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The FCC v. Powers of the Bankruptcy Courts A Closer Look at NextWave and the Other C-Block Cases

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With billions of dollars at stake, recent bankruptcy court opinions involving the Federal Communications Commission's (FCC) C-Block radio spectrum licenses for personal communications services continue to spiral up through the courts of appeal. The FCC has largely emerged as the winner so far in cases that pit the FCC's regulatory powers against the Bankruptcy Code's automatic stay and fraudulent transfer provisions. The decisions have sparked calls on both sides of the issue for legislative clarification of the police and regulatory powers exception to the automatic stay and the treatment of government licenses in bankruptcy cases.

Background

In 1993, Congress amended the Federal Communications Act (FCA) to add, inter alia, §309(j), which authorizes the FCC to conduct competitive bidding auctions for radio spectrum licenses. Omnibus Budget Reconciliation Act of 1993, Pub. L. No. 103-66, §6002(a), 107 Stat. 312, 387 (1993). The FCA directs the FCC to reserve for lease by qualified entities, including small businesses, certain blocks of spectrum, and to make available to such entities deferred payment plans with favorable terms. Pursuant to §309(j), the FCC reserved a block of licenses known as the C-Block licenses for use by qualified entities providing a then-emerging form of wireless communications technology now widely known as "personal communications services."

In 1996, the FCC concluded two sets of C-Block auctions awarding exclusive license application rights to the successful bidders. Several of the winning bidders qualified under §309(j) as "small businesses" and were required to pay only 10 percent of their winning bids in cash with the remaining 90 percent to be paid in installments over a 10-year period at below-market interest rates. In the ensuing three years, the largest companies holding C-Block licenses filed for bankruptcy after failing to make the prescribed installment payments. By 1999, two such companies had filed fraudulent transfer adversary proceedings against the FCC seeking to retain their licenses at a fraction of the bid prices. In re NextWave Pers. Communications Inc. v. FCC, 235 B.R. 263 (Bankr. S.D.N.Y. 1998), rev'd., 200 F.3d 43 (2d Cir. 2000); In re United States v. GW I PCS 1 Inc., 245 B.R. 59 (N.D. Tex. 1999), aff'd., 230 F.3d 788 (5th Cir. 2000). In two other recent C-Block cases, the FCC sought to reclaim C-Block licenses from bankrupt licensees who had defaulted on their installment payments. In re Kansas Pers. Communications Servs. Ltd., 252 B.R. 179 (Bankr. D. Kan. 2000), rev'd., U.S. v. Kansas Pers. Communications Servs. Ltd., 256 B.R. 807 (D. Kan. 2000); In re Pers. Communications Network Inc., 249 B.R. 233 (Bankr. E.D.N.Y. 2000). Several bankruptcy court orders arising from these four bankruptcy cases have generated multiple opinions by courts of appeals and district courts in the Second, Fifth and Tenth Circuits. The most publicized of these cases is NextWave, which was decided in the Second Circuit.

The NextWave Case

NextWave Personal Communications Inc. (NextWave P.C.), the largest C-Block license holder, was the winning bidder of 63 licenses for a total bid price of $4.74 billion. Qualifying as a "small business" under §309(j), NextWave P.C. paid the required $474 million down payment and arranged to pay the remaining $4.26 billion in installment payments. After conducting the statutorily required application process, the FCC approved the company's license applications and formally awarded the licenses to NextWave P.C. in January 1997, four months after the auction. NextWave, 200 F.3d at 46-49.

Prior to and after the C-Block auctions, the FCC had conducted A-, B-, D-, E- and F-Block auctions that had resulted in sharply lower bid prices than those for the C-Block auction when measured in dollars per MHZ-Pop, a generally accepted industry measurement standard. Because the C-Block licensees had paid significantly more for their licenses than other radio spectrum licensees, most, including NextWave P.C., had difficulty securing the financing necessary to meet their installment payment obligations. The C-Block licensees petitioned the FCC for help. After several rounds of administrative hearings, the FCC issued a restructuring order that provided three mutually exclusive options, ranging from the return of the licenses in exchange for forgiveness of debt obligations to a plan that allowed bidders to keep as many of their licenses as they could afford by converting a portion of their down payment into a pre-payment of the full bid price for a smaller number of licenses. The restructuring order did not, however, allow any bidder to keep a license for less than the original bid price because, the FCC reasoned, the auction regulations were designed to ensure that licenses were allocated to users who could demonstrate, through their ability to pay the highest price, that they possessed the most highly valued use for the licenses. Id. at 47.

After exhausting its administrative remedies to reverse the FCC Restructuring Order and losing on appeal to the Circuit Court of Appeals for the District of Columbia, NextWave P.C. filed for chapter 11 bankruptcy protection in the Southern District of New York and instituted an adversary proceeding against the FCC seeking to avoid the company's license installment payment obligations. NextWave P.C. argued that the acquisition of the licenses was a fraudulent conveyance that could be avoided under §544 of the Bankruptcy Code based on, inter alia, NextWave P.C.'s failure to receive reasonably equivalent value for the debt incurred. Rejecting the FCC's argument that the bankruptcy court lacked subject-matter jurisdiction over actions brought against the FCC in its regulatory capacity, which exclusive jurisdiction, the FCC argued, lies with the federal courts of appeals pursuant to federal statute, the bankruptcy court allowed NextWave P.C.'s claims to proceed to trial. The bankruptcy court concluded that the issues before it concerned the creditor-debtor relationship between the FCC and NextWave P.C., and did not implicate the FCC's regulatory authority. As such, the bankruptcy court determined that it had jurisdiction. Id. at 49.

In analyzing a fraudulent conveyance claim under §544(b) of the Code, the courts determine whether a debtor was insolvent at the time of the transfer and, if so, whether the debtor received reasonably equivalent value for the transfer on the effective date of the transfer (e.g., Nextwave, 200 F.3d at 49). At trial, the FCC argued that under its regulations the entire obligation for the bid amount became due at the close of the auction, and that the effective date of the transfer was, therefore, the date of the close of the auction. As such, the $4.74 billion bid amount was the market value of the licenses transferred on the effective date of the transfer. The bankruptcy court concluded, however, that the effective date of the transfer was when the FCC finally granted the licenses in return for the executed notes, which was several months after the auction. By that time the licenses were deemed to have a market value of only $1.023 billion, and so all obligations to the FCC above that amount were constructively fraudulent and avoidable. Amazingly, the avoidance remedy would allow NextWave P.C. to keep the licenses it had acquired at auction by outbidding its opponents, while requiring it to pay less than a quarter of its bid amount. The FCC appealed to the district court, which affirmed the bankruptcy court's decision on substantially the same basis.

The Second Circuit, however, reversed and remanded. First and foremost, the Second Circuit concluded that the lower courts did indeed lack jurisdiction to decide the question of whether NextWave P.C. had satisfied the regulatory conditions placed by the FCC upon its retention of the licenses. The court determined that the FCC's auction rules under §309(j) "have primarily a regulatory purpose: to ensure that spectrum licenses end up in the hands of those most likely to further congressionally defined objectives." Id. at 54. Further, the court held that by allowing NextWave P.C. to retain the licenses for a fraction of the bid price, the lower courts had impaired the FCC's method for selecting licensees and had effectively exercised the FCC's radio licensing function without any power whatsoever to do so. Id. at 55. Lastly, the court found that the transfer date, for purposes of the fraudulent conveyance analysis, was the auction close date, based both on general auction law principles and on the FCC's interpretation of its own regulations, which interpretation had been issued during the pendency of the NextWave P.C. bankruptcy dispute. Id. at 58-59. Accordingly, the court determined, there was no constructive fraud since NextWave P.C. had received equivalent value for its debt obligation—the licenses valued at the $4.74 billion winning bid amount. Id. at 57.

Shortly after the Second Circuit's Dec. 22, 1999, ruling, in a move to retain the licenses, NextWave P.C. agreed to pay the full balance due the FCC. Through public notice, however, the FCC announced that NextWave P.C.'s licenses had cancelled automatically on NextWave P.C.'s default under the payment terms of the licenses, and scheduled the licenses for re-auction. The bankruptcy court granted NextWave P.C.'s motion to declare the public notice null and void based largely on its finding that, because the licenses constituted property of the estate, their revocation violated the automatic stay. To that end, the bankruptcy court determined that the exception under §362(b)(4) to the automatic stay2 did not apply because the FCC's actions were "nothing other than a direct attempt to enforce its pecuniary interests."3 In re FCC, 217 F.3d 125, 132 (2d Cir. 2000).

On writ of mandamus by the FCC to the Second Circuit, the court granted mandamus and directed the bankruptcy court to vacate its order voiding the FCC's license cancellations and notice of re-auction. Id. at 141. The court loudly and repeatedly pronounced that the bankruptcy court's order had violated the Second Circuit's mandate from the previous opinion to refrain from impinging upon the FCC's regulatory authority. The court rejected the bankruptcy court's couching of the FCC's decision to re-auction the licenses due to NextWave P.C.'s failure to make timely payments as a creditor/debtor issue rather than one implicating the FCC's regulatory function. The timing of NextWave P.C.'s payment obligation—like the amount of it—was a regulatory condition established by the FCC, the court concluded. Id. at 138. Further, even if the regulatory condition were arbitrary, the bankruptcy court lacked jurisdiction to determine that issue. Id. at 137.

NextWave P.C. has appealed the FCC's cancellation of its licenses to the District of Columbia Court of Appeals, and this appeal remains pending at this writing.

Cases Following NextWave

While it might have taken two opinions to do so, the Second Circuit's mandate in NextWave has been made clear, at least in that circuit. The bankruptcy court for the Eastern District of New York, citing NextWave, held that it was without power to review the propriety of the FCC's determination that Personal Communications Network Inc.'s (another C-Block licensee) licenses had automatically cancelled pre-petition and were, therefore, not assets of the bankruptcy estate. In re Pers. Communications Network Inc., 249 B.R. 233 (Bankr. E.D.N.Y. 2000).

Likewise, the U.S. District Court for the District of Kansas reversed a bankruptcy court's order denying the FCC's motion to amend Kansas Personal Communications Services Ltd.'s (KPCSI, another C-Block licensee) schedule of assets to reflect that its three C-Block licenses had automatically cancelled post-petition. United States v. Kansas Pers. Communications Servs. Ltd., 256 B.R. 807 (D. Kan. 2000). Giving "controlling weight" to the FCC's own regulatory interpretation that on payment default the licenses cancelled automatically, the district court concluded that the licenses had cancelled without any "act" by the FCC. As such, license cancellation did not violate the automatic stay. Id. at 811. Citing NextWave, the district court also determined that §362(b)(4)'s exception to the automatic stay applied in that the FCC's requirement of timely and full installment payments or automatic license cancellation on default is part of its regulatory scheme rather than furtherance of a "primarily pecuniary government interest" or an "adjudication of private rights." Id.

GWI PCS Inc.

The only FCC defeat not yet reversed among the C-Block battles was handed down by the Fifth Circuit in In re GWI PCS 1 Inc., 230 F.3d 788 (5th Cir .2000). The key procedural difference between GWI PCS and the other C-Block cases, however, is that the district court below had ruled that the debtor's plan of reorganization had been substantially consummated and, accordingly, dismissed the FCC's appeal of the bankruptcy court's confirmation order and avoidance judgment as equitably moot.4

GWI PCS Inc. (GWI) was the winning bidder of 14 C-Block licenses at a total bid price of $1.06 billion. Sharing the fate of other C-Block licensees, GWI took its parent company and 14 wholly owned subsidiaries (all GWI-related entities collectively—GWI PCS) into chapter 11 and brought a preference action against the FCC seeking to avoid more than $900 million of the bid amount still due. The bankruptcy court issued an avoidance judgment in favor of GWI PCS and reduced the amount due the FCC to $60 million. Over the FCC's objections, the bankruptcy court then confirmed the debtors' reorganization plan, which incorporated the bankruptcy court's prior ruling in the avoidance action. The FCC appealed the confirmation order and avoidance judgment to the district court.

Nearly 10 months after the filing of the appeal, and only after the debtors petitioned the Fifth Circuit for mandamus directing the district court to issue a ruling, the district court dismissed the FCC's appeal as equitably moot. Appeal of that ruling was taken by the FCC to the Fifth Circuit Court of Appeals. The court affirmed the confirmation order, finding that the reorganization plan had been substantially consummated by Oct. 27, 1998, 37 days after entry of the confirmation order. Interestingly, the court noted that while the FCC had been granted one stay by the district court for 20 days and another stay by the Fifth Circuit Court for an additional seven days, the FCC's failure to secure additional or lengthier stays was the equivalent, for purposes of the equitable mootness analysis, of not seeking a stay at all—that is, both lead equally to the implementation of the reorganization plan. It is unclear from the opinion why the FCC was unable to obtain stays from the very courts that would, thereafter, determine that failure to obtain the stays, in large part, rendered the appeal of the confirmation order equitably moot.

Also of interest, the appeals court noted in dicta that while the bankruptcy court might well have erred in permitting avoidance and enjoining license cancellation, "thereby taking onto itself a quasi-regulatory function held by the FCC," the FCC's challenge to the bankruptcy court's actions was barred by equitable mootness. The court distinguished NextWave by pointing out that the courts in NextWave had granted the FCC stays such that a reorganization plan there could not have been substantially consummated. The distinction, of course, would ring truer if the Fifth Circuit court itself had not lifted the stay that then allowed the debtors to proceed with the plan.

The court in GWI PCS also upheld the bankruptcy court's avoidance judgment that allowed the debtors to avoid $894 million of the obligation owed to the FCC, and permitted the debtors to retain the C-Block licenses. The court found unpersuasive the Second Circuit's deference in NextWave to the FCC's own regulatory interpretation of when the licenses had transferred to the debtor. The court concluded instead that the transfer date of the licenses was not at the close of the auction, but rather when the license application was finally approved by the FCC and the notes were executed by the debtors. The timing of the transfer, you will recall, was key to valuation of the licenses for purposes of determining whether the debtors received reasonably equivalent value for the debt they incurred.

Commentary

The C-Block spectrum cases reviewed above demonstrate the complexity of competing interests and the approaches courts have taken in dealing with the interplay between government regulatory powers and the powers of the bankruptcy court to promote equitable distribution among creditors. The Second Circuit's "hands off" mandate to the bankruptcy court in NextWave is arguably justified by the public policy it seeks to advance. It is not difficult to see that a different result might easily undermine the integrity of the government's license auctions altogether. Why worry about how much you bid, so long as you are the highest bidder? The bankruptcy courts, after all, would otherwise allow you to keep the prize for a fraction of the amounts of the losing bid. It is difficult, however, to justify wholesale removal of the FCC from the bankruptcy courts' jurisdiction with regard to all aspects of license payment terms and pre- and post-petition license cancellation, as suggested by precedence in NextWave.

The FCC has urged codification of the decisions reached by the Second Circuit in NextWave in opposition to proposed legislative changes to the Code to clarify treatment of government-issued licenses as property of the estate and of the government agency as creditor when it holds the notes of one of its licensees.


Footnotes

1 Mr. Montoya is a commercial litigation and bankruptcy attorney with the law firm of Jackson Walker L.L.P. in Austin, Texas. Return to article

2 11 U.S.C. §362(b)(4) provides an exception under paragraphs (1), (2), (3) and (6) of §362's automatic stay provisions for:

the commencement or continuation of an action or proceeding by a governmental unit...to enforce such governmental unit's police and regulatory power... Return to article

3 Two tests have evolved from the courts, the "pecuniary purpose" test and the "public policy" test, to determine whether agency action fits the §362(b)(4) exception. See, e.g., Eddleman v. United States Dep't. of Labor, 923 F.2d 782, 790 (10th Cir.1991). Return to article

4 The test for determining whether an appeal of a reorganization plan is moot in the Fifth Circuit is whether (1) a stay has been obtained, (2) the plan has been substantially consummated, and (3) the relief requested would affect either the rights of parties not before the court or the success of the plan. GWI PCS, 230 F.3d at 800. Return to article

Journal Date: 
Sunday, April 1, 2001

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