On June 21, 2011, the United States Court of Appeals for the Ninth Circuit reversed a California Public Utilities Commission (“CPUC”) and lower court ruling forcing AT&T to pay PacWest over $10 million in charges for PacWest’s termination of AT&T end user calls to dial-up Internet service providers (“ISPs”).

The Ninth Circuit’s decision was based on its interpretation and application of a 2001 FCC order called the ISP Remand Order. In that order, the FCC established rules limiting and, in some circumstances, completely eliminating the compensation that a telephone provider (“Provider A”) must pay to another telephone provider (“Provider B”) when Provider A to Provider B for Provider B to route and terminate to Provider B’s ISP customer.

The express focus of the ISP Remand Order and the resulting rules was to address a growing “arbitrage” situation that had emerged in the telecommunications industry. Specifically, in a typical arrangement, when a customer of Provider A calls a customer of Provider B, Provider A pays Provider B to route and complete the call to Provider B’s customer. In turn, Provider B pays Provider A when a customer of Provider B calls a customer Provider A. The arrangement is referred to as “reciprocal compensation,” and, under normal circumstances, the amount of traffic sent between the providers should balance out, resulting in the exchange of very little money between providers. In some cases, however, telephone providers specifically target ISP customers because ISPs receive a great deal more telephone calls than they make. This unique imbalance in call flows creates a substantial imbalance in reciprocal compensation payments in favor of providers with ISP customers at the expense of other providers.

In the ISP Remand Order, the FCC restricted these arrangements by, among other things, capping the rates that a provider could charge for ISP-bound traffic termination and, in some cases, precluding such charges altogether. The FCC did so based on a record that primarily involved new competitors (“CLECs”) using ISP customers to garner an imbalance of reciprocal compensation payments from established incumbent providers (“ILECs”), like Verizon.

The case before the Ninth Circuit arose because it involved two CLECs, not a CLEC and an ILEC. Specifically, PacWest (a CLEC) was charging AT&T (a CLEC) to terminate AT&T’s ISP-bound calls, claiming that the ISP Remand Order rules only applied to ILEC-CLEC arrangements, not CLEC-CLEC arrangements. AT&T protested, but the CPUC and a federal district court in California agreed with PacWest.

On further appeal, the Ninth Circuit sided with AT&T and reversed the decisions of the CPUC and the district court. In particular, the Ninth Circuit, bolstered by an amicus brief filed by the FCC, found that, even though the ISP Remand Order was written to address an ILEC-CLEC problem at the time, the language and rationales of the ISP Remand Order were broad enough to encompass CLEC-CLEC arrangements as well. The Ninth Circuit therefore found that the ISP Remand Order restrictions on ISP-bound reciprocal compensation applied and preempted the CPUC’s authority to establish a different result.