Preventing a Haven for Wrongdoers

FCC Enforcement Proceedings Will Not Be Stayed

Telecommunications companies that are considering filing for bankruptcy protection, and users of telecom services, should be aware of the important ramifications of the Code's government exception to the automatic stay provision. For example, the automatic stay is generally inapplicable to FCC enforcement and complaint proceedings.

In interpreting Section 362(b)(4), federal courts have held that when administrative agencies act to enforce the law, they are vindicating the public interest, and the Code's automatic stay provision does not apply. See e.g., EEOC v. Rath Packing Co., 787 F.2d 318, 325 (8th Cir. 1986). Hence, the FCC may investigate a telecom company's alleged misconduct and impose penalties on that company for violation of the Communications Act or the FCC's rules, regardless of whether the company has filed for bankruptcy protection.

Pecuniary vs. Public Policy: Which Proceedings May Be Stayed?

In spite of the wide scope of the government exemption to the automatic stay, not all administrative actions are so exempted. For example, regulatory actions that directly conflict with the debtor's res or property may be stayed. In re First Alliance Mortgage Co., 263 B.R. 99, 107 (9th Cir. BAP 2001). Federal courts have applied two tests to determine whether a government's actions fall within the scope of Section 362(b)(4) and are exempted from the automatic stay. The first is the 'pecuniary purpose' test; the second is the 'public policy' test. Id.

Under the pecuniary purpose test, if a court determines that the government action is being pursued solely to advance a pecuniary interest of a governmental entity, it will impose the automatic stay. Id. Under the public policy test, the court will not impose the automatic stay if the government action is an attempt to prevent future violations of the law; but it will stay proceedings that concern only the parties who are immediately affected by the proceeding. Id. at 108.

Accordingly, administrativeenforcement proceedings against bankrupt companies that are intended to correct illegalities and to protect the public interest will be exempted from the automatic stay, regardless of whether those proceedings are brought by the agency itself or are commenced in response to individual complaints. For instance, the FCC has responded to customer complaints of illegal 'slamming' by imposing substantial fines on bankrupt telephone companies that have engaged in the unauthorized changing of customers' preferred carriers. See e.g., Coleman Enterprises, Inc., 15 FCC Rcd 24385, ' 11, n. 28 (2000).

The NextWave Imbroglio: The FCC As 'Creditor'

If a court determines that a regulatory agency is acting as a 'creditor' to a bankrupt company, it may impose the automatic stay. This is illustrated by the decision of the U.S. Court of Appeals for the D.C. Circuit, NextWave Personal Communications, Inc. v. FCC, 254 F.3d 130 (D.C. Cir. 2001), cert granted March 4, 2002. (For details on the case, see 'NextWave Ruling Spells Victory and Defeat,' by Robert P. Simons, The Bankruptcy Strategist, February 2003.) The NextWave proceeding, which was decided by the D.C. Circuit after a convoluted trek through the bankruptcy court and the U.S. Court of Appeals for the Second Circuit, concerned the legal ramifications of the FCC's canceling a company's licenses that it won at auction because the company had failed to make its required installment payments after it filed for bankruptcy. The D.C. Circuit stated that because the FCC had perfected security interests in the company's licenses, its canceling those licenses was tantamount to foreclosing on collateral; ie, it was enforcing a lien against the company's property and was thus acting as a government creditor. Id. at 151.The court held that the FCC's cancellation of the bankrupt company's licenses was in violation of the Code's automatic stay. Id.

The D.C. Circuit's holding appears to have reversed the Second Circuit, which held that the FCC's canceling the company's licenses was regulatory because it involved the Commission's exclusive power to dictate the terms of licensure and Code section 362(b)(4) exempted it from the automatic stay. FCC v. Next Wave Personal Communication, Inc, 217 F.3d 125, 136-37 (2d Cir. 2000). The D.C. Circuit suggested, however, that it was not disagreeing with the Second Circuit, because the Second Circuit did not decide the issue of whether the regulatory exemption trumps the automatic stay when the regulator (the FCC) is also a creditor. 254 F.3d at 148-49.

The FCC appealed the D.C. Circuit's NextWave decision to the U.S. Supreme Court, which affirmed the D.C. Circuit's holding. In FCC v. NextWave Personal Communications, Inc., 000 U.S. 01-653 (Slip Op.) (2003), the Supreme Court rejected the FCC's argument that it had a right to cancel the company's licenses because of a valid regulatory motive. The Court stated that because the company's failure to pay a debt was the sole cause of the license cancellation, bankruptcy law protected the company from the FCC's action. Id. at 7. The Court further declared that the FCC's regulatory motive was 'irrelevant.' Id.

FCC Regulations' Impact on the Bankruptcy Process

In spite of the Supreme Court's decision on NextWave, most of the FCC's regulatory actions will continue to be exempt from the automatic stay. Accordingly, telecom companies that seek bankruptcy protection should be aware of the ways in which the FCC's 'immunity' to the automatic stay could impact their businesses during the bankruptcy process. For example, the Communications Act and the FCC's rules require telephone companies and other common carriers to obtain authority from the Commission and to provide their customers with 31 days' notice, prior to discontinuing service. See 47 U.S.C. ' 214, 47 C.F.R. ' 63.71. This applies to all types of service discontinuances, including those caused by dissolutions of businesses and bankruptcy. See Internet Commerce and Communications, Inc., 2001 Lexus 5980, 8 (2001). The FCC broadly construes this policy; it has, for example, determined that the sale of any portion of a carrier's customer base is a discontinuance of service, requiring compliance with its authorization and customer notification requirements. Id.

The Commission strictly enforces its discontinuance provisions, regardless of whether a carrier has filed for bankruptcy protection. This enforcement applies even in situations where a bankrupt carrier's customers are automatically transferred to another company pursuant to a bankruptcy court approved agreement, with no interruption in service. Id. Moreover, both the seller and the purchaser may be liable for violations of federal law if either party engages in unauthorized discontinuation of service. Id. at 9.

The FCC also requires that, no later than 30 days prior to a transfer of a carrier's subscriber base, the acquiring carrier must provide the affected subscribers with notice of, and certain information about, the proposed transfer. This information includes: 1) rates, terms and conditions of service provided by the acquiring carrier; 2) the subscriber's right to select a different carrier; and 3) the date upon which the acquiring carrier will commence providing service to the subscriber. See 47 C.F.R. ' 64.1120(e). The acquiring carrier must certify to the Commission that it has complied with that requirement. Id.

Bankruptcy Filing May Not Alleviate FCC Fines

Telecom companies that violate the Act and/or the FCC's rules are subject to monetary forfeitures. See 47 U.S.C. ” 501-504. Those companies will generally not receive a waiver or reduction of their fines merely because they filed for bankruptcy. The FCC has stated that it will not reduce or cancel a fine in response to a claim of inability to pay by a bankrupt company, unless that company submits detailed financial information to the Commission, proving that it cannot pay the fine. Friendship Cable of Texas, Inc., 17 FCC Rcd 8571, 9 (2002). The FCC has reasoned that companies that file for protection under Chapter 11 are still in control of their assets and will be held responsible for their fines unless they prove that they cannot pay; which is a requirement the FCC imposes on all carriers that seek reduction or waiver of a fine. Id.

An exception to the 'forfeiture pay up' rule would occur when a trustee is appointed in a Chapter 7 liquidation proceeding involving a bankrupt telecom company. Under those circumstances, the FCC has stated that it will waive the fine, because requiring the trustee to pay the forfeiture would diminish the estate assets available to creditors, and would serve no public interest. Interstate Savings, Inc., 12 FCC Rcd 2934, 5 (1997).

Bankrupt Carriers Should Comply with Regulatory Obligations

Congress promulgated Section 362(b)(4) to prevent the bankruptcy court from becoming 'a haven for wrongdoers.' First Alliance Mortgage Co., 263 B.R. at 107, citing H.R. Rep No. 595 95th Cong., 1st Sess. 343 (1977). In other words, Congress sought to preclude companies from using the bankruptcy process to avoid the consequences of their illegal actions, and to deter them from continuing their malfeasance. The FCC has never hesitated to invoke Section 362(b)(4) when prosecuting enforcement actions against bankrupt carriers that violate the Communications Act or the Commission's rules. Accordingly, telecom companies should not expect that bankruptcy filings will relieve them from their regulatory obligations, and they would be well advised to make every effort to ensure that they comply with those obligations.

Frederick M. Joyce is the Chair and Ronald E. Quirk, Jr. is Counsel in the Telecommunications Group of Alston & Bird LLP in Washington, D.C.

The current economic downturn has resulted in a huge number of bankruptcy filings by publicly traded companies. During 2001, for example, a record 257 publicly traded companies filed for bankruptcy. See FDIC Bank Trends, No. 02-01 (Jan. 2002). The telecommunications sector was particularly hard hit, as 14% of those bankruptcies were filed by publicly traded telecom companies. Id. The downward trend continued in 2002, with industry giants such as WorldCom and Global Crossing filing for bankruptcy, not to mention the numerous CLECs and wireless carriers that have sought protection through the bankruptcy courts.

The Code's Automatic Stay and Its Police/Regulatory Exception

The U.S. Bankruptcy Code's automatic stay provision (11 U.S.C. ' 362(a)) would appear to deflect some of the immediate problems faced by financially troubled companies. But the automatic stay does not prevent the government from enforcing the law and defending the public interest. The Code provides an important exception, which precludes a bankruptcy filing from operating as a stay of an action by a government entity to enforce its police or regulatory powers. See 11 U.S.C. ' 362(b)(4). Although 'police or regulatory powers' have not been defined, the U.S. Supreme Court has held that they are 'the least limitable' of all government powers. See Queenside Hills Realty Co., Inc. v. Saxl Com'r of Housing and Buildings of New York , 328 U.S. 80, 83 (1946). Hence, courts have broadly construed the scope of Section 362(b)(4).

FCC Enforcement Proceedings Will Not Be Stayed

Telecommunications companies that are considering filing for bankruptcy protection, and users of telecom services, should be aware of the important ramifications of the Code's government exception to the automatic stay provision. For example, the automatic stay is generally inapplicable to FCC enforcement and complaint proceedings.

In interpreting Section 362(b)(4), federal courts have held that when administrative agencies act to enforce the law, they are vindicating the public interest, and the Code's automatic stay provision does not apply. See e.g., EEOC v. Rath Packing Co. , 787 F.2d 318, 325 (8th Cir. 1986). Hence, the FCC may investigate a telecom company's alleged misconduct and impose penalties on that company for violation of the Communications Act or the FCC's rules, regardless of whether the company has filed for bankruptcy protection.

Pecuniary vs. Public Policy: Which Proceedings May Be Stayed?

In spite of the wide scope of the government exemption to the automatic stay, not all administrative actions are so exempted. For example, regulatory actions that directly conflict with the debtor's res or property may be stayed. In re First Alliance Mortgage Co., 263 B.R. 99, 107 (9th Cir. BAP 2001). Federal courts have applied two tests to determine whether a government's actions fall within the scope of Section 362(b)(4) and are exempted from the automatic stay. The first is the 'pecuniary purpose' test; the second is the 'public policy' test. Id.

Under the pecuniary purpose test, if a court determines that the government action is being pursued solely to advance a pecuniary interest of a governmental entity, it will impose the automatic stay. Id. Under the public policy test, the court will not impose the automatic stay if the government action is an attempt to prevent future violations of the law; but it will stay proceedings that concern only the parties who are immediately affected by the proceeding. Id. at 108.

Accordingly, administrativeenforcement proceedings against bankrupt companies that are intended to correct illegalities and to protect the public interest will be exempted from the automatic stay, regardless of whether those proceedings are brought by the agency itself or are commenced in response to individual complaints. For instance, the FCC has responded to customer complaints of illegal 'slamming' by imposing substantial fines on bankrupt telephone companies that have engaged in the unauthorized changing of customers' preferred carriers. See e.g., Coleman Enterprises, Inc., 15 FCC Rcd 24385, ' 11, n. 28 (2000).

The NextWave Imbroglio: The FCC As 'Creditor'

If a court determines that a regulatory agency is acting as a 'creditor' to a bankrupt company, it may impose the automatic stay. This is illustrated by the decision of the U.S. Court of Appeals for the D.C. Circuit, NextWave Personal Communications, Inc. v. FCC, 254 F.3d 130 (D.C. Cir. 2001), cert granted March 4, 2002. (For details on the case, see 'NextWave Ruling Spells Victory and Defeat,' by Robert P. Simons, The Bankruptcy Strategist, February 2003.) The NextWave proceeding, which was decided by the D.C. Circuit after a convoluted trek through the bankruptcy court and the U.S. Court of Appeals for the Second Circuit, concerned the legal ramifications of the FCC's canceling a company's licenses that it won at auction because the company had failed to make its required installment payments after it filed for bankruptcy. The D.C. Circuit stated that because the FCC had perfected security interests in the company's licenses, its canceling those licenses was tantamount to foreclosing on collateral; ie, it was enforcing a lien against the company's property and was thus acting as a government creditor. Id. at 151.The court held that the FCC's cancellation of the bankrupt company's licenses was in violation of the Code's automatic stay. Id.

The D.C. Circuit's holding appears to have reversed the Second Circuit, which held that the FCC's canceling the company's licenses was regulatory because it involved the Commission's exclusive power to dictate the terms of licensure and Code section 362(b)(4) exempted it from the automatic stay. FCC v. Next Wave Personal Communication, Inc , 217 F.3d 125, 136-37 (2d Cir. 2000). The D.C. Circuit suggested, however, that it was not disagreeing with the Second Circuit, because the Second Circuit did not decide the issue of whether the regulatory exemption trumps the automatic stay when the regulator (the FCC) is also a creditor. 254 F.3d at 148-49.

The FCC appealed the D.C. Circuit's NextWave decision to the U.S. Supreme Court, which affirmed the D.C. Circuit's holding. In FCC v. NextWave Personal Communications, Inc. , 000 U.S. 01-653 (Slip Op.) (2003), the Supreme Court rejected the FCC's argument that it had a right to cancel the company's licenses because of a valid regulatory motive. The Court stated that because the company's failure to pay a debt was the sole cause of the license cancellation, bankruptcy law protected the company from the FCC's action. Id. at 7. The Court further declared that the FCC's regulatory motive was 'irrelevant.' Id.

FCC Regulations' Impact on the Bankruptcy Process

In spite of the Supreme Court's decision on NextWave, most of the FCC's regulatory actions will continue to be exempt from the automatic stay. Accordingly, telecom companies that seek bankruptcy protection should be aware of the ways in which the FCC's 'immunity' to the automatic stay could impact their businesses during the bankruptcy process. For example, the Communications Act and the FCC's rules require telephone companies and other common carriers to obtain authority from the Commission and to provide their customers with 31 days' notice, prior to discontinuing service. See 47 U.S.C. ' 214, 47 C.F.R. ' 63.71. This applies to all types of service discontinuances, including those caused by dissolutions of businesses and bankruptcy. See Internet Commerce and Communications, Inc., 2001 Lexus 5980, 8 (2001). The FCC broadly construes this policy; it has, for example, determined that the sale of any portion of a carrier's customer base is a discontinuance of service, requiring compliance with its authorization and customer notification requirements. Id.

The Commission strictly enforces its discontinuance provisions, regardless of whether a carrier has filed for bankruptcy protection. This enforcement applies even in situations where a bankrupt carrier's customers are automatically transferred to another company pursuant to a bankruptcy court approved agreement, with no interruption in service. Id. Moreover, both the seller and the purchaser may be liable for violations of federal law if either party engages in unauthorized discontinuation of service. Id. at 9.

The FCC also requires that, no later than 30 days prior to a transfer of a carrier's subscriber base, the acquiring carrier must provide the affected subscribers with notice of, and certain information about, the proposed transfer. This information includes: 1) rates, terms and conditions of service provided by the acquiring carrier; 2) the subscriber's right to select a different carrier; and 3) the date upon which the acquiring carrier will commence providing service to the subscriber. See 47 C.F.R. ' 64.1120(e). The acquiring carrier must certify to the Commission that it has complied with that requirement. Id.

Bankruptcy Filing May Not Alleviate FCC Fines

Telecom companies that violate the Act and/or the FCC's rules are subject to monetary forfeitures. See 47 U.S.C. ” 501-504. Those companies will generally not receive a waiver or reduction of their fines merely because they filed for bankruptcy. The FCC has stated that it will not reduce or cancel a fine in response to a claim of inability to pay by a bankrupt company, unless that company submits detailed financial information to the Commission, proving that it cannot pay the fine. Friendship Cable of Texas, Inc., 17 FCC Rcd 8571, 9 (2002). The FCC has reasoned that companies that file for protection under Chapter 11 are still in control of their assets and will be held responsible for their fines unless they prove that they cannot pay; which is a requirement the FCC imposes on all carriers that seek reduction or waiver of a fine. Id.

An exception to the 'forfeiture pay up' rule would occur when a trustee is appointed in a Chapter 7 liquidation proceeding involving a bankrupt telecom company. Under those circumstances, the FCC has stated that it will waive the fine, because requiring the trustee to pay the forfeiture would diminish the estate assets available to creditors, and would serve no public interest. Interstate Savings, Inc., 12 FCC Rcd 2934, 5 (1997).

Bankrupt Carriers Should Comply with Regulatory Obligations

Congress promulgated Section 362(b)(4) to prevent the bankruptcy court from becoming 'a haven for wrongdoers.' First Alliance Mortgage Co., 263 B.R. at 107, citing H.R. Rep No. 595 95th Cong., 1st Sess. 343 (1977). In other words, Congress sought to preclude companies from using the bankruptcy process to avoid the consequences of their illegal actions, and to deter them from continuing their malfeasance. The FCC has never hesitated to invoke Section 362(b)(4) when prosecuting enforcement actions against bankrupt carriers that violate the Communications Act or the Commission's rules. Accordingly, telecom companies should not expect that bankruptcy filings will relieve them from their regulatory obligations, and they would be well advised to make every effort to ensure that they comply with those obligations.

Frederick M. Joyce is the Chair and Ronald E. Quirk, Jr. is Counsel in the Telecommunications Group of Alston & Bird LLP in Washington, D.C.