I. FCC Allows Operators to “Pass-Through” Past Due Franchise Fees

On March 2, 1998, the FCC’s Cable Services Bureau (“Bureau”) released a Memorandum Opinion and Order (D.A. No. 98-396) which held that cable operators may “pass through” (i.e. identify as a line item on subscriber’s monthly cable bills) the underpayment of franchise fees. The franchise fee underpayments in question result from cable operators’ reliance on a Bureau decision in United Artists Cable dated April 6, 1995, which held that operators are not required to include franchise fee revenue in their calculation of “gross revenues.”

a. Background

In United Artists Cable, 11 FCC Rcd. 18158 (1995), the Bureau concluded that gross revenues do not include the franchise fee collected from subscribers. On reconsideration the FCC held that the “franchise fees that a cable operator collects from its subscribers are not part of an operator’s ‘gross revenues’ for purposes of calculating the total amount of franchise fees owed by the operator to its local franchising authority.” The FCC’s decision was then appealed by the Cities of Dallas and Laredo Texas to the Fifth Circuit Court of Appeals.

On July 31, 1997, the Fifth Circuit overturned the FCC’s decision ruling that cable operators must include revenue from the franchise fee in the operator’s calculation of total gross revenues on which the franchise fee is paid. See Dallas v. FCC, 118 F.3d 393 (1997). As a result of cable operators’ reliance on United Artists Cable, dating back to April 1995, some operators may have underpaid up to $2.00 per subscriber in franchise fees to their franchising authorities.

While the Dallas decision was a victory for cities, implementation of the decision has been slow and inconsistent throughout the Country. In some cases, cable operators immediately changed their calculation of franchise fees to come into compliance with the Dallas decision. In other cases, cable operators sent out correspondence to franchising authorities seeking a waiver from compliance with the decision. In many other cases, cable operators are just now bringing their billing systems into compliance.

b. The Arguments Presented

Since the Dallas decision, the cable industry has been unified in its position that any retroactive application of the decision to collect franchise fee underpayments should be collected from subscribers on their monthly bills (i.e. “passed-through”). In other words, if a cable operator owes a community $50,000 in franchise fee underpayments as a result of the operator’s reliance on United Artists Cable, the operator desires to charge this $50,000 back to the subscriber base as a line item on their monthly cable bills.

Cities no doubt took issue with the industry’s position and argued that retroactive application of the Dallas decision should not allow cable operators to pass franchise fee underpayments on to subscribers. Many cities argued that operators’ risky reliance on United Artists Cable, while the decision was on appeal, should not now provide those same operators with relief via subscribers’ wallets.

The March 2, 1998 decision of the Bureau held in favor of cable operators and allows the franchise fee underpayments to be “passed-through” to subscribers. However, despite the fact that the Bureau’s decision has only recently been released, there is already interest among some municipalities to further appeal this decision or seek reconsideration.

c. What should you do now?

In reaction to the Bureau’s March 2, 1998 decision, franchising authorities should consider the following points:

1. Do not execute any “Settlement Agreement” proposed by your cable operator which may “waive” your rights to seek reimbursement of these past-due franchise fees without having such reimbursement passed on to subscribers. Be sure to reserve all your rights in the event the Bureau’s decision is overturned.

2. Be sure to get an accurate accounting of all past-due franchise fees. Some operators implemented the original decision of April 1995 retroactively to the beginning of January 1995. Clearly, the first three months of 1995, if applicable, would not be subject to the Bureau’s decision. Moreover, it does not appear that the time period from the date of the Dallas decision (July 31, 1997) to present would be affected absent express permission from the franchising authority. Therefore, operators may not be able to pass-through underpayments arising over the last seven (7) months.

If you would like a copy of the Bureau’s decision or have any questions regarding implementation, please feel free to contact Brian Grogan at (612) 347-0340.

II. To Upgrade or Not to Upgrade: That is the Question

As franchise agreements around the country are being renewed, one of the key questions addressed in each renewal is whether to mandate an upgrade of the existing cable system. In some cases, the upgrade is a forgone conclusion given the social contracts some operators have entered into with the FCC. These social contracts are essentially agreements between the operator and the FCC, which relieve the operator of certain rate regulation proceedings in return for commitments to upgrade systems and other related matters.

Both Time Warner and MediaOne have social contract requirements to upgrade all of their cable systems up to a minimum of 550 Mhz (in excess of 80 channels of capacity). In these cases, cities may not need to spend significant time reviewing the capabilities of the cable system serving their community, or pressing the system upgrade issue during negotiations, since it is virtually guaranteed as a result of the social contract obligations. These communities may instead focus on ancillary issues such as institutional networks, channels for local programming and related matters.

Other communities, however, are not as lucky. For example, some large multiple system operators have chosen not to upgrade cable systems, even those in the top fifty markets, but rather are seeking to use compression technology or digital compression to provide greater channel capacity. Digital compression is accomplished by taking one or more existing analog channels (6MHz of capacity) and pushing through up to 12 digital signals. Operators attempt to use capacity on their existing, in some cases antiquated, cable systems to reduce upgrade costs. The jury is still out regarding whether such compression technology will achieve its stated goals and whether such systems can provide the same benefits as an upgraded/rebuilt cable system.

When considering whether to mandate a system upgrade in a renewed franchise, cities should not only be interested in increasing channel capacity, but also in improving the reliability of the system, and the quality of the signals at subscribers’ homes. Obviously, a complete system rebuild or upgrade will address all three of these issues. Compression technology, however, often only addresses the improvement of channel capacity. Since compression technology depends on the existing cable system, reliability and signal quality are typically unaffected. Moreover, since digital compression requires use of existing analog channels, subscribers not selecting the new digital services may actually have fewer analog channels available to them.

For example, assume a cable system with 35 channels of capacity (about a 330 MHz system) all of which are currently programmed. If the cable operator completely upgrades the system, there will be 80-110 analog channels which the operator may use to increase basic and expanded basic offerings, provide additional premium or pay-per-view services, or use for additional compression services.

In contrast, if the operator attempts to take this same 35-channel system and use digital compression, the capacity of at least 3 of the 35 channels will now be required to offer the new digital services. That will reduce the number of available analog channels from 35 to 32 and displaces 3 existing programming services. Subscribers not electing the new digital conventors (perhaps $3.00/mo./TV set) and digital programming packages (perhaps another $5.00-$10.00/mo.) will receive little or no benefit from the purported system improvements and will lose 3 programming services.

Operators often question whether a city really wants to mandate a costly system upgrade which will only serve to further increase subscriber rates. The answer to the question differs in each community, although careful consideration is advised since your city likely will not be back in a position to mandate system improvements until the franchise is once again up for renewal.

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Brian T. Grogan is a shareholder with the Minneapolis law firm of Moss & Barnett, specializing in cable television, telephone and communications law. Mr. Grogan represents municipalities throughout the country on franchise renewals, transfers of ownership, telecommunications planning, rate regulation, zoning and tower site issues, First Amendment issues, right-of-way regulation, litigation and other related communications matters. Mr. Grogan is a frequent presenter at state and national conferences regarding cable and telecommunications.

The materials in this Municipal Communications Law Update have been compiled from a variety of sources and address only a portion of the relevant issues contained within hundreds of pages of regulations and decisions. We have not addressed many important points, which may apply to your situation. You should consult with legal counsel before taking any action on matters covered by this Municipal Communications Law Update.

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