******************************************************** NOTICE ******************************************************** This document was converted from WordPerfect to ASCII Text format. Content from the original version of the document such as headers, footers, footnotes, endnotes, graphics, and page numbers will not show up in this text version. All text attributes such as bold, italic, underlining, etc. from the original document will not show up in this text version. Features of the original document layout such as columns, tables, line and letter spacing, pagination, and margins will not be preserved in the text version. If you need the complete document, download the WordPerfect version or Adobe Acrobat version, if available. ***************************************************************** DA 96-2123 December 17, 1996 Leonard J. Kennedy, Esq. Richard S. Denning, Esq. Dow, Lohnes & Albertson, PLLC 1200 New Hampshire Ave., N.W. Suite 800 Washington, D.C. 20036 Re: Note and Security Agreement for C-Block Licensees Dear Messrs. Kennedy and Denning: This is in response to your memorandum of November 20, 1996, explaining your major concerns regarding the Installment Payment Plan Note and Security Agreement to be executed by grantees of Broadband PCS C-Block conditional licenses. Subordinated Interests in the Proceeds of License Sales. Your memorandum asserts that the Security Agreement's definition of "Collateral" and its restriction on security interests in the "proceeds, profits and products of any sale of other disposition of the License" impedes a licensee's ability to obtain bank and other financing. We have heard similar assertions from other C-Block auction winners. As you state, under current Commission regulations and policies, lenders are not granted direct security interests in FCC licenses. However, we understand that it is customary in commercial financings to grant lenders security interests in the proceeds of the sale of FCC licenses. In implementing Section 1.2110(e) of the Commission's rules, we have no desire to impede or adversely affect a licensee's ability to obtain bank or other financing. Accordingly, the terms of the Security Agreement have been revised to allow the debtor to grant to other parties a subordinated security interest in the proceeds of an authorized assignment or transfer of the license to a third party, provided however that any such security interest shall be subordinated to and in no way inconsistent with the Commission's first security interest in the Collateral. The revised Security Agreement was sent to the designated contact persons for the conditional licensees. Transfer of PCS Systems as "Going Concerns." Your memorandum states that "the Security Agreement implies that the Commission's preferred remedy in default situations will be to revoke and re-action [sic] the Licenses." We believe that no such implication is intended or even possible under the Commission's current policy, which was expressed in the Second Report and Order and the Fifth Memorandum Opinion and Order in the competitive bidding docket (PP Docket No. 93-253). For your convenience we restate this policy below (footnotes omitted): 130. Parties have asked questions about how the Commission would resolve issues associated with an entrepreneurs' block licensee becoming financially insolvent. In particular, there is concern about the status of the license when the licensee cannot make the required installment payments, and in the case of when a licensee enters bankruptcy. 131. In the Second Report and Order, we clarified that "a designated entity that has defaulted or that anticipates default under an installment payment program" may request a three to six-month grace period before the Commission cancels its license. During this grace period, a defaulting licensee could maintain its construction efforts and/or operations while seeking funds to continue payments or seek from the Commission a restructured payment plan. We will evaluate requests for a grace period on a case-by-case basis . . . deciding whether to grant such requests or to pursue other measures, we may consider, for example, the licensee's payment history, including whether it has defaulted before and how far into the license term the default occurs, the reasons for default, whether the licensee has met construction build-out requirements, the licensee's financial condition, and whether the licensee is seeking a buyer under a distress sale policy. Following a grace period without successful resumption of payment or upon denial of a grace period request, we will declare the license cancelled and take appropriate measures under the Commission's debt collection rules and procedures. 132. Since several commenters . . . requested clarification as to what the Commission would allow in the event a licensee defaults on payment of its installment monies, we clarify that lenders and entrepreneurs' block licensees are free to agree contractually to their own terms regarding situations where the licensee has defaulted under the Commission's installment payment program, and possibly other obligations. As long as there is no transfer of control, we would not become involved in the particulars of a voluntary workout arrangement between a designated entity and a third- party lender. 133. Specifically, an entrepreneurs' block licensee and its lenders may agree that, in the event the licensee defaults on its installment payments, the lenders to that licensee will cure this default by assuming the designated entity's payments to the government. Barring any transfer of control, we would not object to such an arrangement. 134. In the event a transfer of control is sought under the terms of the workout, the licensee and its lenders must apply for Commission approval of the transfer, in accordance with Section 310(d) of the Communications Act. In a situation where the lender itself is the proposed buyer or transferee, we would scrutinize such an application to determine whether, by virtue of the loan agreement, an earlier transfer of control was effectuated. We clarify that we would also expect that any requirements that arise by virtue of a licensee's status as an entrepreneur or as a designated entity would be satisfied with respect to such a sale. Thus, for example, the transfer would need to be to another qualified entrepreneur if it is to occur within our five-year holding period. 135. In the event an entrepreneurs' block licensee becomes subject to bankruptcy, our existing rules and precedent clarify how the Commission would dispose of a license in such a circumstance. Specifically, transfer to a bankruptcy trustee is viewed as an involuntary transfer or assignment to another party under Section 24.839 of the Commission's Rules. In such a case therefore, there would be a pro forma involuntary assignment of the license to a court-appointed trustee in bankruptcy, or to the licensee, as a debtor-in-possession. Assuming the bankrupt estate is liquidated or the trustee finds a qualified purchaser for the licensee's system, and assuming payments to the Commission are maintained or a grace period granted, we will continue generally to defer to federal bankruptcy laws on many matters. We would, however, ultimately have to approve any final transfer of the license. As stated above, we would expect that any requirements that arise by virtue of a licensee's status as an entrepreneur or as a designated entity would be satisfied with respect to such a sale. Thus, for example, the transfer would need to be to another qualified entrepreneur if it is to occur within our five-year holding period. Fifth Memorandum Opinion and Order, PP Docket No. 93-253, 10 FCC Rcd 403, 471 (1994). More recently, the Commission stated that "[m]arket-oriented solutions to problems of financial distress will often be preferable to the FCC reclaiming and reauctioning licenses." Report and Order, WT Docket No. 96-59 and GN Docket 90-314, 11 FCC Rcd 7824, 7864  85 (1996) (amending Section 24.839 of the Commission's rules to eliminate the three-year holding period for entrepreneurs' block licenses). Accordingly, we believe that commercial lenders and equipment vendors already have assurances from the Commission that in most situations of financial distress licensees can expect to be transferred as "going concerns" subject, of course, to the rights of the Commission to the payments of obligations created under the Commission's rules, the license conditions and the Note and Security Agreement. At the same time, however, we are sure that licensees and their other creditors understand that the Commission's interests in the license must be protected in the bankruptcy context where the debt is nonperforming and service to the public is jeopardized. Opportunities to Cure Defaults. Your memorandum notes that in the "Event of Default," as defined in the Note, there is no distinction between a non-material and a material breach of the Communications Act of the orders and regulations of the Commission, or a non- material or material violation of a covenant or term of the Note or Security Agreement. You claim that any infraction, no matter how immaterial, technically accelerates payment in full and that there is no "cure period" for any non-monetary defaults. We believe that your fears are exaggerated. First, it should be noted that the documents do not provide that any violation of the Communications Act is a "default" under the Note. Rather the Note states that a default occurs if the licensee fails to comply with a condition for holding the license. There are many violations of the Communications Act for which the penalties are less than license forfeiture. The purpose of the non-monetary default provision is to permit the Commission to declare a default on the note if it determines that the license should be forfeited for failure to comply with a condition of the license. Of course, before such a conclusion could be reached by the Commission, the licensee would have the full panoply of administrative procedural rights afforded to any Commission licensee. See, e.g., 47 U.S.C.  312(b)-(e) (license revocation procedures), 5 U.S.C.  558(c)(1) (notice), (2) (opportunity to demonstrate or achieve compliance) and  706(2) (administrative actions that are arbitrary, capricious, an abuse of discretion or otherwise not in accordance with law are subject to reversal by court). Therefore, unless otherwise specified in the Commission's rules or orders, the Note and Security Agreement do not take away these regulatory safeguards and procedures or the opportunity to cure defaults created by established commercial practices as embodied in the Uniform Commercial Code (UCC) or other bodies of law. See, e.g., First Interstate Bank of Idaho v. Small Business Administration, 868 F.2d 340 (9th Cir. 1989) (question of whether action was a substantial breach is determined under general federal law; the test of materiality for a federal contract is an all-the-circumstances test), citing, inter alia, Restatement (Second) of Contracts  241. A non-monetary default involving a violation of the Communications Act, the Commission's rules or the license conditions would thus be triggered only after Commission action in this regard becomes final and the default remains unremedied. Risk of Loss of License. Your memorandum states that the use of the phrase, the "license will automatically cancel pursuant to 47 C.F.R.  1.2110" in Section 8(a) of the Security Agreement will cause commercial lenders serious concern and create an obstacle for the licensee when attempting to obtain financing. However, as in the language quoted above and as pointed out in your memorandum, the Commission has repeatedly provided that license cancellation for non-payment of installment payments occurs only after conclusion of the regulatory process set forth in the Note and Section 1.2110(e) of the Commission's rules. Section 8(a) of the Security Agreement in no way changes this process. Reauction of License. Your memorandum interprets Sections 8(d) and 8(e) of the Security Agreement to allow the Commission to "concurrently" deny the debtor any right or interest in the proceeds of any reauction of the license by the Commission and continue to collect from the debtor the amount of the Note. You state that this "power to collect the Note twice would probably not be enforceable" and would conflict with the Uniform Commercial Code (UCC). It appears that you may be misinterpreting the scope of the Commission's remedies under the Security Agreement and applicable law. First, Section 8(e) of the Security Agreement concerns only the debtor's liability for "costs of collection and reasonable attorneys' fees and expenses incurred or paid by the Commission in enforcing [the Security Agreement.]" While Section 8(c) of the Security agreement allows the Commission to "demand, sue for, and collect the outstanding balance of the unpaid Obligations [under the Note]," the preamble to Section 8 states that such remedies are cumulative "to the extent permitted by applicable law" and may be enforceable alternatively. If certain remedies are not enforceable or not otherwise permitted by applicable law, the Commission, of course, will not pursue them. Moreover, we also note that the Commission's rules state that upon default, the Commission will cancel the license and initiate debt collection procedures. Under the Debt Collection Act, as amended, 31 U.S.C. Chapter 37, and Federal Claims Collection Standards, 4 C.F.R. Parts 101-105, it is our understanding that, where there is collateral in goods or other tangible property, the proceeds from the liquidation of collateral would be applied to debts (and other costs) due. See 4 C.F.R.  102.10. In the case of FCC licenses that are cancelled and reauctioned, however, there is no liquidation of the collateral by the FCC and no proceeds from the resale of the defaulted license because the license is canceled and, in effect, disappears. The Commission would be simply auctioning another initial license to use the same spectrum to another entity, not transferring the original license. Nevertheless, although there would be no liquidation of the collateral for purposes of the Debt Collection Act and Federal Claims Collection Standards, the equity principles established therein should allow the federal government to forgive any outstanding debt so long as it has been made whole (penalties and costs included) in a subsequent auction. Thus, the Commission would not be collecting from the debtor twice, but rather reclaiming the license and ensuring that any remainder due to the federal government on the Note is either collected or recovered in a reauction (if authorized). Second, with regard to the issue of the rights of the debtor, or other creditors, to the excess proceeds (if any) from a reauction following a default, Section 309(j)(8) of the Communications Act provides that all proceeds from the use of competitive bidding shall be deposited in the Treasury of the United States or used to cover certain of the Commission's costs. See 47 U.S.C.  309(j)(8). Therefore, while the proceeds from the liquidation of the collateral through a FCC-conducted reauction would generally be applied to debts due, the Commission is constrained by the terms of the Communications Act with regard to the distribution of excess reauction proceeds to the debtor or other creditors. Applicable Law. In your memorandum, you object to the reference to "federal law" in the Security Agreement. You state that there "is no body of commercial law within the Communications Act, Commission orders and regulations or federal law." You and other representatives of C-Block licensees suggest instead that the rights and obligations of the Commission and licensees arising under the Note and Security Agreement should be governed by state law, particularly the Uniform Commercial Code (UCC) as adopted in the District of Columbia or other states. A review of applicable case law demonstrates that the rights and obligations of the FCC and its licensees arising from the installment payment program are clearly matters of federal common law. See Clearfield Trust Co. v. United States, 318 U.S. 363, 367 (1943) (in absence of an applicable act of Congress fixing rights and duties of the United States on commercial paper which it issues, it is for the federal courts to fashion the governing rule of law according to their own standards); United States v. Kimbell Foods, Inc., 440 U.S. 715, 726 (1979) (priority of liens stemming from federal Small Business Administration and Farmers Home Administration Loans are "questions of the rights of the United States" governed by federal common law). Moreover, the Note and Security Agreement address exclusively federal interests (license installment payments to the U.S. Treasury and the use of federal radio spectrum licenses). See Ivy Broadcasting Co. v. American Tel. & Tel. Co., 391 F.2d 486, 492 (2d Cir. 1968) (emphasizing the need for a uniform federal rule dealing with telecommunications carriers under the jurisdiction of the FCC). In fashioning appropriate federal common law rules, however, we note that the courts will follow the principles of the UCC (or other bodies of law) that are not in conflict with the implementation of specific federal policies; but the court will apply those principles as "federal common law," not as the state law per se. See United States v. Kimbell Foods, Inc., supra (Federal courts would adopt the various state laws on perfection and priority of security interests for SBA and FHA loans). Federal courts will use these principles to create a uniform national rule where uniformity is necessary. West Virginia v. United States, 479 U.S. 305, 308 (1987) (a single nationwide federal rule should be adopted if the incorporation of state law would not give due regard for federal interests, and application of federal common law would not disrupt existing commercial relationships predicated on state law). See Clearfield Trust Co., supra (applying uniform national rule to avoid "making identical transactions subject to the vagaries" of state law); Wissner v. Wissner, 338 U.S. 655 (1950) (application of California community property law would undercut Congressional intent of giving servicemen liberal rights to name beneficiaries in military life insurance policies); American Tel. & Telegraph Co. v. New York City Dep't of Human Resources, 736 F. Supp. 496 (S.D.N.Y. 1990) (in suit for payment of long distance telephone charges under FCC tariffs and the Communications Act, the carrier was not required to comply with state law requiring pre-litigation notice to City). Thus, it is likely that a federal court would apply the basic principles of Article 9 of the UCC in interpreting the Note and Security Agreement, modifying state law principles as necessary to produce a uniform national result consistent with Congressional intent and FCC policies set forth in the Communications Act and applicable FCC rules and orders. In areas where the application of the law of individual states would not conflict with federal policies, the courts may well adopt aspects of state law, and decline to impose a uniform national standard. For example, where the licensee is a limited partnership formed under the law of a state that insulates limited partners from liability of the partnership, the federal common law will likely adopt state law as the federal rule determining the liability of the limited partners for a default on the license payments. See Redwing Carriers, Inc. v. Saraland Apartments, Ltd., 94 F.3d 1489 (8th Cir. 1996) (looking to state law to determine liability of limited partners as "owners" for purposes of CERCLA litigation). Interest Rate. Your memorandum and an earlier letter submitted by counsel for Omnipoint PCS Entrepreneurs, Inc. question whether the interest rate on the first round of C- Block Notes (7 percent) was properly computed under Section 24.711(b) of the Commission's Rules. The interest rate of 7 percent for the C-Block licenses conditionally granted to eligible small businesses on September 17, 1996, is correct. Section 24.711(b)(3) of the Commission's rules state that, for small businesses, "interest shall be imposed based on the rate for ten-year U.S. Treasury obligations applicable on the date the license is granted." See also Fifth Report and Order in PP Docket 93-253, 9 FCC Rcd 5532, 5593  138-40 (1994), on recon., 10 FCC Rcd 403, 459  102 (1995); Sixth Report and Order in PP Docket 93-253, 11 FCC Rcd 136, 158  40 (1995). While Omnipoint has argued that the interest rate should be based on the yield for notes auctioned by the Treasury in August 1996, the Commission's rules state clearly that the interest for installment payments will be based on the rate for such notes applicable on the date that the license is granted. Given that the current rate on Treasury obligations is established at the time of each Treasury auction, the Commission, in consultation with the U.S. Treasury Department's Bureau of the Public Debt, determined that the applicable Treasury auction occurred on August 7, 1996, and the rate was 7 percent. Accordingly, this rate was applied to C-Block licenses conditionally granted on September 17, 1996. We conclude that the rate was properly computed. Clarifications to Terms and Conditions. Finally, your memorandum indicates that some terms in the Note and Security Agreement are not drafted clearly or the application of some terms need to be clarified, especially due to the Commission's role as both creditor and regulator. We appreciate you pointing out areas where revisions would make the terms more clear. However, at this time, we see no need to make further revisions and clarifications. Conclusion. We hope that this information is helpful to your clients and their lenders in understanding the terms and conditions under which the Commission is offering installment financing to C-Block licensees. For the benefit of other C-Block licensees, we are releasing this letter to the public. For further information, please contact Peter Tenhula or Stewart Block in the Office of General Counsel at 202-418-1700, D'wana Speight in the Wireless Telecommunications Bureau at 202-418-0600, or Jerome Fowlkes in the Auctions Division, Wireless Telecommunications Bureau, at 202-418-0660. Sincerely, William E. Kennard General Counsel Michele C. Farquhar Chief, Wireless Telecommunications Bureau cc: Mark J. Tauber, Esq.