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FRANCHISE RENEWAL: Industry Consolidation

Creates New Challenges for Franchise Negotiations

Introduction

According to the FCC’s most recent report on competition, the eight largest providers of multichannel video programming (“MVP”) serve 80% of all cable subscribers in the United States. The four largest MVPs serve over 53% of all cable subscribers. These statistics are about to become even more overwhelming with the pending merger of the number one cable operator, AT&T Broadband, with the number three cable operator, Comcast Communications. A combined AT&T Comcast will serve nearly 22 million cable subscribers with over $16 billion in annual revenue. In addition, the number four cable operator, DirectTV, is seeking a merger with Echostar Communications, the number six cable operator, which would give it nearly 18 million cable subscribers throughout the country.

While consolidation of the largest cable operators is evolving so too are the regions in which they operate. The United States has 88 million cable subscribers. 69 million are subscribers to hardwired cable operators with DBS and other satellite providers adding another 19 million. Of the 69 million wired cable subscribers approximately 55 million are served by huge regional cable operator clusters. There are 108 regional clusters in the United States serving more than 100,000 cable subscribers each. Cable operators are vying for these regional clusters to improve operating efficiencies, take advantage of advertising sales opportunities, and market expanded services such as high-speed data and video-on-demand.

The problem with the regionalization of cable operators is the difficulty for competition to take hold. Regional clusters in excess of 100,000 cable subscribers are very difficult for small competitors to penetrate. As a result, most of the wired competition in the country is found in smaller jurisdictions where independent telephone companies or small start-ups are able to compete in areas where regional clusters are not feasible.

By way of example, there are 33,000 community units identified by the FCC in the United States. A community unit is a city, town, county or other jurisdiction where a cable operator has sought permission from the FCC to provide cable service. Of those 33,000 community units only 419 have effective competition. This means just over 1% of communities in the country face competition from another wired cable operator. The cable industry argues that competition is present from DBS providers nationwide and, therefore, the presence of another wired competitor does not mean competition is not present. However, given that 35% of all cable programming is affiliated with one of the major cable operators such as AT&T, AOL Time Warner and others, is not difficult to understand the concern of consumer groups regarding the horizontal and vertical concentration within the cable industry.

This paper will review some of the problems franchising authorities are experiencing as a result of this industry consolidation and ways in which franchising authorities are attempting to address the ever-changing cable industry.

1. Regionalization = No Local Presence

As cable operators create large regional clusters often the first thing to be eliminated is the local office. Cable operators are attempting to address years of poor customer service by creating large regional call centers to handle telephone inquiries. Cable operators then attempt to eliminate local offices because such offices no longer handle telephone traffic and walk-in traffic can be handled with a drop box or by contracting with another local retailer. The result is that cable subscribers may be forced to drive 30 miles or more to actually speak face-to-face with a cable operator representative.

This lack of local presence extends beyond customer service issues and also impacts the relationship between the franchising authority and the cable operator. Previously, franchising authorities were are able to maintain a direct line of communication with the local office and local general manager to address citizen complaints, deal with outages and maintain positive communications between the franchising authority and the cable operator. Once the local office is gone so too is the local presence of staff to maintain contact with the franchising authority.

Regionalized call centers also bring with them a whole new set of problems for franchising authorities. When operating correctly and under normal conditions, regional call centers can process customer calls in an efficient manner. These call centers can track telephone calls using sophisticated computer systems to provide reports to verify compliance with franchise standards. Unfortunately, the larger the regional call center the more likely it is to be impacted by outages, line cuts, weather conditions and related issues virtually every day. This results in unusually high call volume from various portions of the region thereby affecting an entire region.

If a fiber is cut on the north side of an operating region knocking out service to 10,000 customers, phone lines will be flooded with calls from that portion of the region. In the southern portion of the region service may be operating fine and customers may simply be calling in with billing questions or routine service issues. Because of the unusually high call volume associated with the issues in the northern part of the region, all customers will be impacted and will be unable to reach a customer service representative. The larger the region the more often abnormal operating conditions will exist resulting in significant down time for the entire call center.

An additional frustration of franchising authorities is the inability for such regional call centers to provide system specific data. Many franchises will require that a cable operator respond to telephone inquiries within 30 seconds and that customers receive a busy signal less than 3% of the time. Generally, these standards are measured on a quarterly basis and must be complied with at least 90% of the time. Cable operators argue that they can only provide a region-wide report and cannot break out numbers for each individual jurisdiction. Moreover, many operators will argue that abnormal operating conditions throughout the region should relieve them of franchise compliance regardless of whether such conditions ever existed within a given jurisdiction.

The ultimate goal of all franchising authorities is to ensure quality customer service for cable subscribers. The ability to verify compliance, however, is significantly more complex with the advent of regional call centers and the unique problems they present. The key to resolving some of these issues is to address them upfront during franchise renewal negotiations to ensure that objective standards are included within the franchise document and that accurate reports are submitted by the cable operator to verify compliance.

2. Precedent

When cable operators serve regional clusters the desire is to operate the entire region as one large system irrespective of jurisdictional boundaries. In order to do so, the cable operator must endeavor to have the same franchise obligations and requirements within all cable franchises. It is not uncommon for large regional clusters to serve as many as 100 different jurisdictions each with a separate franchise. The result for franchising authorities is a cable operator that may pursue negotiation positions that have little or nothing to do with your community, but rather are meant to establish a region-wide precedent to minimize the burdens on the cable operator.

For example, one of the items often negotiated by franchising authorities in renewal negotiations is channel capacity for local public, educational or governmental (“PEG”) programming. The number of PEG channels which a franchising authority may seek will be based upon the need in that community. It is not uncommon for franchising authorities to seek up to three channels solely for educational purposes which may serve school districts, community colleges and universities. This same community may also seek a channel for public access programming and one or more channels for governmental access programming.

The cable operator, however, may have set aside only three PEG channels for use in the region. The cable operator will endeavor to have the same channel line-up throughout the region to aid in its advertising sales and communication with cable subscribers. Thus, only three channels will be set aside in the line-up for community programming setting up a difficult negotiation process for a franchising authority which may have a local need for greater local capacity. In such negotiations, the cable operator may argue that if additional channel capacity is to be allocated it will result in a reduction of satellite delivered programming that cable subscribers may otherwise benefit from. This presents elected officials with a difficult dilemma and ultimately may have very little to do with the local cable-related community needs and interests but rather the cable operator’s regional plans and desires.

A cable operator will use the same arguments with respect to funding for community programming, institutional networks, security funds, letters of credit and related franchise requirements. The cable operator will no doubt seek the lowest common denominator of previously granted franchises arguing that it cannot agree to requirements above those in other communities. Some cable operators have included provisions within franchises stating that if future franchises are agreed to within the region containing more favorable provisions, the cable operator will provide such benefits to that community. When the next negotiation is conducted with a neighboring community the cable operator will argue that it cannot agree to more favorable terms because it would result in an undue financial burden on the cable operator as it would be forced to give other jurisdictions similar benefits.

3. Limited Local Authority

As cable operators have consolidated, the authority given to the regional system managers or state directors of franchising has diminished. Generally, local cable managers have little authority to commit to obligations without first seeking approval from corporate. The centralization of franchising has resulted in protracted renewal negotiations and significant backtracking in the renewal process.

Franchising authorities will often begin renewal negotiations with the local general manager and/or director of franchising. As this process unfolds the statement will often be made by the local cable manager’s representatives that the issue appears acceptable although they will have to run it by corporate first. The corporate legal counsel located in Denver, St. Louis or on the east coast may not be completely familiar with the franchising authority, its needs, or the negotiation process that is unfolding. Yet corporate will be used as the bad cop in the negotiation process in an attempt to limit or reduce franchise commitments to be made by the local cable manager.

The result for the franchising authority is a delay in the negotiation process and, on frequent occasions, the need to retract agreed upon positions as the cable operator may be forced to back away from prior commitments made during negotiations.

4. Company Policy

As cable operators have grown in size so too has their negotiation strength. More and more frequently, cable operators are attempting to establish nationwide policy for franchise negotiations. Most recently, cable operators have attempted to take the position that bonds, security funds and letters of credit should no longer be mandated in the franchise as it presents an undue financial burden on the cable operator and a waste of limited financial resources. The cable operators will argue that because they have never been found in violation of their existing franchise and have otherwise been a good corporate citizen they should no longer be forced to provide financial security to the franchising authority. Unfortunately, this argument completely ignores the possibility that the cable operator may go bankrupt (i.e. Adelphia) or may transfer the system to a less financially secure cable operator. In addition, absent some form of security fund or bond the franchising authority will have no enforcement mechanism available to it other than termination of the franchise.

Cable operators have also recently attempted similar negotiation tactics with respect to the transfer of ownership provisions, financial support for PEG access channels, scope of authority to be contained in the franchise, definition for gross revenues on which franchise fee payments are based and institutional network services.

Historically, cable operators have negotiated the above-requirements franchise by franchise based on the local community needs and interests. As the cable operators have become larger and more focused on regional clusters it has become more important for franchising authorities to clearly document all of their local needs and interests during the renewal process. If informal negotiations prove unsuccessful, the franchising authority is then prepared to enter into formal renewal procedures to protect its rights and interests.

5. Debt Load High, Cash Flow Low

As the major cable operators have consolidated and grown in size so too has their accumulated debt. Recently, Charter Communications announced to shareholders that it would attempt to reduce its swelling $18 billion of debt to improve its 2003 cash flow. One of the main strategies for reducing debt is to cut back on capital expenditures. This means that system upgrades not already mandated within local franchises may be impacted by a reduction in capital expenditures. In addition, the rollout of new services such as high-speed data, video-on-demand, interactive television and related product offerings may be delayed as cable operators attempt to grapple with the high debt carried on the systems. In a recent Forbes article, James Chanos identified the per subscriber debt of cable operators, including 1) Cox $1,100 debt per subscriber, 2) Comcast $1,352 debt per subscriber, 3) Cablevision $2,404 debt per subscriber, and 4) Charter $2,497 debt per subscriber. Bankrupt Adelphia’s debt was $2,508 per subscriber (numbers were not available for AT&T and AOL Time Warner). With cable industry stocks trading at a fraction of their 52-week high, 2003 is not expected to be a strong year for capital spending as a percentage of revenue.

Key Legal Decisions Regarding the Franchise Renewal Process

1. Frontier Operating Partners, L.P. v. Town of Naples, Maine, No. 01-16-P-DMC, 2001 WL 220192 (D.Me Mar. 7, 2001).

The court found in favor of the Town in a dispute over the applicable deadlines imposed by 47 U.S.C. § 546. Often cities and cable operators will enter into agreements clarifying whether the renewal process is being conducted “formally” or “informally.” The Naples decision is helpful in clarifying the statutory deadlines imposed upon operators and cities involved in a formal renewal process.

2. Cablevision of the Midwest, Inc. v. City of Brunswick, Ohio, No. 199CV1442 (N.D. OH Dec. 18, 2000).

The court found that there was sufficient evidence in the record to conclude that “Cablevision failed substantially to comply with material provisions of the existing franchise agreement.”

The City used a hearing officer to conduct the administrative hearing required under 47 U.S.C. § 546, but ultimately issued findings contrary to those of the hearing officer. The court held that while the City was entitled to use a hearing officer to promote administrative efficiency, it was not bound to accept the hearing officer’s findings of fact and conclusions of law. This decision is particularly important in that it supports the decision of Union CATV, Inc. v. City of Sturgis, Kentucky, 107 F.3d 434 (6th Circuit 1999) by specifying that the task of the District Court was to “determine whether, considering the evidence in the light most favorable to Brunswick, a reasonable fact finder could have found by a preponderance of the evidence that Cablevision had not substantially complied with the material provisions of the franchise.” This standard of review is quite favorable to municipalities and strengthens their rights during franchise renewal.

3. Union CATV, Inc. v. City of Sturgis, Kentucky, 107 F.3d 434 (6th Cir. 1997).[1]

On February 24, 1997 the City of Sturgis, Kentucky’s decision to deny Union CATV’s proposal for renewal of its cable television franchise was upheld by the United States Court of Appeals for the Sixth Circuit. The Sixth Circuit found that the Cable Act “provides for limited judicial review” of a franchising authority’s identified cable-related community needs and interests and that the preponderance of the evidence supported the City’s determination that Union’s proposal for franchise renewal was not reasonable to meet those needs and interests.

On July 10, 1995 the City adopted a Resolution denying Union’s renewal proposal on the grounds that it failed to meet the identified cable-related community needs and interests. Union filed a complaint in Federal District Court alleging that the City’s denial was not supported by a “preponderance of the evidence” as required by the Cable Act. On December 29, 1995 the Federal District Court granted the City’s motion for summary judgment. On appeal Union claimed that the District Court erred in refusing to conduct any review of the City’s identification of its needs and interests.

The Sixth Circuit found that the granting of a cable franchise is a legislative act traditionally entitled to considerable deference from the judiciary. The Court stated that “the City Council’s knowledge of a community gives it an institutional advantage in identifying a community’s cable needs and interests. A Court should defer to the franchising authority’s identification of the community’s needs and interests except to the extent necessary to weigh the needs and interests against the cost of implementing them.” The Court also found that the judicial review in such cases is similar to the review of a jury verdict on a motion for a judgment as a matter of law. In that situation the Court must not substitute its judgment for that of a jury, but instead “must view evidence in a light most favorable to the nonmoving party.” Likewise, the Sixth Circuit concluded that Congress intended that courts would give a franchising authority a degree of deference comparable to that owed a jury.

4. Robin Cable Systems, L.P. v City of Sierra Vista, No. CIV93-020 (D. Az. June 10, 1993).

The City assessed an annual license fee of 5% of gross revenues from the operation of the cable system in the City. One provision of the license agreement required the cable operator to reimburse the City for the costs incurred in the licensing process in an amount not to exceed $30,000. The court held that while the Cable Act allows a municipality to make charges over and above the 5% license fee “incidental to the awarding….of the franchise…. A fee of up to $30,000 is more than incidental. Any substantial fee charged on top of the annual 5% license fee was determined by the court to be inconsistent with the Cable Act. The annual 5% license fee was determined by the court to be inconsistent with the Cable Act. Moreover, the court held that nothing in the license agreement demonstrated that Robin Cable Systems had waived its ability to assert its statutory rights.

5. Time Warner Entertainment Co. v. Briggs, C.A. No. 92-40117-GN (D. Mass. Jan. 14 1993).

The towns of Athol and Orange, Massachusetts had in place bylaws governing the operation of cable television operators in their communities. In October 1992 both towns granted renewed licenses to Time Warner, certain portions of which were inconsistent with the bylaws. Time Warner brought an action alleging that the bylaws regulating the issuance of cable television licenses violated Time Warner’s constitutional rights and were inconsistent with federal law. The court concluded that certain provisions of the bylaws were preempted by the Cable Act. The provisions included such matters as mandatory universal service, reimbursement of consultant fees, collection of personally identifiable information and most favored community status. Each of these provisions were all held to be in conflict with the Cable Act.

6. Rolla Cable Systems, Inc. v. City of Rolla, 761 F. Supp. 1398 (E.D.Mo. 1991) (Rolla II).

a. Cable operator argued it was denied due process because City was prejudiced. The court concluded that some predisposition was inevitable although not objectionable. Court stated that had Congress wanted “complete neutrality” it could have required a neutral third-party to conduct the renewal proceedings. A franchising authority’s familiarity with the cable operator’s service places the franchising authority in the best position to gage the renewal request which is why Congress relegated the renewal decision to the franchising authority, not a neutral third-party.

b. Cable operator argued that it did not receive proper notice and an opportunity to cure its poor performance. The court concluded that notice from the City administrator, rather than the City council, was insufficient. In addition, the notice must be specific in its explanation of the problem so that the cable operator can respond. Simply stating that the service is poor is too vague.

c. Cable operator argued that denial based on financial, legal and technical qualifications was improper. The City had submitted testimony from a consulting engineer and court concluded that in deciding technical competence the past performance of the cable operator is highly relevant and may be considered.

7. Continental Cablevision Inc. v. Irwin, No. 91-11256-N, (D. Mass., June 4, 1991).

The court held that a cable operator can challenge the procedures utilized during formal administrative hearings at any time, even before the hearings have been completed. A cable operator is allowed to call witnesses at administrative hearings and has a right to present “all” evidence without delay or interruption.

8. Triad CATV, Inc. v. City of Hastings, No. L89—30090 (W.D. Mich. Dec. 21, 1989) aff’d, 916 F. 2d 713, (6th Cir. 1990).

The franchise was set to expire on May 12, 1990. Thus, the six month window existed between May 12, 1987, and November 12, 1987. On November 24, 1987, the cable operator sent notice of its intent to renew. On December 2, 1987, the City received the letter. The court held that the notification letter must be received during the six month window. Thus, the cable operator waived its right to proceed under the formal renewal process contemplated within Section 626 of the Cable Act.

9. Rolla Cable Systems, Inc. v. City of Rolla, 745 F. Supp. 574 (E.D.Mo. 1990) (Rolla I).

City denied renewal on the ground that the cable operator lacked the required financial, legal and technical ability to provide the services it promised and had failed to comply with the franchise or provide adequate service in the past. The court held that the cable operator is not entitled to retry the renewal issues in district court and therefore the review is not de novo. In other words, the court will only look to the record of the administrative hearing to determine if it is supported by a preponderance of evidence as opposed to retrying the evidence in the case. However, a review of procedural issues may be more stringent and in certain cases the court may look beyond the record of the City’s administrative proceeding “where fundamental due process concerns are implicated.”

10. TCI of South Carolina v. City of Bennettsville, No. 89-03341-2 (D. S.C. July 17, 1990).

In this case the City of Bennettsville issued a preliminary decision denying franchise renewal without conducting formal renewal proceedings required under the Cable Act. The court held that the actions of a franchising authority can be reviewed by the court at any time in the formal renewal proceedings and the court may grant relief where the action of the franchising authority was found to violate procedural requirements of the Cable Act. Therefore, the formal procedure is not rendered obsolete simply because the parties pursue informal negotiations. Moreover, once the formal renewal process is initiated it must proceed to conclusion unless mutual agreement is reached by the parties.

11. Eastern Telecom Corp. v. Borough of East Conemaugh, 872 F. 2d 30 (3rd Cir. 1989) cert. denied, 493 US 811 (1989).

The Borough solicitor conducted renewal hearings. The solicitor notified the cable operator to submit a renewal proposal. Solicitor provided a “verbal” notification of a deadline (April 30, 1986). The cable operator missed the deadline. The court held that it is up to the franchising authority, not the clerk (solicitor), to set the deadlines. The Cable Act establishes a significant federal law expectation in the renewal of a franchise; therefore, the franchising authority must give “formal written notice” of a deadline for submission of an operator’s proposal.

12. Birmingham Cable Communications, Inc. v. City of Birmingham CV 87-L-07555 (N.D. Ala., May 3, 1989).

The City required the cable operator to reimburse various franchising expenses, including consultant’s fees, as a condition for renewal of its franchise. The court held that the cable operator may apply for and obtain renewal of its franchise without having to pay, or agree to pay (above and beyond the Cable Act’s 5% franchise fee limitation) the City’s franchising expenses, consultant costs, or any other regulatory costs or fees.

Key Legal Decisions Regarding the Franchise Transfer Process

1. AT&T Corp v. City of Portland, 216 F.3d 871 (9th Cir. 2000).

On June 22, 2000 the United States Court of Appeals for the Ninth Circuit reversed the judgment of the District Court by holding that a franchising authority may not regulate cable broadband Internet access because the transmission of Internet service to subscribers over cable broadband facilities is a “telecommunications service” and not a “cable service” under the Communications Act of 1934, as amended by the Telecommunications Act of 1996 (“Communications Act”).

At the heart of the appeal, the Ninth Circuit addressed the question of whether a local cable franchising authority may condition a transfer of a cable franchise upon the cable operator’s grant of unrestricted access to its cable broadband transmission facilities for Internet service providers (“ISPs”) not affiliated with the operator’s proprietary service.

The case began with the proposed merger between AT&T, one of the nation’s largest long distance carriers, and Tele-communications, Inc. (“TCI”), one of the nation’s largest cable television operators. On December 17, 1998 the City of Portland and Multnomah County, Oregon (collectively, “Portland”) approved the proposed transfer of the local cable television franchise to AT&T subject to an open access condition which would allow subscribers to purchase cable broadband access separately from unaffiliated ISPs. Portland argued that without such a provision, subscribers would have no choice over the terms of Internet service such as content and bandwidth restrictions. The service to be offered by AT&T was known as “@Home,” which bundles its cable conduit with Excite, an ISP, under an exclusive contract.

AT&T refused Portland’s condition which resulted in a denial of the request for the transfer of the cable television franchise. At such time, AT&T brought an action charging that the open access condition violated the Communications Act, among other claims. The District Court rejected all of AT&T’s claims and granted summary judgment to Portland.[2] In the Ninth Circuit decision, the court grappled with the question of whether @Home is a “cable service” to be governed by a local cable television franchise or a “telecommunications service” governed by the common carrier provisions of the Communications Act, of which local governments have no control. The Ninth Circuit held that AT