On March 12, 2014, the Media Bureau of the Federal Communications Commission (FCC) issued a Public Notice providing guidance on how it will review pending and future proposed broadcast television acquisitions that contain sharing arrangements or contingent interest agreements (such as option agreements or loan guarantees).1 A statement from the Media Bureau Chief accompanying the Public Notice states that the newly issued guidance is “not a change in our underlying rules or  polices,”2 but there are important respects in which this guidance appears to depart from current practice or adds potentially material new dimensions to the FCC review process for transactions involving such arrangements.
In particular, we highlight the following potentially significant implications for these transactions going forward:
- Public Interest Standard and Burden of Proof. The guidance suggests a potentially broad application of the FCC’s public interest standard to deal terms; in addition, the guidance makes clear that the burden of proof will be on applicants to demonstrate, with full documentation, that a transaction satisfies this public interest standard.
- Net Economic Incentives for Licensee, Including at Exit. The overall, net economics of transactions must reflect the maintenance of licensee economic incentives – both with respect to a licensee’s current interest in ongoing station profits and its longer term interest in extracting value in an exit transaction.
- FMV Allocation to License Assets; Abandonment of Current 80-20 Model. In any sale of assets in which license assets and other station operating assets are bundled separately and conveyed to different parties, the purchase price must be allocated to the license assets based on fair market value. This abandons the current informal “80-20” safe harbor in which regulated assets have been regarded as sufficiently valued as long as the regulated assets are valued at 20% or more of the overall station asset value.
- Scrutiny of Guarantees and Lending Terms. The guidance contemplates closer scrutiny of loan guarantees and parallel loans by one lender to two same-market broadcasters with a common sharing arrangement, with an emphasis on ensuring the arm’s-length nature of the loan terms.
With these points of emphasis, we turn to the framework established by the guidance and discuss each of the key elements it sets forth.
The Overall Framework for the Guidance
Animating the newly issued guidance is its emphasis on the application of a public interest standard in reviewing transfer of control and assignment applications. The guidance explains that this public interest standard, as applied to transactions contemplating sharing arrangements and contingent interest agreements, turns on whether the terms of these agreements, taken in the aggregate, create undue degrees of operational and financial influence by one broadcaster over another. The guidance further suggests that sharing arrangements and contingent interests, individually or taken together, will be scrutinized to ensure that their economic structures would not operate to deprive a station licensee of sufficient financial incentives to control its station’s programming.
Specifically, the focus on financial incentives points to two potential lines of inquiry: first, whether the licensee has a current, on-going economic interest in the ratings and business performance of the station, including through control of programming; and, second, whether the licensee has a long-term incentive to maximize the value of the station business that may be realized in an exit transaction (such as the exercise of an option).
In addition, we also observe that as a general matter, the public interest standard appears to also give rise to a potential totality-of-the-circumstances test. It is possible that the guidance may be interpreted as suggesting that individual deal elements that have been previously approved by the Media Bureau in past transactions may not garner approval in future instances where the FCC determines that these transactions elements, taken together, are seen by the FCC as diminishing licensee incentives or as otherwise conflicting with the public interest.
The Key Elements of the Guidance
Against this backdrop, the Media Bureau stated that it will closely scrutinize applications for transactions that contain (i) sharing arrangements or (ii) contingent interest agreements (i.e., agreements that become attributable in the future based on the exercise of a right under the agreement or other action by the parties, such as a loan guarantee or option). Below, we review the key elements emphasized in the guidance.
Burden of Proof
Significantly, the guidance makes clear that it is the applicant who bears the burden of showing that approval of the proposed transaction is consistent with the public interest and who must “provide sufficient information and documentation to fully [emphasis in original] describe its proposed transaction, including any side agreements, and establish that it is an arm’s-length transaction.”3
Beyond contemplating disclosure of the full universe of contemplated transaction documents, it is not clear what will be required of parties in order to “fully describe” the proposed transaction. We anticipate that parties may be impelled to prepare supplementary materials that set out affirmatively the public interest benefits of the proposed transaction, as well as demonstrating, such as through projected revenues and profits, how the transaction creates and maintains the necessary economic incentives of the station licensee.
With respect to sharing arrangements, the Media Bureau provides little detail as to how it will apply the public interest standard in reviewing these agreements, apart from noting a focus on ensuring that the licensee maintains an economic interest in the station. The absence of more specific guidance on sharing arrangements may suggest that, because the Media Bureau has previously reviewed sharing arrangements in extensive detail, there is no effective change to its current approach to reviewing sharing arrangements apart from giving further emphasis to its focus on economic interests of the licensee.
The Media Bureau has applied the public interest standard to same-market joint sales and shared services arrangements and, upon review of those arrangements, found there to be sufficient economic incentives and projected profits that “would align” with the licensee’s ownership of the stations.4
Contingent Interest Agreements: Options
The guidance gives greater attention to the treatment of contingent interest agreements, such as loan guarantees and options. With respect to options, there are two key elements of the guidance: First, the guidance suggests that a licensee may be regarded as lacking an incentive to create long-term station value where it has granted an option to purchase station assets with an exercise price that is deemed to be less than fair market value. Second, in a sale where the license assets and non-license assets are bundled separately and conveyed to different parties, the Media Bureau will closely examine the allocation of the aggregate purchase price between the two bundles of assets to ensure that each reflects fair market value.
Importantly, in identifying this second element, the guidance deviates from existing FCC practice by abandoning the current informal “80-20” safe-harbor model. Under the 80-20 model, the FCC’s practice has been to regard license assets as sufficiently valued as long as they are at 20% or more of the overall station asset value. The new emphasis on fair market value – with no apparent safe harbor approach – raises potential practical issues. It is not clear from the guidance how parties will establish that an aggregate purchase price for station assets has been allocated to specific sets of assets in a manner that is demonstrably in accord with the fair market value of each asset set.
In addition to this fair market value test, it is not clear whether the guidance may have a second test in which parties are also required to demonstrate that a transaction is, according to the guidance, “truly at arm’s-length.”5 It may be that this reference to arms-length terms is intended to further underscore the departure from the “80-20” model because a sale of assets at less than fair market value would not be consistent with arm’s-length negotiation.
Contingent Interest Agreements: Loan Agreements
With respect to lending arrangements, the guidance identifies loan guarantees as warranting enhanced scrutiny because they could create a basis for undue financial influence over the licensee. It is not clear in what manner a guarantee may give rise to such influence. We observe that a loan guarantee does not confer rights or benefits on the guarantor. Rather, a loan guarantee provides a lender with enhanced security (or hedged risk) by providing the lender with recourse against a second party. The guarantee does not immunize a borrower from risk of default or otherwise alter its economic incentives to run the station or repay the loan. It may therefore behoove applicants to demonstrate how a loan guarantee fits in with an overall arm’s-length transaction and to demonstrate that the loan guarantee is for the benefit of the lender and does not represent an instrument by which licensee incentives are diminished or a guarantor gains influence in the station’s business.
In addition, the guidance also raises the potential for scrutiny in transactions where two same-market broadcasters in a sharing arrangement “share the same lending institution.”6 Subject to the ongoing application of the FCC’s equity/debt plus rule, it is not clear to us that the mere presence of a common lender should itself bear on the arm’s-length nature of the lending transaction. Customary financing arrangements are elaborately negotiated with major third-party financial institutions on market terms that are necessarily at arm’s-length. That being the case, one practical result of the emphasis on lending terms is that it may become necessary for parties to have substantially developed the terms of their financing arrangement as a precondition to obtaining FCC approval of a proposed transaction.
As a result, another potential practical impact is that the guidance may compel lenders and their counsel to look beyond the established black-letter strictures of FCC rules concerning guarantees and secured interests to assess a more generalized FCC perspective. The result will require a careful balancing between credit-risk management and maximized security, on the one hand, with the business imperatives of relationship banking, which, on the other hand, facilitate a client’s strategic acquisition through leveraged finance. While such a balance – at least for now – is nebulous, it will clearly necessitate close collaboration among counsel to lenders and borrowers alike.
Given the generalized nature of the public interest standard and the shift in application of certain existing practices, the practical implications of the guidance on future transactions may not be clear until new precedent is established. That said, the Media Bureau in past decisions has also recognized the need for parties to design transactions based on an expectancy of accepted structures and terms.7 We expect that sharing arrangements and contingent interest agreements may continue to be important elements of deals, provided that care is given to their construction and the points of emphasis established in the new guidance.