All businesses – and their shareholders and financiers – are facing challenges these days during what is now often referred to as the greatest financial crisis since the Great Depression of the 1930s. Special considerations apply to Canada’s regulated communications businesses in these times of tight credit and an uncertain economy. These considerations are felt at all stages of the business financial cycle: raising capital, day-to-day business operations, the consolidation or sale of the business, and managing the business in distress.
In this bulletin, we discuss some recent developments in the communications sphere that are directly relevant to regulated communications businesses and their financial backers in difficult times.
Security in the Regulated Business - Communications Licences
Lenders focus not only on the return but also on ultimate repayment, and thus, on the security they hold in the enterprise. In legal terms, security means the interest that a lender has to assume control over, and ultimate ownership or disposition of, the assets or shares of an undertaking.
In the communications sector, complex legal issues are raised by the status of communications licences issued under the Broadcasting Act and the Radiocommunication Act as “property” of a business. This issue is significant because the concept of “property” lies at the heart of both the provincial regulation of security, and the federal regulation of bankruptcy and creditor protection. Simply put, are broadcasting and radiocommunication licences the property of a business? If they are, then a business is likely able, at law, to pledge those licences as security for its obligations to third parties. But, if these licences are not the property of a business, and transferable by it, then the lender’s ability to exercise its remedies as a secured party against these critical assets may be questioned.
Particularly in these times of financial crisis, it is in the interests of both regulated businesses and their financiers to have a clear understanding of the rules.
A recent Supreme Court of Canada case (Saulnier v. Royal Bank of Canada,  SCC 58 (October 24, 2008)) illustrates the potential risk associated with taking security in government issued licences, while at the same time providing some comfort to lenders. That decision involved fishing licences issued under the Fisheries Act (Canada). The borrower was a licensed fisher who obtained a loan from the Royal Bank of Canada. The loan was secured by a general security agreement, which granted a security interest in favour of the Bank over all of the “property” of the borrower. The borrower defaulted and the Bank sought to enforce its security. The borrower argued that those licences were not its own property, but were, rather, property of the Crown and were not transferable by the licensee (under the terms of regulations made under the Fisheries Act (Canada)). Consequently, the borrower alleged, those licenses were not subject to the security interest granted to the Bank, nor were they included in the borrower’s own “personal property” under the Bankruptcy and Insolvency Act (Canada). The borrower accordingly refused to sign documents relating to a transfer of the licences by the Bank in connection with the enforcement of the Bank’s security. The Court ruled in favour of the Bank.
It is not difficult to extend the fact scenario involving a licensed fisher to a licensed communications company in the broadcasting or radiocommunication sectors. In those sectors, while there may be a large physical infrastructure supporting the active business, the key asset in that business is often the government issued licence. The large amounts paid recently by bidders for spectrum licences for advanced wireless services (“AWS”) and other spectrum in the 2 GHz range illustrates the value of these licences as “stand alone” assets, even before the related physical assets have been deployed.
The Saulnier decision attempts to provide clarity on the issue of whether a government licence is the property of the holder that can be pledged, at law, to secure the holder’s obligations. The Court found that the fishing licences were the borrower’s “property”, within the meaning of the provincial personal property security legislation and the federal Bankruptcy and Insolvency Act and were, therefore, required to be transferred at the direction of the Bank to settle the borrower’s liabilities.
It is clear, therefore, that in some instances the courts will be prepared to view the interest of a licensee in a government-issued licence as “property” for the purposes of personal property security and bankruptcy legislation. However, it may be difficult to apply the reasoning of the Court to licences that are issued in the communications sector.
In Saulnier, the Court held that the interest of a licensee in a government fishing licence could be viewed as “property” because the government licence amounts not only to a right to do something that would otherwise be prohibited (i.e. to engage in a commercial fishery) but also to a proprietary interest in other property – namely, the wild fish caught. This kind of licence was distinguished (in a case quoted by the Court) from a licence that is merely a licence to do something that is otherwise prohibited such as a liquor licence. In adopting this analysis the Court rejected other analytical approaches which had previously guided lawyers and lenders (such as reference to the overall regulatory framework within which the licence was issued and the development of commercial practices over time).
It is an open question whether a broadcasting licence or a radio authorization (such as a spectrum licence) is both a right to do something as well as a proprietary interest in other property, and thus within the Supreme Court’s analysis of what constitutes a debtor’s property. If it were determined that communications licences did not qualify as “property” that could be subject to a security interest, a secured lender could take some comfort from the fact that no one else could hold such a security interest. However, the clear risk would remain that the borrower could contest the orderly transfer of licences or assert that any proceeds of disposition of the licences should accrue to the borrower.
Lenders and other parties seeking to obtain effective security over businesses operating in the communications sector must be aware of the complexities of taking effective security over communications businesses and related licences. Standard-form general security agreements may not make adequate provision for communications licences, and for the enforcement of rights in connection with those licences.
Enforcing Security and other Creditor Rights
Realization of security over the assets of a debtor is a complicated process for almost any business, but it is even more challenging in the regulated communications environment.
For example, before enforcing a comprehensive security interest over a communications business it will often be necessary for a secured party to obtain regulatory approval. This is because a broadcasting licence may not be transferred and a new licence must be issued to a transferee of the underlying business, and radio authorizations may not generally be transferred without prior regulatory approval. Furthermore, the appointment of a receiver or receiver-manager, for example, over the assets of an undertaking will usually be understood to result in a “change in control” of that undertaking. Under the various regulations made under the Broadcasting Act, as well as by the terms of many radio authorizations issued under the Radiocommunication Act, a change of control requires the prior approval of the regulatory agency (the CRTC in the first case and the Minister of Industry in the second).
In the broadcasting sector, the CRTC has become well-acquainted over the years with dealing with businesses in distress. The CRTC has in the past given quick administrative-style approval to applications for the appointment of receivers for companies in the process of reorganization or bankruptcy proceedings. The basis for this approval is typically that the receiver or receiver-manager will operate the undertaking on a day-to-day basis while looking for a suitable purchaser for the undertaking. The ultimate acquisition of the undertaking by the purchaser would then be subject to the CRTC’s usual application and public review procedures under the Broadcasting Act.
Temporary Management Agreements – The Remstar/TQS Decision
The CRTC’s recent decision approving Remstar Diffusion inc.’s application to acquire control of TQS inc. (Broadcasting Decision CRTC 2008-129) may present additional opportunities for secured parties to protect their interests during the period of uncertainty between the time a company seeks creditor protection or a receiver is appointed, and the time the CRTC ultimately deals with the substantive application. In that case, the CRTC approved a temporary management agreement by which Remstar Corporation (a related company) would assume management of TQS even while the CRTC considered the substance of Remstar’s application to assume permanent control. In its decision, the CRTC emphasizes in several places the fact that TQS was in a position of “technical bankruptcy”, but the position of a company emerging from creditor protection under the Companies’ Creditors Arrangement Act and the position of a bankrupt company subject to the control of a formal receiver are not necessarily parallel.
This arrangement was criticized strongly by some participants in the CRTC process. It may be recalled that, after having received CRTC approval to manage TQS on a temporary basis, Remstar initiated significant employee lay offs in the TQS news department and reduced TQS’s production of newscasts. In its final decision, the CRTC referred to the concerns expressed by the participants but, notably, did not find that Remstar had breached any applicable regulatory requirements by its actions (at least, the CRTC decision is silent on that issue).
The Remstar experience illustrates that there is an opportunity for secured parties (and even prospective purchasers) to obtain a high degree of managerial control over companies in distress while the regulatory process takes its course. At the same time, certain aspects of the Remstar example may cause the CRTC to view temporary management agreements with greater caution. There is no doubt that the actions taken under the temporary management agreement resulted in considerable controversy.
No (or Minimal) Regulatory Approval Required?
While the exercise of security interests against communications companies and their undertakings will often require prior regulatory approval, this is not always the case.
There is, for example, no general requirement for prior approval of the transfer of control, or of assets, of telecommunications companies that do not hold separate radiocommunication authorizations. In those situations, a primary concern of a creditor seeking to realize value from an insolvent company, especially a non-Canadian creditor, may be to maintain the Canadian eligibility of operations during a period of insolvency and to find eligible Canadian purchasers for regulated assets.
It is generally accepted, for example, that Canadian telecommunications carriers may obtain arms’ length financing from non-Canadian sources without necessarily affecting their Canadian eligibility. If, however, a non-Canadian seeks to exercise its security over the carrier by taking control of the assets or the shares, even for the purpose of seeking to transfer them to Canadians, or extracts covenants that appear to give the foreign lender control over the day-to-day operations of the enterprise, concerns may well be raised as to whether that Canadian carrier remains effectively controlled by Canadians and therefore eligible to operate in Canada.
It is also important to note in respect of radio authorizations that Industry Canada is seeking, as a matter of formal policy, to rely more on the operation of market forces and has stated, indeed, as its first enabling guideline to implement its policy that “market forces should be relied on to the maximum extent feasible”. The Department has also stated, as a matter of policy, that reliance on market forces includes aspects such as “the removal of barriers to secondary markets for spectrum authorizations”.
The AWS authorizations recently auctioned by Industry Canada reflect this approach. These licences have “enhanced transferability and divisibility rights”: a licensee may apply to transfer its licence in whole or in part in both the bandwidth and the geographic dimensions. Proposed transferees are required to demonstrate their Canadian eligibility as a radiocommunication carrier (and, in the case licences originally granted to “new entrants” from the spectrum set aside for that purpose, must also meet the definition of “new entrant”), but otherwise there are no limits on eligibility. Also, since these licences are divisible, it is possible to sell them off in geographic or bandwidth blocks – which will, presumably, increase their marketability. In other words, while there is still a prior approval requirement for the transfer of these radiocommunication licences, the process is predisposed to facilitate transfers. This pro-market regulatory approach may help secured parties to more easily realize the value in spectrum licences in the event of financial crisis.
While radio licences obtained through the auction process are intended to have enhanced transferability and divisibility rights, Industry Canada has also indicated that certain aspects of those rights (such as divisibility) may be applied to some of the more traditional “first-come, first-served” licences as well. The Department has indicated in its revised terrestrial licensing policy that while these kinds of licences will not be transferable “in their own right” (i.e. they cannot be transferred other than in connection with business assets being used as a part of a going concern), they will be divisible in the geographic dimension and may, in certain circumstances, be divisible within the allocated bandwidth. Again, this should assist secured parties to liquidate regulated assets used in a radiocommunication business. It will not, for example, necessarily be required to locate a single purchaser for an entire business when the radio frequency and related assets may be divided on a geographic or bandwidth basis.
In the case of both auction-based licences and firstcome, first-served licences, it will be necessary to review the terms of those licences carefully, together with the applicable regulations and policies to determine the extent of divisibility, and the applicable transfer requirements.
Generally, the Canadian regulated communications sector is strong and well-positioned to meet many of the challenges of current market conditions. There are special considerations, however, that regulated companies and their financiers will wish to take into account in devising strategies to best position themselves to overcome these challenges.