homas Gutierrez, David LaFuria
Could it be that the C-block auction is too successful? After overcoming numerous pre-auction challenges, both from the industry and the Supreme Court, a new and potentially disruptive problem within the auction grows each day. The C-block auction for personal communications services licenses, at what appears to be its mid-point, is raising more money than most industry experts predicted would be pledged in total. The potential that C-block auction winners will have paid such huge sums as to preclude their ability to operate profitable business ventures is very real. Here we provide thoughts on three possible actions the Federal Communications Commission can take to minimize the likelihood that winners will become losers.
Prices are outlandish
Let’s examine a few auction facts: At the close of bidding in round 45 (the last round completed as of the date this article was written), gross bids were in excess of the $11 billion mark and bids “net of bidding credits” were well past $8 billion. Thus, small business entrepreneurs in this auction already have agreed to pay over 50 percent more than what was paid by the truly large entities in the entire A- and B-band auctions to obtain only one-half of the spectrum that was available in the A- and B-band auctions-and there may be as many as 50 more rounds to go! These considerable extra costs must either be passed on or absorbed. In what promises to be a very competitive wireless market, either may be difficult to do.
Virtually all entrepreneurial applicants qualified as being small businesses. Thus, they received the maximum bidding credit of 25 percent and six years interest-only financing terms. C-block auction prices have inflated accordingly as bidders properly considered bidding credits and installment payments in determining the amount of “real” dollars that would be bid. Clearly, such considerations are major factors contributing to the skyrocketing prices in this auction. Whereas one can easily conclude that while the benefits bestowed upon C-block applicants have served their purpose of providing an opportunity to compete for spectrum, it appears clear that they have done so without providing the kind of special economic benefits that should cause the FCC to create or maintain artificial barriers in order to guard against unjust enrichment.
The potential problem confronting the industry and the FCC is straightforward. How can PCS C-band licensees pay the huge C-band auction prices and effectively survive against embedded cellular licensees, many of whom paid nothing for their spectrum; PCS A- and B-block winners, who by and large paid far less for their spectrum and obtained larger geographic coverage; and the multitude of other communications entities seeking financing as Congress commands the FCC to auction more and more spectrum to permit additional programs to fit within the budget?
Financing is the key
If C-block licensees are to compete with other wireless carriers, in the long run and in any meaningful way, the FCC must re-examine its applicable rules and policies with the benefit of having in hand the auction results. In doing so, the FCC should take further steps to address again the pivotal issue of small business financing-the very issue that the FCC repeatedly has recognized as being the primary impediment to small business success. It also should appreciate that the extremely high level of prices has removed any previously existing valid concern that C-band licensees may somehow profit inappropriately as a result of receiving “special” economic benefits from the auction process.
One important step that the FCC can and should take is to permit lenders to take a security interest directly in an authorization. This is by no means a novel idea. Four years ago, the FCC invited comment regarding creditors being permitted to hold security interests in broadcast station authorizations generally, but never acted formally to permit such interests. Statements made by the FCC in 1992 concerning the virtues of permitting liens to be held against authorizations appear to be more true now than they were then. For example, the FCC appears to be still committed to “reducing unnecessary constraints on investment;” it no doubt still appreciates that “the availability of capital has recently become a matter of increasing concern to the industry;” and the FCC would likely not take issue with the fact that small businesses “including, in particular, minorities and women, have experienced [difficulties] in obtaining adequate financing.” In view of the fact that these core problems have remained unsolved over the last four years, and as the wireless industry approaches a critical developmental stage, now is the time for the FCC to act on this proposal.
By permitting cellular licensees to sell bare construction authorizations in other proceedings, and by openly auctioning spectrum, Congress and the FCC have obviously recognized spectrum’s inherent economic value and stepped far away from the archaic proposition that such value cannot be placed on a government license. Why not extend that recognition one small but significant step further so as to encourage investment in these new industries?
Permitting primary debt holders (and possibly even some forms of equity investors) to obtain a security interest in authorizations is a necessary step toward encouraging them to place a considerable investment in C-block licensees. Without this change in the rules, C-block licensees (as well as other FCC licensees) are at a considerable artificial disadvantage vis-a-vis the multitude of other businesses that routinely seek financing and are able to obtain a security interest in all of a borrower’s assets. In the case of C-band licensees, who are already at a disadvantage vis-a-vis cellular and A- and B-band competitors due to headstart and the stark differences in market size, the security interest disadvantage could well be the straw that breaks the proverbial camel’s back. It is particularly important to permit creditors to have a lien on licenses because, if the license is lost, the value of having a lien on all other related assets is reduced considerably.
Admittedly, the issue of liens on authorizations has become more complex with the advent of auctions, now that the FCC has assumed the role of creditor. These complications are outweighed by the potential costs of not acting. Moreover, the mere question of where one creditor (i.e., private financial institutions) stands vis-a-vis another creditor (the FCC) certainly presents no insurmountable obstacle. One solution may lie in the FCC permitting only primary lenders providing direct system investment in equipment and operating capital to obtain a security interest in FCC authorizations. While in theory the FCC would be moving from a first secured position to a second position, there are important counter balancing considerations that may cause there to be a considerable increase in the protection this move would provide to the FCC.
Since creditors contribute genuine value to a licensee’s business, which value most often exceeds the creditor’s investment, there should be more, rather than less, remaining value available to the FCC in the event of a payment default. As we move further from an era of spectrum shortage to one of spectrum abundance, the FCC could well find itself, even if technically in the role of a first position creditor, foreclosing on an authorization that is held by a corporation with no other assets and has a value considerably less than that of the outstanding balance of payments due. Whether the FCC ultimately resells the authorization at a subsequent auction or permits its transfer in bankruptcy, all other creditors will likely suffer far worse than the government-which loses pledged money, not out-of-pocket investment dollars.
Assuming this to be the case, the FCC’s position would likely be improved if it were to permit the above-mentioned creditors to take a first lien, provided th
at the type of security arrangements involved include certain routine provisions that would safeguard against transferring assets and would otherwise act to preserve unlicensed assets and cause them to subject to FCC retrieval rights. Creditors already are required to provide the FCC with 10 days notice before taking control of an authorization, and security agreements routinely reflect this requirement. Certainly the FCC could craft requirements to meet its needs in this regard.
There is yet another, perhaps more important reason for the FCC to permit security interests in authorizations: The government’s obligation to its citizens, especially those small entrepreneurs who risk far more than their truly gigantic counterparts, compels it to take every possible legal and proper measure to make viable those businesses born and cultivated by the auction process. Recouping monies due and owing is appropriate, but because service to the public would be disrupted if a company defaults on an installment payment is sufficient reason to implement rules that will minimize such a possibility. It is fortunate in this case that the rule changes needed to implement security interests in authorizations are deregulatory and consistent with Congress and the FCC’s often-stated goals of stimulating growth and competition in the communications industry. Additionally, although the rule would apply across the board, its practical effect would be to advantage small business, which truly need to offer lenders full security in order to obtain critical financing.
Relax transfer rules
The FCC’s bidding credits and the installment payment benefits have not conveyed the type of special economic benefit initially contemplated by the rules, as evidenced by the C-block prices. Thus, there is no need for the FCC to strictly enforce rules designed to safeguard against recipients of any special benefits becoming unjustly enriched by virtue of licensee transfers during the first license term. Rather, the FCC should relax, without eliminating, existing restrictions on transfers of C-block licenses, and should recognize this as being a necessary step to permit investment to flow into small business entities.
An investor’s willingness to invest will be limited wherever its ability to protect such investment is restricted by artificial regulation. To illustrate: without question, the terms, and indeed even the willingness to consider investment, will differ vastly depending on whether a potential investor that does not itself qualify for small business status will be able to take control of an entity in the event that such control is necessary in order to protect its investment. Absent such relief, an investor that could help a struggling licensee, by increasing its investment, could be prohibited from doing so out of concern such increased investment would violate applicable rules.
Proposals to consider
Upon completing the C-block auction, the FCC should openly consider rule changes which would permit investors to be protected and business to flourish. The following are examples only:
Some relief from the strict prohibition on transfers during the first three years should be afforded. Licensees should be permitted to make a showing, including financial data, of financial hardship warranting a transfer to one of its investors or creditors.
The requirement that the bidding credit be subject to unjust enrichment penalties should be removed, effective at the close of the initial three-year period.
Investors should be able to obtain options to acquire more than a 25 percent attributable interest in the licensee company after three years of operation in connection with making significant equity investments. Not an easy task.
Some will undoubtedly agree that all remains fine in the C-block auction-but the facts (prices) belie such a notion. Others have publicly threatened litigation if the FCC changes any of its rules-but they overlook the fact that the FCC can and must be flexible as it learns from what is still a very new process. In any event, Congress commanded the FCC to make real, and not illusory, opportunity available to small business and the prospects for any chance at success may well vanish unless the FCC acts quickly. Also, a proactive approach may well save the FCC from being limited to a reactive role later on.
It will be up to the FCC and industry in the post-auction environment to strike the appropriate balance between growing the industry and maintaining the integrity of the auction process. While the FCC cannot abandon its rules, neither can it abandon its licensees through an unyielding application of its rules. Although the issues raised herein may not be ripe for FCC action, clearly the time has come to begin the process of confronting the post-auction landscape.
Thomas Gutierrez is a partner in the law firm of Lukas, McGowan, Nace & Gutierrez, Chartered, in Washington, D.C. He has been practicing law in the mobile communications industry for 16 years, specializing in cellular, PCS and nationwide paging.
David LaFuria also is a partner in the same law firm. He has practiced communications law for more than 10 years, specializing in cellular, PCS and emerging wireless technologies.
