Telecommunications Bankruptcies: What Carriers and Customers Should Know
 
October 21, 2002
 
Eric Fishman - New York
Richard E. Lear- Washington

The financial crisis of the telecommunications industry has forced many service providers into bankruptcy, and driven surviving carriers and customers in search of strategies to protect their interests.  While such a task would be daunting in any industry, it is especially formidable in the telecommunications sector, where service providers are heavily regulated, interconnection and other service agreements among carriers are quite common, and conflicting principles of bankruptcy and telecommunications law must be resolved.  What follows is a brief  overview of some of the key issues creditor carriers and customers should consider.

Bankruptcy Law

Automatic Stay.  One of the most important bankruptcy protections is the automatic stay imposed by 11 U.S.C. § 362(a).  Applicable to all entities, it stays most actions, including commencement or continuation of all judicial or administrative proceedings against the debtor that were or could have been commenced prior to the filing of the bankruptcy petition, or any other action to recover a claim against the debtor that arose prior to the filing of the bankruptcy petition; any act to obtain possession of property of the estate or to exercise control over the property of the estate; and any act to collect, assess or recover a claim against the debtor that arose before the commencement of the case.  In general, the automatic stay operates in favor of debtors and remains in effect until a case is closed.  As a result of the automatic stay, parties are bound by their contracts with bankrupt carriers, unless the Bankruptcy Court allows the stay to be terminated or modified (see below).

Exceptions to and Terminations of Automatic Stays.  Section 362(b) of the Bankruptcy Code carves out several exceptions to the automatic stay.  Of these, the most relevant to telecommunications carriers and customers is the so-called "regulatory exemption" which applies to "the commencement or continuation of an action or proceeding by a governmental unit . . . to enforce such governmental unit’s … police and regulatory power, including the enforcement of a judgment other than a money judgment, obtained in an action or proceeding by the governmental unit to enforce such governmental unit’s … police or regulatory power."  Bell Atlantic-Delaware, Inc. v. MCI, FCC 02-223, released August 14, 2002. 

Although the FCC is plainly a "governmental unit" for Section 362(b) purposes, the extent to which this provision applies to FCC regulatory proceedings is currently at issue in a case before the U.S. Supreme Court, NextWave Personal Communications, Inc. v. FCC, 254 F.3d 130 (D.C. Cir. 2001).

A party can seek to obtain relief from the automatic stay for cause by filing a motion for relief with the Bankruptcy Court.  11 U.S.C. § 362(d).  Motions for relief from the stay are required to be heard on an expedited basis.  11 U.S.C. § 362(e).

Executory Contracts.   A debtor in possession may elect, with bankruptcy court approval, to either assume or reject an unexpired lease or executory contract.  11 U.S.C. § 365.  Although not defined in the Bankruptcy Code, most courts define an executory contract as an agreement in which material performance remains to be performed on both sides.  A debtor in possession may defer its decision on whether to assume or reject an executory contract through the course of the bankruptcy case, although this period may be shortened by the court.

Although the power to assume or reject an executory contract lies wholly with the debtor, the proper designation of certain types of telecommunications agreements, such as IRU contracts, is not always clear-cut.  Any dispute between parties over whether a particular agreement is an executory contract must be resolved by the court. 

Also, the Bankruptcy Code requires the debtor to assume or reject a contract in its entirety – it may not "pick and choose" specific contract terms.  This limitation may give non-debtor parties to the contract some leverage in their negotiations with debtors.

Finally, if the debtor in possession elects to assume the contract or lease, it must cure any default or give adequate assurance that the default will be promptly cured, and provide adequate assurance of future performance.  If the debtor in possession elects to reject the contract or lease, such rejection constitutes a breach of the contract or lease.

Utilities.  Under Section 366 of the Bankruptcy Code, a utility may not alter, refuse, or discontinue service to or discriminate against a debtor solely for filing a bankruptcy claim.  The utility, however, may alter, refuse or discontinue service if the debtor, within 20 days of bankruptcy, does not furnish adequate assurance of payment, in the form of a deposit or other security, for service after such date.  On request of a party in interest and after notice and a hearing, the court may order reasonable modification of the amount of the deposit or other security necessary to provide adequate assurance of payment. 

Although not defined in the Bankruptcy Code, the courts have historically applied the term "utility" to providers of wireline telecommunications service, and/or entities that supply services that cannot be readily obtained or replaced elsewhere.  A telecommunications provider, however, may wish to challenge its designation as a utility for Section 366 purposes, since utilities are required to provide service to bankrupt entities as long as the debtor provides adequate assurance of payment, as determined by the court, even if the debtor's "adequate assurance" showing seems inadequate to the utility.

License Revocation.  Pursuant to Section 525 of the Bankruptcy Code, a governmental unit may not deny, revoke, suspend or refuse to renew a license of a debtor or bankrupt solely because the debtor or bankrupt has sought bankruptcy protection, was insolvent before the commencement of its case or has not paid a debt that is dischargeable.   Although this provision would prohibit the FCC from revoking a debtor's licenses solely because of its bankrupt status, Section 525 would not restrict the Commission's authority to revoke an authorization on other grounds.

Telecommunications Law

Seeking Bankruptcy Protection.  Under Sections 214 and 310 of the Communications Act of 1934, as amended, an assignment or transfer of control of a telecommunications authorization generally requires prior FCC approval.  A limited exception to this rule are bankruptcy court filings, which the FCC views as involuntary assignments (i.e., from the licensee to the trustee or debtor-in-possession).  In such instances, parties must seek agency approval for the involuntary or pro forma assignment within 30 days after the fact.

Post-Bankruptcy Restructuring or Acquisitions.  If a bankruptcy case results in a restructuring or acquisition of a debtor or its assets, such a restructuring or acquisition can only take place after the FCC has approved the subject transaction.  Pursuant to its rules, the FCC will notify the public of the debtor's application for regulatory approval, and afford all interested parties an opportunity to comment.  The Commission has stated that it "will only approve applications that are consistent with the requirements of the Communications Act and our rules."

Slamming.  During a bankruptcy case, a debtor may sell its customer base to another company.  If that occurs, the FCC's rules require the new company to provide customers 30 days' advance notice of the transfer, including information about its rates and services, and entitle customers to accept the new company or choose another company without penalty.  A customer transferred to a new company without receiving notice is entitled to relief under the FCC's slamming rules.

Terminating Service.  Under Section 214 of the Act, a carrier may not discontinue, reduce or impair its provision of telecommunications service without obtaining from the FCC "a certificate that neither the present nor future public convenience and necessity will be adversely affected thereby."  The Commission's implementing rules require carriers to provide written notice of the discontinuance to all affected customers, and require the carrier to incorporate specific wording advising customers of their right to file comments with the Commission against such discontinuance.  In the case of domestic service, carriers may only discontinue service on the 31st day after the issuance of the public notice (61 days for international service), barring notification otherwise from the Commission.  In this context, the FCC has recently stated that the 31-day period "is a minimum period, and the Commission may extend it if consumers would be unable to receive service or a reasonable substitute from another carrier, or if the Commission otherwise finds that the public convenience and necessity is adversely affected by the discontinuance."

Note:  It should be emphasized that the provisions of Section 214 of the Communications Act apply only to carriers of "telecommunications services."  The latter is a term of art under the Act, and does not include so-called "information services" or "enhanced services," such as Internet services and e-mail.  As a result, to the extent an entity provides information services, prior FCC approval for the discontinuance of such services may not be required.

Tariff Changes.  Since the WorldCom bankruptcy, several incumbent local exchange carriers (ILECs) have attempted to modify their tariffs to require security deposits and other protections against financially troubled companies not covered in their existing tariffs.  Such revisions require approval by both the FCC and the Bankruptcy Court (when applicable), and have been opposed by various carrier customers.  To date, the FCC has determined that the objections to these revisions raise substantial questions regarding their lawfulness, has suspended them for five months and has set them for investigation.

Refusing Service to Bankrupt Debtors.  Pursuant to Sections 201 and 202 of the Communications Act, a common carrier must provide service upon reasonable request and non-discriminatory terms and conditions.  As a result, even if a bankrupt debtor rejects an executory contract with a carrier, the carrier may be required to furnish service to the post-petition entity.  In a petition to the FCC filed earlier this year, Winstar Communications, LLC (IDT Winstar), the successor in interest to Winstar Wireless, Inc. (Old Winstar) has claimed that various ILECs have threatened that if IDT Winstar refuses to assume the debts of Old Winstar under pre-existing interconnection agreements, the ILECs will disconnect the circuits and other facilities of customers wishing to use IDT Winstar as their carrier going forward. 

The ILECs have rejected these assertions and filed a counter-petition for declaratory ruling that: (a) the Communications Act does not except carriers from the rights afforded by Section 365 of the Bankruptcy Code; (b) where one Competitive Local Exchange Carrier (CLEC) wishes to take over another's service arrangement with nothing more than a name change, that constitutes an "assignment or transfer" within the meaning of the ILEC tariffs, so that the assignee/transferee CLEC must assume the outstanding indebtedness of the prior CLEC for such services; and (3) to clarify the circumstances under which carriers in bankruptcy are obligated to provide notice of possible discontinuance or transfer to their customers.

State Requirements.  Under the federal scheme, state public service commissions have jurisdiction over intrastate telecommunications service.  State laws typically contain provisions that parallel the above federal principles, and should be carefully considered.

Summary

In order to protect their interests, parties doing business with bankrupt carriers are well-advised to monitor the activities of these debtors in both Bankruptcy Court and the FCC, and to participate in such proceedings as appropriate.  On a going-forward basis, parties also should consider the possibility of bankruptcy when negotiating agreements with telecommunications service providers.  With the uncertainty in the current environment, such a two-pronged strategy is essential.

For more information, contact Eric Fishman or Richard Lear, toll free, at 888-688-8500.