A New York bankruptcy court recently considered the effects of Bankruptcy Code section 552 on a lender’s security interest in the proceeds of an FCC broadcast license and held that a prepetition security interest extended to proceeds received from a post-petition transfer of the debtors’ FCC license. Sprint Nextel Corp. v. U.S. Bank. N.A. (In re Terrestar Networks, Inc.), Case No. 10-15446, Adv. Pro. No. 10-05461 (Bankr. S.D.N.Y. Aug. 18, 2011). This result directly conflicts with Spectrum Scan LLC v. Valley Bank and Trust Co. (In re Tracy Broadcasting Corp.), 438 B.R. 323 (Bankr. D. Colo. 2010), which was recently upheld on appeal to the district court.1 In Tracy Broadcasting, a bankruptcy court determined that a security interest in the proceeds of an FCC license could not attach prepetition unless the FCC approved an agreement to sell the license before the bankruptcy petition was filed. The New York bankruptcy court rejected the notion that an FCC approved sale agreement must be in place before a security interest can attach to the proceeds of an FCC license.

In Terrestar, the debtors were providers of mobile satellite services, which required various FCC licenses. Before their bankruptcy, the debtors issued notes secured by their economic rights in the FCC licenses, including the proceeds from any sale of the licenses. During the bankruptcy case, a group of unsecured creditors commenced an adversary proceeding to challenge this security interest. After the adversary proceeding commenced, the debtors sold their assets including their FCC licenses, subject to FCC approval. The sale price was less than the outstanding indebtedness owed to the noteholders. After the sale, the unsecured creditors and noteholders filed cross motions for summary judgment to resolve the FCC license security interest issue.

The unsecured creditors argued that: (1) the noteholders’ lien could not attach to the FCC licenses themselves, and therefore could not attach to the proceeds of the licenses and (2) even if the noteholders could obtain a lien on the debtors’ economic interest in the licenses, such a lien cannot attach until after the licenses are sold. Since the sale occurred in the bankruptcy case, the unsecured creditors argued that Bankruptcy Code section 552(a) prevented the noteholders from acquiring an interest in the post-petition proceeds of the license.

The noteholders acknowledged that a security interest may not be granted in an FCC license itself, but argued that a lien may exist on the economic value of a license. The noteholders argued that the lien attached prepetition, when it was purportedly granted by the debtors. Thus, the noteholders argued that section 552 of the Bankruptcy Code is not applicable.

After engaging in a lengthy discussion of prior FCC license cases, the Terrestar opinion concludes that the noteholders held a valid lien on the economic value of the debtors’ FCC licenses even if they could not hold a lien on the licenses themselves. On the section 552 issue, the court expressly rejected the Tracy Broadcasting holding “as contrary to the clear weight of authority and inconsistent with the well-established policy of permitting liens on the economic value of FCC licenses.” The court noted that the burdensome Tracy requirement for lien attachment – that the FCC has approved a sale agreement – “would make it difficult, if not impossible, for such a lien to survive the filing of a bankruptcy, notwithstanding the wealth of authority that such liens are permissible and the FCC’s conclusion that such liens are desirable.” Such a result, according to the court, “would unsettle expectations by invalidating such liens in the bankruptcy context or permitting all or other creditors to come before the liens, thus severely diminishing or eliminating their value.” Accordingly, the Terrestar court concluded that the noteholders’ liens in the FCC licenses were valid.

Shortly after the Terrestar decision was issued, a Colorado district court affirmed the bankruptcy court’s Tracy Broadcasting decision. The district court noted the existence of contrary authority outside of the Tenth Circuit. But it determined that the split of authority was not grounds for reversal. Thus, Tracy Broadcasting remains authority, at least in Colorado, for the proposition that FCC approval of a sale agreement is a prerequisite to perfect a security interest in the proceeds of an FCC license.

The competing Terrestar and Tracy Broadcasting decisions have created a conflict on the issue of when a lien on the economic rights of an FCC license may perfect. Resolution of this conflict is important so that lenders can be certain that security interests in the proceeds of FCC licenses will retain their value in a bankruptcy case. Both cases have already been appealed – Tracy Broadcasting to the Tenth Circuit and Terrestar to the district court. Since Tracy Broadcasting has already seen one round of appeals, the Tenth Circuit will likely be the first circuit court to weigh in on this issue.