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from: Kreucher Law

The FCC’s Competitive Franchising Order: 109 Pages of Posterior Protection

It seems unusual to most in local government that a federal agency can take a vote on a document before that document is even made public . . . but that’s what the FCC did on December 20, 2006, when it adopted its Competitive Franchising Order on a 3-2 vote. The Commission finally released the Order yesterday . . . for those who are counting, that’s seventy-five days later. The Report and Order and Further Notice of Proposed Rulemaking, all 109 pages of it, can be downloaded here.

Of course, it will take some time for the impact of the Order to be fully understood. Even so, battle lines have been drawn. One organization

which represents local government officials, the National Association of Telecommunications Officers and Advisors (”NATOA“), announced several weeks ago that it had already retained counsel and that it anticipated litigation as soon as the Order was released. The National League of Cities has also proclaimed that reversing the Order is one of its top legislative goals for the year. Of course, the telephone companies immediately praised the ruling – even though it’s clear that they didn’t get a fair amount of what they wanted. The cable industry hasn’t released official comments, but they may come in the next several days.

The FCC was well aware that it was picking up a hornets’ nest on this issue. Not only has it come under attack from local governments, but it has also been subjected to a significant amount of oversight by Capitol Hill in recent weeks. As a consequence, it appears that the Commission’s Republican majority used the intervening 75 days between vote and publication wisely. A significant portion of the 109 page Order is devoted to covering the Commission’s posterior: Much is made of the Commission’s legal authority to enter the Order, for example, and other portions of the Order seem watered down, as they provide no more clarity on the issues than was already available from reading the Cable Act and relevant FCC orders.

The Order deals with six issues: 1) deadlines by which local franchising authorities (”LFAs”) must issue competitive video franchises; 2) “build-out” requirements, i.e., having a competitive provider serve a larger portion of a community than the provider prefers; 3) franchise fees, and the types of “incidental” costs that count against the 5% franchise fee cap; 4) PEG fees and I-Nets, and what would be deemed unreasonable as to new competitors; 5) demands for non-cable services and facilities; and 6) “Level Playing Field” provisions. Keep in mind that we’re all in the early stages of analysis – at this point, however, the first issue appears to be the most substantive by far. A brief review of each matter is provided below:

§ DEADLINES FOR ISSUANCE OF COMPETITIVE FRANCHISES

As expected, the Order sets a “shot clock” for responding to applications from competitive video providers. The clock is started when a provider submits a request for a franchise that contains the information identified by the Commission, i.e.: 1) the applicant’s name; 2) the name of the applicant’s officers and directors; 3) the business address of the applicant; 4) a contact’s name and contact information; 5) a description of the area that the applicant proposes to serve; 6) PEG channel capacity and capital support proposed; 7) the term of the agreement proposed; viii) whether an existing authorization to access the rights-of-way is held by the applicant; 9) the amount of franchise fees the applicant is offering to pay; and 10) any additional information required by applicable state or local laws.

Once that information is filed and clock begins to tick, an LFAs has either i) 90 days to negotiate, and to approve or deny a franchise request in the case of a provider that already has access to rights-of-way, or ii) 180 days where no access authority already exists. The time may be tolled if an LFA is waiting for a response to an information request or extended by mutual agreement of the parties, but it seems that there would be little incentive for the provider to do the latter, absent a legitimate threat that its franchise request will otherwise be denied – that’s because the FCC’s Order purports to grant the applicant interim operating authority once the applicable deadline passes.

According to the Commission, “[t]he record is replete with examples of unreasonable delays in the franchising process,” and “90 days provides LFAs ample time to review and negotiate a franchise agreement with applicants that have access to the rights-of-way.” If the deadline passes and interim operating authority is deemed granted, the FCC expects that the parties will continue their negotiation. According to the Commission, “LFAs will want to ensure that their constituents continue to receive the benefits of competition and cable providers will want to protect the investments they have made in deploying their systems.”

On this front, the majority’s reasoning is particularly shallow and naïve. As pointed out in the white paper published by the International City/County Management Association, the foundational concept of the franchising process is negotiation. The Cable Act created a fine balance between the interests of local governments and the interests of large video providers, and that balance provides an opportunity to engage in meaningful negotiations so that each party can protect their respective interests and drive the best bargain possible. The Commission’s Order changes the relative bargaining power of the parties as established by the Cable Act. Under the FCC’s Order, for example, there is virtually no incentive for a video provider to even make itself available for negotiations during the first 90 days – the provider can simply wait out the clock and get the operating authority it wants. Alternatively, the video provider can engage in some window dressing by appearing at the negotiation table, but then become intransigent about every term it seeks. The Commission blew it here – a negotiation requires two parties, and when one has no incentive to engage, no negotiation will occur. Without meaningful negotiation, it’s likely that local governments will be forced by the FCC’s rules to use the 90 days to build cases for denying applications.

§ BUILD OUT REQUIREMENTS

The 90 day/180 day shot clock had been leaked too broadly for the Commission to back away. Its lack of decisiveness on the remaining issues, however, may well have resulted from the pressure that had been applied by other interested parties over the last several weeks.

On the build out issue, for example, the Commission found that an LFA’s action would amount to an “unreasonable refusal to award a competitive franchise” if that LFA required “unreasonable build-out mandates.” A bit circular, you say? Well, the Commission provided some additional direction – but not much.

What does the FCC define as “unreasonable” in this area? Actions that most every LFA would have the good sense to avoid: 1) an LFA shouldn’t require a competitive provider to serve everyone before it serves anyone; 2) phone companies shouldn’t be required to build beyond the footprint of their current facilities before they have provided service to anyone; 3) a competitor should be given the same amount of time to build a system that the incumbent was given; and 4) a competitor shouldn’t be required to serve an area of lower density (i.e., homes per mile) than the incumbent is required to serve. Three out of these four seem pretty straightforward. The outlier is the third, which involves the time to build. Here, the Commission missed it again: If facility-based providers are simply upgrading their facilities, as the majority asserts, there would be no reason to provide the same period of time to build as a provider starting from scratch would have required.

Notably, the Commission didn’t go nearly as far on this issue as the telephone companies would have preferred. Ideally, the telcos don’t want any obligation to ever build outside their “wire center” boundaries. While the Order suggests that the wire center would be an appropriate place to start video service, it also provides other “safe harbors” that could be used to require the telcos to extend service beyond the initial wire center area. According to the Commission: “it would seem reasonable for an LFA in establishing build-out requirements to consider the new entrant’s market penetration. It would also seem reasonable for an LFA to consider benchmarks requiring the new entrant to increase its build-out after a reasonable period of time had passed after initiating service and taking into account its market success.”

§ INCIDENTAL COSTS AND FRANCHISE FEES

The Order’s substantive guidance slips even further with respect to the franchise fee issue. No definition of “gross revenues” is offered by the Order, and the FCC instead relies heavily on the holdings of case law. The Commission repeated the provision in the Cable Act which defines “payments for bonds, security funds, letters of credit, insurance, indemnification, penalties, or liquidated damages” as “incidental” to the award of a franchise and, consequently, that such fees that are not included when calculating the 5% franchise fee cap. The Commission also reiterated, at some length, that attorney fees incurred by a local government in awarding a franchise were not “incidental” to the award, i.e., that the community would either have to bear such costs out-of-pocket or that such expenses would be counted against the 5% franchise fee cap. “For further guidance,” the FCC counsels, “LFAs and video service providers may look to judicial cases to determine other costs that should be considered “incidental.’” Finally, the Commission noted that “any requests that are unrelated to the provision of cable services by a new competitive entrant are subject to the statutory 5 percent franchise fee cap.” So park benches, wildflower plantings and the like will be considered part of the franchise fee in the very unlikely event that such grants are actually sought by any LFA.

No great surprises here – and no real help with respect to the length of time claimed by the Commission to be associated with the negotiation of a “gross revenues” definition.

§ PEG CAPITAL AND I-NETS

Some speculators had believed that the FCC’s Order would find that any funds required for PEG or I-Nets would be counted against the 5% franchise fee cap. I felt otherwise – and like with the franchise fee issue, there is little in the Order related to PEG support and I-Nets that changes the existing landscape. The Commission cautions that, while “adequate” PEG support may be sought by communities, “adequate” means “satisfactory or sufficient,” not “significant.” To clarify this distinction, the FCC notes that it would be “unreasonable for an LFA to impose on a new entrant more burdensome PEG carriage obligations than it has imposed upon the incumbent cable operator.” It also believes that “completely duplicative PEG . . . requirements imposed by LFAs would be unreasonable.” Finally, the Commission reiterated the Cable Act’s direction with respect to capital costs associated with PEG: Grants for bricks and mortar are OK and do not count against the franchise fee cap, while grants for salaries or other operational costs do. Here, too, the FCC offers a safe harbor, but in this case one apparently intended for the provider rather than for the LFA: “We also agree that a pro rata cost sharing approach is one reasonable means of meeting the statutory requirement of the provision of adequate PEG facilities. To the extent that a new entrant agrees to share pro rata costs with the incumbent cable operator, such an arrangement is per se reasonable.” Put differently, it appears that the Commission may believe that it would be unreasonable for an LFA to reject an application on the basis of the PEG support offered if the applicant agrees to assume a pro rata share of the incumbent’s existing PEG grants. Left uncertain is how such share would be calculated and distributed in practice.

One of the few potential accommodations offered to LFAs in the Order comes in the area of I-Nets. While the FCC noted that the complete duplication of PEG support would be unreasonable, it qualified that finding with respect to I-Nets; in that case, “[s]uch duplication generally would be inefficient and would provide minimal additional benefits to the public, unless it was required to address an LFA’s particular concern regarding redundancy needed for, for example, public safety.” Additionally, the FCC clarified that “an I-Net requirement is not duplicative if it would provide additional capability or functionality, beyond that provided by existing I-Net facilities. We note, however, that we would expect an LFA to consider whether a competitive franchisee can provide such additional functionality by providing financial support or actual equipment to supplement existing I-Net facilities, rather than by constructing new I-Net facilities.”

§ NON-CABLE SERVICES AND FACILITIES

While the FCC broke this out as a separate category for treatment, the issue plays out in the Commission’s discussion of franchise fees: Non cable-related grants or in-kind services required by a franchise are to be counted against the 5% franchise fee cap.

§ LEVEL PLAYING FIELD PROVISIONS

According to the Commission, cable incumbents use “level playing field” provisions secured during renewal negotiations to keep competitors out of their markets. Consequently, the Commission asserts that level-playing-field mandates “which impose terms and conditions identical to those in the incumbent cable operator’s franchise” would appear to be unreasonable. However, the FCC also sought additional comments in their concurrently-published Further Notice of Proposed Rulemaking. According to the Commission, they’d like to learn more about “what effect, if any, the findings in this Order have on most favored nation clauses that may be included in existing franchises.”

CONLCUSION

It’s only been a few hours since the Commission published its Order – an Order that took months to write and another 75 days to massage – so it will be a while before the new guidance can be fully digested. That’s assuming, of course, that there’s a need. Any lawsuit would likely seek to suspend the operation of the rules during the pendency of the action.

For the moment, however, the greatest harm to the interests of local governments is found in the “shot clock” requirement of the Order. While it’s just one aspect of the ruling, it does massive damage to the long-established process of franchise negotiations because it upsets the delicate balance of negotiating power previously distributed between video providers and local governments. Under the terms of the Order, there is next to no incentive for a video provider to actively negotiate a video franchise: Instead, providers can simply sit at the table and demand only those terms that they find acceptable. As a consequence, we’ll probably see some spike in the number of franchise denials (or threatened denials) and, possibly, the need to negotiate — not after interim operating authority is deemed granted, but, instead, while a lawsuit is pending. This won’t create certainty. Instead, as Commissioner Adelstein put it, the Order “will solve nothing, create much confusion, and provide little certainty or progress on our shared goal of promoting real video competition and universal broadband deployment.” Put differently, any incremental advancement in broadband deployment will result from market forces that existed before the Order was ever issued – not as a result of the Order itself.