Recently secured parties, including some indenture trustees, have found the priority, scope, validity and enforceability of seemingly properly perfected security interests in Federal Communications Commission (“FCC”) licenses, authorizations and permits, and any proceeds or value derived therefrom, challenged by creditors in bankruptcy proceedings. Those challenging FCC liens have generally argued that an FCC licensee cannot grant a security interest in its license because the licensee does not have an underlying ownership right in the license and because the license is a public right to which no lien may attach, since it provides for use of the airwaves or spectrum. While parties with perfected first priority security interests have for the most part prevailed in these challenges, such litigation can nevertheless be time consuming and costly and may also carry some reputational risk for trustees.
The ION Media Networks Case
In the ION Media Networks, Inc. bankruptcy,1 Cyrus Select Opportunities Master Fund, Ltd. (“Cyrus”), a holder of second lien notes issued by the company prior to the bankruptcy filing, commenced an adversary proceeding against all the ION Media debtors, the administrative agent for the debtors’ prepetition credit facility, the collateral agent under the security agreement and the trustees for the debtors’ first priority senior secured notes and second priority senior secured notes. The lawsuit sought a declaratory judgment that the first lien lenders did not hold valid and enforceable security interests in the FCC licenses because such licenses could not be legitimately encumbered due to their special character as a federally sanctioned and regulated right to use the airwaves in the public interest. According to Cyrus, the FCC licenses were not – and could not be – collateral under the pledge and security agreement (and thus Cyrus was not improperly challenging the liens granted to the first lien lenders) and should therefore be available for pari passu distribution to creditors. Separately, Cyrus also objected to the debtors’ DIP financing with the first priority secured lenders and to the debtors’ proposed plan of reorganization. It is important to note that in purchasing second lien debt expressly subject to the terms of an intercreditor agreement, Cyrus had agreed not to raise or pursue any challenge or dispute regarding the validity of liens granted to the first lien lenders.
On Nov. 24, 2009, the bankruptcy court entered a Memorandum Decision finding that based on the restrictions in the intercreditor agreement Cyrus lacked standing to object to (1) the liens of the first lien lenders, (2) the priority of the first lien lenders’ claims or (3) the plan. The bankruptcy court decision emphasized Cyrus’ own breach of the intercreditor agreement and the fact that the intercreditor agreement established the relative priorities of the first priority secured parties and the second priority secured parties in respect of the collateral, even if the validity of the security interests granted in the collateral was uncertain. The court found that the security agreement’s use of the phrase “purportedly securing” to describe the universe of liens granted by the debtors in favor of the secured parties evidenced the intent of the secured parties to establish their relative legal rights vis a vis each other, regardless of the ultimate validity of each individual right granted by the debtors and to insulate the first lien lenders’ collateral package from attack by the second lien lenders. The court further stated that “[b]y virtue of the Intercreditor Agreement, the parties have allocated among themselves the economic value of the FCC Licenses as Collateral (regardless of the actual validity of liens in these licenses).” (emphasis added.) The court found that the intention of the parties to the intercreditor agreement to grant a security interest in the economic value of the FCC licenses to the first lien lenders was further evidenced by the utilization of special purpose subsidiaries to hold the FCC licenses, the concomitant pledge of the equity interests in each FCC License subsidiary to the secured parties and the intercreditor agreement’s restrictions on actions by second lien lenders.
The court overruled Cyrus’ objections to confirmation and confirmed the debtors’ plan which allocated substantially all economic value to the first lien lenders, although the plan provided for the first lien lenders to receive far less than they were owed. The court found unconvincing Cyrus’ arguments that it was not in violation of the intercreditor agreement in objecting to the debtors’ plan because it was acting in the capacity of an unsecured creditor. The court also found that Cyrus’ “willful” breaches of the intercreditor agreement and presumption of a right to act based on its “own untested” legal theories had resulted in a material and unjustified increase in administrative expenses in the debtors’ cases. Cyrus appealed the bankruptcy court’s confirmation order to the district court, but the district court has yet to rule on the appeal.
The TerreStar Networks Case
In the TerreStar Networks, Inc. case,2 the official committee of unsecured creditors (the “creditors committee”) and a separate unsecured creditor (“Sprint”), challenged the liens granted to the indenture trustee and collateral agent for the company’s senior secured payment-inkind (PIK) notes. Unlike in the ION Media case, the parties challenging the liens granted by the debtors in the Terrestar FCC licenses were not subject to an intercreditor agreement, which allocates the economic value of the collateral and/or purported collateral, regardless of the validity of liens granted in the FCC licenses, among different classes of creditors. Nor did the challenging parties agree to refrain from disputing the validity of any liens granted in the FCC licenses.
In their separate complaints, the creditors’ committee and Sprint both claimed that (1) federal law prohibits a licensee from granting a security interest in an FCC license and (2) the Bankruptcy Code and/or New York Uniform Commercial Code precludes any purported security interest granted pre-petition from attaching to proceeds or value acquired, derived or realized from the FCC licenses post-petition (so-called after-acquired proceeds). Sprint’s complaint contained the additional claim that the indenture trustee’s secured claim should be equitably subordinated to Sprint’s unsecured claim because of the debtors’ failure to reimburse Sprint for its alleged bandwidth-clearing expenses in accordance with an FCC ruling.
In response to the complaints, the indenture trustee argued that case law is nearly unanimous in upholding a debtor’s private right to the profit generated from the sale of an FCC license – separate and distinct from the FCC’s public right to approve the transfer of the license – and that a debtor may pledge the private property right as collateral for a loan. The indenture trustee also pointed out that the FCC itself has explained that permitting a security interest in the economic value of a license does not interfere with the FCC’s statutory duty to approve every license applicant.3 In response to the claim that the indenture trustee’s security interest did not attach to proceeds of the sale of an FCC license post-petition, the indenture trustee argued the courts have also been nearly unanimous in holding that a security interest in the right to proceeds of an FCC license should be considered a lien on a “general intangible” of the debtor that may be perfected prior to any sale of the license, and therefore, the proceeds of a post-petition sale of the license constitute proceeds of such intangible property. The indenture trustee further argued that a debtor acquires a general intangible when it acquires the right to pursue the intangible’s economic value, not when the value materializes upon a future transfer.
In response to Sprint’s claim for equitable subordination of the indenture trustee’s secured claim, the indenture trustee argued that there was no evidence of any inequitable conduct on its part or by the noteholders that resulted in injury to the debtors or their creditors or that conferred an unfair advantage on the indenture trustee. The indenture trustee also noted that it was not a party to the FCC proceedings between TerreStar and Sprint and thus the FCC ruling, which explicitly stated that it was not an adjudication of the parties’ claims, could have no preclusive effect upon the indenture trustee.
In their summary judgment briefs, both the plaintiffs and defendants in the TerreStar case discussed the recent decision by a bankruptcy court in the District of Colorado, In re Tracy Broadcasting.4 In that case, the court held that Section 552(a) of the Bankruptcy Code precluded a secured lender’s lien on the proceeds of an FCC license because at the time of the bankruptcy filing the debtor did not have an agreement to sell the license and did not have the FCC’s approval of a sale, thereby rendering the secured lender’s interest in the proceeds of the license “too remote.” But the defendants in the TerreStar case argued that Tracy was wrongly decided, among other reasons, because it ignores the well-settled distinction between public and private rights in an FCC license and appears to rely extensively on case law that pre-dates the addition to the uniform commercial code of general intangibles as securable assets.
An ad hoc group of holders of the debtors’ senior secured PIK notes has been permitted to intervene in the TerreStar adversary proceeding and has filed briefs generally supporting the indenture trustee’s position, including an opposition to the plaintiffs’ motions for summary judgment.
The bankruptcy court has yet to rule on the summary judgment motions in the TerreStar adversary proceeding, and the debtors withdrew their proposed plan of reorganization, which would have distributed 97 percent of the new equity in the debtors to the holders of secured claims.
At a time when junior creditor interests are generally making aggressive challenges in bankruptcies and reorganizations to the liens of secured creditors, those secured creditors, including indenture trustees in some instances, will want to be cognizant of the fact that liens granted in and to FCC licenses, permits and authorizations may be subject to particular challenge because of the special character of those licenses, which include both the public’s interest in regulating the airwaves and license holders’ private property rights in the economic value of the proceeds of the license. While it appears the ION decision has established a precedent whereby a well written intercreditor agreement should defeat any challenge by a party to the intercreditor agreement, the Terrestar case still leaves the issue open when there is not an intercreditor agreement. As we await the Terrestar decision, perhaps the Terrestar ad hoc noteholders said it best in the summary judgment reply:
The issues presented… ultimately boil down to one simple question: will courts honor credit agreements pursuant to which money is lent to a borrower in exchange for a lien on the economic value of its FCC licenses? If the answer is ‘yes,’ then FCC licenses as collateral and the plethora of existing credit agreements that include such collateral grants are valid. If the answer is ‘no,’ then FCC licenses will be excluded from issuing secured debt backed by the economic value of their FCC licenses in the future and all existing credit agreements granting such interests are invalid.
Thus, indenture trustees should be prepared for the possibility that current deals in which an issuer has pledged an FCC license could default or need replacement collateral. Additionally, it may be beneficial for issuers and underwriters to include language regarding the risk of taking a security interest in a FCC license in future offering memorandum.