerous new obligations, including the proper payment of franchise fees to each community served. It is not uncommon, however, for cable operators to handle franchise fee payments in a generic “one-size fits all” manner regardless of the language contained within a given franchise. This occurs despite the fact that each franchise typically contains a slightly different definition for “gross revenues” on which franchise fee payments are based.

For years, cities have routinely conducted franchise fee audits of cable operators to determine whether the operator is paying the appropriate fees under the franchise. However, recent franchise fee reviews have discovered more errors than historically have been present, even from large cable operators. This is due in part to the complexity of cable operations and the numerous revenue sources which are now available to cable operators. Further, several new court decisions have changed the manner in which cable operators can collect franchise fee revenue. Below is a description of a recent Fifth Circuit decision which impacts the collection of franchise fees by cable operators.

Pasadena Case

In October of 2001, the Federal Communications Commission (FCC) issued an order involving the City of Pasadena, California (“Pasadena Order”) which permitted cable operators to pass-through franchise fees to subscribers on cable television bills based on gross revenues that encompass “non-subscriber” revenue. Specifically, this non-subscriber revenue included income generated by advertising sales and home shopping commissions. As a result of the Pasadena Order many cable operators around the country increased franchise fees on subscribers’ bills by .25% or more.

A number of local franchising authorities (LFAs) around the country, including a group of Texas franchising authorities and the National Association of Telecommunications Officers and Advisers petitioned the Fifth Circuit for review of the Pasadena Order. On March 27, 2003, the Fifth Circuit denied the LFAs’ petition for review on the grounds that the FCC had acted within its broad discretion and not in a manner that was arbitrary, capricious or manifestly contrary to the statute in question. See Texas Coalition of Cities for Utility Issues v. FCC, 324 F. 3d 802 (5^th Cir. March 27, 2003).

The LFAs argued that the Pasadena Order should be reversed because it conflicts with two particular provisions of the Cable Act, 47 U.S.C. §§ 542 and 543. In particular, the LFAs contended that where the franchise fee is based on the percentage of the cable operator’s gross revenue, only the portion of that fee attributable to revenue from the subscribers may be passed through to subscribers. The LFAs argued that the Pasadena Order permitted an improper shifting of costs on to subscribers and that each class of the cable operator’s customers should bear a proportionate amount of the franchise fee (i.e., the portion of the franchise fee attributable to advertising revenue should be passed through to advertisers). The Fifth Circuit concluded that whether or not the court may have interpreted the statutes differently the FCC’s decision is entitled to deference and its order is not arbitrary and capricious.

The practical result for franchising authorities across the country is that cable operators can pass-through as a separate line item on subscribers’ bills all franchise fees due and owing the franchising authority. These franchise fees may include non-subscriber revenues, including home shopping and advertising revenues. In other words, cable operators will be permitted to reap the benefits of growth in non-subscription revenue while subscribers must bear the financial burden of increased franchise fees.

By way of example, if a cable operator sells $100 worth of advertising to a local business to provide commercial spots on the cable system, many franchises require the cable operator to pay a 5% franchise fee on that revenue. Prior to the Pasadena Order in 2001 cable operators paid the applicable $5 franchise fee on the $100 of revenue and/or assessed the $5 fee to the advertiser. Under the Pasadena Order this $5 franchise fee is now spread over all subscribers in that jurisdiction resulting in a minimum .25% increase per month in the total franchise fee paid by a subscriber. In essence, the more advertising a subscriber watches, the higher the franchise fee on their bill.

The Fifth Circuit decision has not resulted in any reduction in franchise fee payments to LFAs although subscribers must now bear the burden of additional franchise fee payments even as cable operators increase non-subscription revenue. If a city chooses to conduct a franchise fee audit, the city staff should pay particular attention to the franchise language which may include mandatory reimbursement of any audit fees incurred by the city should the city discover an underpayment of franchise fees.

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Brian T. Grogan is a shareholder with the Minneapolis law firm of Moss & Barnett practicing in the areas of telecommunications and cable television law. Brian represents entities throughout the country on franchise renewals, transfers of ownership, competitive franchising, telecommunications planning, right-of-way management, first amendment issues, tower siting, leasing and zoning, litigation and other related communication matters.

As part of the cable communications practice of Moss & Barnett a Communications Law Update is regularly prepared and distributed. At least four (4) times each year this newsletter provides current information about events in Congress, the FCC and recent court decisions that may impact municipalities’ role in regulating cable communications. If you would like to begin receiving Moss & Barnett’s Communications Law Update, please notify:

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