NextWave and the Implications of a Broad Interpretation of Section 525(a)

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Jun 2003

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Two recent decisions involving interpretations of §525(a) of the Bankruptcy Code,² the highly publicized Jan. 27 decision of the U.S. Supreme Court in Federal Communications Commission v. NextWave Personal Communications Inc.³ and the far less discussed decision of the Second Circuit in In re Stoltz,⁴ are certain to have wide-ranging implications for future cases involving that provision.

Section 525(a) of the Code, which was enacted to codify and expand the Supreme Court's 1971 decision in Perez v. Campbell,⁵ prevents any governmental unit, as defined in the Code,⁶ from revoking, suspending, denying or refusing to renew, or discriminating in any way with respect to, a government license, permit, employment or "other similar grant" to a debtor or former debtor or its affiliate "solely because" the debtor is or was in bankruptcy, was insolvent before it was adjudged a bankrupt, or did not pay a debt dischargeable in the bankruptcy case. The statute furthers the "fresh-start" policy underlying the Code.⁷

Cases Before NextWave

Courts have grappled with how broadly §525(a) should be interpreted. In particular, much of the litigation has centered on how narrowly the "other similar grant" language should be construed. On the one hand, courts have applied §525(a) to prevent a state mortgage fund from (1) denying a mortgage to a former debtor,⁸ (2) rejecting a public college's practice of denying transcripts to students whose student loans had been discharged in a bankruptcy proceeding,⁹ (3) denying Florida taxing authorities' attempt to prevent a debtor from obtaining a certification showing that all state and county taxes were paid, where the taxes were dischargeable in the debtor's bankruptcy proceeding,¹⁰ and (4) preventing the government from revoking a real estate license for which payment had been made from a government real estate recovery fund.¹¹ On the other hand, some courts have refused to apply §525(a) in cases involving state-funded mortgage assistance payments,¹² the eviction of a public housing tenant where pre-petition rent payments were discharged in bankruptcy,¹³ and the application of a driver's license restoration fee.¹⁴

Where courts have found that the governmental unit's action occurred "not solely because" the debtor is or was bankrupt, was insolvent, or is or was the beneficiary of a bankruptcy discharge of a particular debt consistent with the legislative history, they have refused to apply §525(a).¹⁵ In particular, courts have refused to apply §525(a) in cases involving horse racing commission licenses where the state commission had reasons other than those specified in §525(a) for denying or revoking a racing license. For example, in one case, the commission found that the applicant, a chapter 11 debtor, lacked financial integrity and future financial resources, and that the local market was saturated.¹⁶ In another, the commission found that the suspension of the debtor's license three times for his failing to maintain insurance, together with his racing-related debts and his bankruptcy, justified the revocation of his license.¹⁷ The court agreed, and thus §525(a) was held not to have been violated.¹⁸

In the NextWave¹⁹ and Stoltz decisions,²⁰ the courts strengthened the protections to debtors under §525(a) and broadly interpreted the statute, ruling that §525(a) controls even where it arguably conflicts with another federal statutory provision. In NextWave, the other provision was §309(j) of the Communications Act of 1934.²¹ In Stoltz, the other provision was §365 of the Code.²² In each case, the court denied the government's "solely because" argument, and in Stoltz, the court also denied the government's "other similar grant" argument.

As discussed infra, the broad interpretations by the courts in these important cases of the language of the statute make it clear that the public policy issues under §525(a)—concerning the public's interest in revenue raising and in awarding or continuing in effect licenses, permits, etc.—are not to be addressed by the judiciary, but only by Congress.

NextWave: The License Acquisition

At a Federal Communications Commission (FCC)-regulated auction of broadband personal communications services licenses, NextWave was awarded 63 C-Block licenses on bids totaling $4.74 billion, and 27 F-Block licenses for $123 million. NextWave made a down payment on the purchase price and executed promissory notes for the balance, as well as security agreements covering the licenses. The FCC perfected its security interests in the licenses by filings under the Uniform Commercial Code (UCC). The licenses stated that they were "conditioned upon full and timely payment of all monies due pursuant to...the terms of the Commission's installment plan as set forth in the Note and Security Agreement by the licensee."²³ The licenses also stated that the "[f]ailure to comply with this condition will result in the automatic cancellation of this authorization."²⁴

NextWave proceeded to experience financial difficulties and was unable to make the installment payments. The FCC granted NextWave the option of restructuring the deal by surrendering some or all of the licenses in exchange for partial or full forgiveness on the outstanding debt. Instead of agreeing to any such restructuring plan, NextWave filed a chapter 11 petition in New York.²⁵

After extensive litigation, the FCC announced that the licenses had been canceled automatically when NextWave missed its first payment and put the licenses up for re-auction.²⁶ After further litigation, NextWave filed a petition with the FCC seeking reconsideration of the license cancellation.²⁷ When that petition was denied, NextWave appealed to the D.C. Circuit Court of Appeals pursuant to 47 U.S.C. §402(b).²⁸ The D.C. Circuit reversed the FCC decision, citing §525(a) and holding that the FCC had "violated the provision of the Bankruptcy Code that prohibits governmental entities from revoking debtor's licenses solely for failure to pay debts dischargeable in bankruptcy."²⁹ The FCC then appealed the decision to the Supreme Court. The Supreme Court granted certiorari,³⁰ and in an 8-1 decision, affirmed.³¹

The Supreme Court's Rationale

The FCC presented three principal arguments to the Supreme Court. It first contended that it had revoked NextWave's license not "solely because" of NextWave's failure to make the required payments. Instead, it argued, it had a "valid regulatory motive" for the cancellation of the licenses.³² The FCC argued that since it made timely payment a regulatory requirement, it should be permitted to cancel licenses for failure to meet that requirement.³³

The Court disagreed, stating that any such motive is irrelevant: "Section 525 means nothing more or less than that the failure to pay a dischargeable debt must alone be the proximate cause of the cancellation—the act or event that triggers the agency's decision to cancel, whatever the agency's ultimate motive in pulling the trigger may be."³⁴ The Court went on to hold that there is no exception under §525(a) for "cancellations that have a valid regulatory purpose"³⁵ except where they are explicitly provided for in the Code.³⁶

The FCC next argued that the debtor's license obligations to it were not debts that were dischargeable in bankruptcy. The FCC's contention was that a regulatory condition is not categorized as a debt even when the condition is of a "financial nature."³⁷ The Court rejected the FCC's position and stated that "a debt is a debt, even when the obligation to pay it is also a regulatory condition."³⁸ It held that "a discharge in bankruptcy discharges the debtor from all debts that arose before bankruptcy..." except for those specific discharge exceptions enumerated in Code §523.³⁹

Finally, the Supreme Court rejected the FCC's argument that §525(a) should not be applied because it conflicts with the Communications Act, 47 U.S.C. §309(j). The majority found nothing within §525(a) that conflicted with the auctioning provisions of §309(j), because the Communications Act does not provide that cancellation is a sanction for failure to make timely payments for a license. The Court also stated that the FCC's auction provisions merely reflect an administrative preference on its part for "(1) selling licenses on credit and (2) canceling licenses rather than asserting security interests when there is a default."⁴⁰ Such a preference, the Court held, cannot form the basis for denying NextWave rights where such denial is clearly prohibited by the plain meaning of §525(a). The Court further held that §525(a) of the Code and §309(j) of the Communications Act can be plainly read together, demonstrating that each statute is effective and that the FCC was not authorized by applicable law to revoke NextWave's license.⁴¹

In dissent, Justice Breyer disagreed with the majority's literal reading of the statute. Justice Breyer's view was that §525(a) applies only where the license revocation is "related to the fact that the debt was dischargeable in bankruptcy."⁴² How is a court to divine such a "relationship?" Justice Breyer did not say. Looking to the legislative history, Justice Breyer also stated that §525(a) was intended to apply only where the governmental unit's action would "undercut the 'fresh start' that is bankruptcy's promise..."⁴³ This view of the statute, he stated, would protect the public from the deprivation of the "full value of the public assets that it owns."⁴⁴ Justice Breyer concluded by stating that the majority opinion did not make clear whether under §525(a) the government retained its right to enforce its security interest in the licenses, and thereby left open the issue of whether NextWave could simply keep the licenses without paying. He suggested that a remand was the appropriate disposition of the case.⁴⁵

The Stoltz Decision

In Stoltz,⁴⁶ the Second Circuit applied §525(a) to bar the eviction of a debtor from public housing in Brattleboro, Vt., even though she had failed to pay pre-petition rent and the obligation to pay such rent had been discharged in her bankruptcy case.⁴⁷ The Brattleboro Housing Authority argued that a public housing lease was not an "other similar grant" as defined under §525(a) and that the statute did not prohibit the eviction, but only the denial of the debtor's reapplication for a future lease. The court disagreed.

Moreover, the court was confronted with a potential conflict between §§365 and 525(a) of the Code. The Housing Authority argued that §365, the executory contract provision, required the debtor to cure the rent default as a condition of assuming the housing lease. This seemingly conflicted with §525(a)'s anti-discrimination mandate, which the court assumed prevented the eviction of a debtor for failure to pay pre-petition rent. The Stoltz court held that §525(a) was more specific than §365 because it applied only to governmental units and government licenses and permits. The court stated that it is "a basic principle of statutory construction that a specific statute... controls over a general provision."⁴⁸ In addition, to further the "fresh start" policy of the Code, §525(a) had to be construed to prevent the government from evicting a debtor from public housing under an existing lease. The court rejected the Housing Authority's argument that the eviction was valid and that §525(a) could only apply to prevent the government from prohibiting the debtor, once evicted, from reapplying for public housing. Rather, as a public-policy matter, the maintenance of the debtor's existing public housing was essential to her "fresh start," because an eviction might result in homelessness for her and her family.⁴⁹

Ramifications of the Decisions

These decisions pose a substantial public policy dilemma. On the one hand, they broadly protect debtors from government action that would place the government in a better position than a private creditor in a bankruptcy case. They stand for the proposition that, notwithstanding other provisions of the Bankruptcy Code that distinguish government creditors from private creditors,⁵⁰ where the issue is a government license or similar government grant or benefit, the government, like a private creditor in other circumstances, loses its claim for payment if the debtor is discharged. They cite the "fresh start" policy underlying the Code as supporting their statutory interpretation.⁵¹

However, the broad interpretation of §525(a) could potentially deprive the public of billions of dollars and essentially provide a windfall to debtors whose debts to the government are discharged. It is one thing for a private creditor to deal with a party pre-petition and take the risk that the party's obligation could be wiped out if it files an individual chapter 7 or a corporate chapter 11 and obtains a discharge. It is quite another thing for the government to issue a permit, license or public housing lease, and then have no recourse when the recipient does not pay. In NextWave, for example, after the licensee defaulted, the government resold NextWave's licenses for nearly $16 billion.⁵² As a result of the Supreme Court's decision, the public was deprived of all of those funds. The policy issues become even more problematic when one examines the three curious express exceptions contained in §525(a). These are for the Perishable Agricultural Commodities Act of 1930, the Packers and Stockyards Act of 1921, and §1 of the Act entitled "An Act making appropriations for the Department of Agriculture for the fiscal year ending June 30, 1944, and for other purposes." The public interest implicated by these three statutes would seem to be less significant than that involved in many other federal statutes, and their inclusion as statutory exceptions only add to the apparent unfairness that can result from the application of §525(a).

Justice Breyer struggled with this public-policy issue in his dissenting opinion. Although earlier lower-court cases had interpreted §525(a) narrowly and rejected its application,⁵³ the Supreme Court's new mandate of broad interpretation of §525(a) must now be followed by the lower courts. Accordingly, the courts will no longer be able to address the public policy concerns engendered by §525(a) by narrowly interpreting the statute. Indeed, as the Supreme Court stated in NextWave, the statute says what it says.⁵⁴ Yet Justice Breyer's attempted judicial solution, a labored construction of §525(a) that would be virtually impossible to apply,⁵⁵ is not the answer. These issues must be addressed by Congress. For now, more often than not, the courts will apply §525(a) to protect a debtor's "fresh start," regardless of the impact on the public.

Footnotes

¹ Neil P. Forrest is a partner and Marco-Aurelio Casalins III is an associate in the New York office of Swidler Berlin Shereff Friedman LLP. Return to article

² 11 U.S.C. §525(a) (2003). Return to article

³ 123 S.Ct. 832 (2003). Return to article

⁴ 315 F.3d 80 (2d Cir. 2002). Return to article

⁵ 402 U.S. 637 (1971). In Perez, the U.S. Supreme Court held that a state cannot suspend an individual's driver's license solely because a judgment against the license-holder arising out of an automobile accident had been discharged in the driver's bankruptcy proceeding. Return to article

⁶ 11 U.S.C. §101(27) (2003). Return to article

⁷ NextWave, 123 S.Ct. at 843 n.4 (2003) (stating that it would undermine the debtor's "fresh start" "if there [were a] revocation of a license solely because of a bankrupt's failure to pay dischargeable debts"); Stoltz, 315 F.3d at 90. Return to article

⁸ In re Rose, 23 B.R. 662, 668 (Bankr. D. Conn. 1982). Return to article

⁹ Lee v. Board of Higher Educ. of the City of New York, 1 B.R. 781, 789 (S.D.N.Y. 1979). Return to article

¹⁰ In re General Development Corp., 163 B.R. 216, 220 (S.D. Fla. 1994). Return to article

¹¹ In re Walker, 927 F.2d 1138, 1142-43 (10th Cir. 1991). Return to article

¹² Watts v. Pennsylvania Hous. Fin. Agency, 876 F.2d 1090, 1094 (3d Cir. 1989). Return to article

¹³ In re Bacon, 212 B.R. 66, 76 (Bankr. E.D. Pa. 2000). Return to article

¹⁴ Geiger v. Pennsylvania, 143 B.R. 30, 35 (E.D. Pa. 1992) (state refusal to reinstate driver's license unless fee is paid). Return to article

¹⁵ See, e.g., Will Rogers Jockey & Polo Club Inc., 111 B.R. 948, 953 (Bankr. N.D. Okla. 1990) (denial of racing license on the basis of the "financial integrity and hope of financial success" of the debtor and market saturation). See, also, H.R. Rep. No. 595, 95th Cong., 1st Sess. 367 (1977), reprinted in Collier on Bankruptcy, App. Pt. 4(d)(i) (15th rev. ed. 2002). Return to article

¹⁶ Will Rogers Jockey & Polo Club, 111 B.R. at 953. Return to article

¹⁷ In re Christmas, 102 B.R. 447 (Bankr. D. Md. 1989) (suspension of horse trainer's license where, inter alia, debtor could not demonstrate financial responsibility). Return to article

¹⁸ Id. Return to article

¹⁹ 123 S.Ct. 832 (2003). Return to article

²⁰ 315 F.3d 80, 95 (2d Cir. 2002). Return to article

²¹ 47 U.S.C. §309(j) (2003). Return to article

²² 11 U.S.C. §365 (2003). Return to article

²³ Radio Station Authorization for Broadband PCS (issued to NextWave Jan. 3, 1997), 2 App. to FCC Pet. for Cert. 388a. Return to article

²⁴ Id. Return to article

²⁵ In re NextWave Personal Communications Inc., 235 B.R. 263, 267 (Bankr. S.D.N.Y. 1998). Return to article

²⁶ Upon re-auction, the government received bids of nearly $16 billion from carriers such as Verizon Wireless on licenses for which NextWave had bid $4.7 billion. Greczyn, Mary, "Supreme Court Rules FCC Couldn't Void Nextwave C-Block Licenses," Communications Daily, Jan. 28, 2003. Return to article

²⁷ In re Public Notice DA 00-49 Auction of C and F Block Broadband PCS Licenses, Order on Reconsideration, 15 FCC Rcd. 17500 (2000). Return to article

²⁸ This section of the Communications Act provides, in pertinent part, that "appeals may be taken from decisions and orders of the Commission to the U.S. Court of Appeals for the District of Columbia...[b]y the holder of any construction permit or station license which has been modified or revoked by the Commission." 47 U.S.C. §402(b)(5). Return to article

²⁹ FCC v. NextWave Personal Communications, 254 F.3d 130, 133 (D.C. Cir. 2001). Return to article

³⁰ 535 U.S. 904 (2002). Return to article

³¹ NextWave, 123 S.Ct. at 842. Return to article

³² Id. at 839. Return to article

³³ Id. Return to article

³⁴ Id. Return to article

³⁵ Id. Return to article

³⁶ 11 U.S.C. §525(a) contains three express statutory exceptions: "the Perishable Agricultural Commodities Act, 1930, the Packers and Stockyards Act, 1921, and §1 of the Act entitled 'An Act making appropriations for the Department of Agriculture for the fiscal year ending June 30, 1944, and for other purposes,' approved July 12, 1943..." 11 U.S.C. §525(a) (2003). Return to article

³⁷ NextWave, 123 S.Ct. at 839 (citing Brief for Petitioner FCC 33). Return to article

³⁸ Id. Return to article

³⁹ Id. at 840 (citing Ohio v. Kovacs, 469 U.S. 274, 278 (1985)) (emphasis in original). See 11 U.S.C. §523 (2003) (enumerating discharge exceptions). Return to article

⁴⁰ Id. Return to article

⁴¹ Id. at 841. Return to article

⁴² Id. at 844 (Breyer J., dissenting). Return to article

⁴³ Id. 845 (citation omitted). Return to article

⁴⁴ Id. Return to article

⁴⁵ Id. at 849. Return to article

⁴⁶ 315 F.3d 80, 95 (2d Cir. 2002). Return to article

⁴⁷ Id. at 89. Return to article

⁴⁸ Id. at 93 (citing HCSC-Laundry v. United States, 450 U.S. 1, 6, 101 S.Ct. 836, 839 (1981)). Return to article