FRANCHISE RENEWAL

With few exceptions, the cable television franchise renewal process has remained unchanged since it was enacted into law twenty years ago. The renewal process under the Cable Act (47 U.S.C. § 546) provides cable operators with a high presumption in favor of renewal. Franchising authorities, in particular elected officials, often have difficulty understanding why negotiations regarding franchise renewal are so different than other contract negotiations which cities conduct each day. This paper will attempt to address some of the most frequently asked questions regarding franchise renewal in hopes of clarifying some misunderstandings regarding the renewal process.

1. Why can’t we put the franchise up for competitive bid and award a new franchise to the highest bidder?

RESPONSE: The Cable Act does not permit a franchising authority to deny a cable operator’s request for franchise renewal because another operator may be willing to agree to more favorable franchise terms. Under the formal renewal process an operator can only be denied franchise renewal for one of the following four reasons:

1) Operator’s failure to comply with existing franchise.

2) Quality of operator’s service.

3) Operator’s legal, technical and financial qualifications.

4) Reasonableness of operator’s proposal in relation to costs.

Unless a franchising authority can support denial based on the one of the above four reasons the incumbent operator is entitled to continue to provide cable service in the community. Thus, even if another operator were willing to meet more aggressive franchise obligations that fact would not preclude the incumbent operator from continuing to provide service until the franchising authority either accepts or denies its request for franchise renewal.

Twenty years after the Cable Act there are still relatively few competitive overbuilds where two wired cable operators compete head-to-head for subscribers in a jurisdiction. Thus, while nothing prohibits a franchising authority from seeking a competitive overbuilder via a bidding process, such a process will not affect an incumbent operator’s renewal protections under the Cable Act.

2. Should our city conduct renewal negotiations informally or pursuant to the formal renewal process under the Cable Act?

RESPONSE: Under the Cable Act your operator is required to submit a request for franchise renewal approximately three years prior to expiration of its franchise. This written request triggers the formal renewal protections outlined in the Cable Act. Failure by the cable operator to submit such a written request for renewal may result in a loss of the formal protections afforded under the Cable Act.

In its formal request for renewal an operator will often ask that the franchising authority commence “informal” renewal negotiations in hopes of reaching agreement on a new franchise. Cable operators are generally more comfortable handling renewals informally for a number of reasons. First, every major cable operator has professional government relations staff and employees that do nothing but negotiate new franchise agreements on behalf of the company. These employees are well versed in cable regulations and often are experienced lobbyists, skilled in the art of influencing elected officials. These operators seek to negotiate complicated franchises with city staff or elected officials knowing that city staff may only deal with cable television negotiations once every 10-15 years. In this scenario the operator enjoys a distinct advantage at the negotiation table.

Second, cable operators recognize that a franchising authority has no ability to deny franchise renewal under the informal negotiations. If negotiations are unsuccessful the parties still must resort to the formal process to bring renewal to a conclusion. Operators also recognize that if a city has invested significant time and energy into an informal process it is far less likely to start over in formal proceedings. Thus, the operator will enjoy greater negotiating leverage so long as the parties do not move into the formal renewal procedure.

Finally, cable operators have very little incentive to agree to aggressive local franchise regulations or other in-kind franchise obligations which may have been typical in prior cable television franchises. Given that the city has no ability to deny renewal, cities have very little leverage to mandate aggressive franchise requirements under informal proceedings.

Based on these and other factors a franchising authority is best served by proceeding with formal and informal negotiations simultaneously. In other words, a franchising authority, upon receipt of a request for franchise renewal, should commence proceedings to assess:

1) the city’s future cable-related needs and interests; and

2) the operator’s past performance under the existing franchise.

While the city is undertaking its formal needs assessment nothing precludes the parties from engaging in informal negotiations in hopes of arriving at a mutually acceptable franchise agreement. If the informal negotiations prove unsuccessful the franchising authority has already commenced its needs assessment and can easily move into the formal procedure if necessary. The ability of the franchising authority to move into the formal process without significant delay and additional cost is crucial in maintaining a strong negotiation position with the operator and providing options for elected officials should an informal agreement prove unacceptable.

3. Why is the renewal process more difficult today than it was five or 10 years ago?

RESPONSE: There are a number of reasons why the cable industry is more aggressive today in franchise renewal negotiations. One reason is that the industry has been consolidated over the last decade with relatively few operators controlling a significant percentage of subscribers in the country.

MPVD Market*
Comcast	23%
Time Warner	12%
Charter	7%
Cox	7%
Adelphia	5%
Cablevision	3%
DirecTV	12%
EchoStar	9%
Others	22%
TOTAL	100%
*Approximations from FCC’s 10^th Report on Competition.

The top four MSOs now control 50% of total cable subscribers in the country while the top 10 MSOs control nearly 80% of all subscribers. Moreover, DBS companies now have over 20 million subscribers, and in 2004 accounted for almost 25% of all cable subscribers in the country. In 1999, DBS accounted for only slightly more than 10% of all cable subscribers. Anyone who has been in franchise renewal negotiations in the last several years has repeatedly heard the cable industry refer to DBS competition. The cable industry argues that DBS is not required to pay a franchise fee nor support local PEG access and therefore cable operators are at a significant disadvantage when competing for subscribers.

With the market consolidation and increasing competitive pressure from DBS cable operators have become far more reluctant to agree to even modest franchise requirements. Cable operators are resisting customer service regulations, channel capacity for PEG access, capital support for PEG access, institutional network capacity for municipal applications and related in-kind franchise obligations. This has resulted in protracted renewal negotiations with significantly greater expense incurred by the franchising authority.

4. Residents in the community complain that cable rates are continuing to increase, what can we do about that in renewal?

RESPONSE: Cable operators remain subject to rate regulation, but only for the Basic Service Tier (“BST”). All other service tiers including digital and premium channels are free from rate regulation. Moreover, regulation of the BST is accomplished only through the FCC’s rate regulations established on either a benchmark or cost of service formula. While franchising authorities can only regulate rates for the BST, such regulation can still provide meaningful relief to cable subscribers for both the price of the BST as well as the equipment necessary to receive the BST.

Franchising authorities that may not previously have been certified to regulate rates are still permitted to obtain certification and begin regulating the rates for the BST. In certain cases, operators may be forced to trace back to rates from the early 1990s to justify the current BST rates which could result in significant refunds or reductions for BST subscribers.

Cable operators will often argue that if subscribers are concerned about the cost of cable service, franchising authorities should respond by reducing or eliminating franchise obligations so as to minimize pressure on subscriber rates. However, cities will argue that even if all franchise obligations are completely eliminated there is no guarantee that a cable operator will ultimately reduce cable rates but rather may simply achieve a greater profit margin in the system.

5. How can a city maximize the franchise fee payments received from the cable operator?

RESPONSE: Federal law at 47 U.S.C. § 542 provides that during any 12 month period the franchise fees paid by the cable operator with respect to any cable system shall not exceed 5% of the operator’s gross revenues derived in such period from the operation of the cable system to provide cable services. The key in franchise negotiations is how the parties define “gross revenues” for purposes of calculating the 5% franchise fee.

Below is a standard definition for “gross revenues” which encompasses many of the known revenue sources from cable operators today. It is also drafted broadly enough to encompass new revenue sources which an operator may derive from the provision of cable services in the future.

Gross Revenues shall mean any and all revenue derived directly or indirectly by Grantee and/or its Affiliates from the operation of its Cable System within the City including, but not limited to, 1) all Cable Service fees, 2) Franchise Fees, 3) late fees, returned check charges, and collection agency charges, 4) Installation and reconnection fees, 5) fee payments or other consideration earned (whether or not received) by the Grantee from programmers for carriage of Cable Services or marketing support in connection with the Cable Services on the Cable System, 6) upgrade and downgrade fees, 7) advertising revenue with no deduction or offset for internal commissions earned by employees of Grantee or its affiliates and external commissions earned by advertising agencies/representation firms/brokers/etc. regardless of whether such commissions are withheld from remittances to the Grantee, 8) home shopping commissions, 9) Converter and remote control rental fees, 10) Lockout Device fees, 11) guides, 12) production charges, and 13) to the extent permissible under Applicable Laws, Internet Service and equipment fees and any and all other related consideration earned or derived by Grantee resulting from the provision of cable modem service and data services within the City. The term Gross Revenue shall not include bad debts or any taxes on Services furnished by Grantee imposed upon Subscribers by any municipality, state, or other governmental unit and collected by Grantee for such governmental unit.

Over the last several years two cases have emerged that have provided clarification regarding the imposition of franchise fees on cable operators and whether such fees can be passed through to subscribers. These cases have been briefly summarized below.

a. The Pasadena Case

In October of 2001, the Federal Communications Commission (FCC) issued an order involving the City of Pasadena, California (“Pasadena Order”) which permitted cable operators to pass-through franchise fees to subscribers on cable television bills based on gross revenues that encompass “non-subscriber” revenue. Specifically, this non-subscriber revenue included income generated by advertising sales and home shopping commissions. As a result of the Pasadena Order many cable operators around the country increased franchise fees on subscribers’ bills by .25% or more.

A number of local franchising authorities (LFAs) around the country, including a group of Texas franchising authorities and the National Association of Telecommunications Officers and Advisers petitioned the Fifth Circuit for review of the Pasadena Order. On March 27, 2003, the Fifth Circuit denied the LFAs’ petition for review on the grounds that the FCC had acted within its broad discretion and not in a manner that was arbitrary, capricious or manifestly contrary to the statute in question. See Texas Coalition of Cities for Utility Issues v. FCC, 324 F. 3d 802 (5^th Cir. March 27, 2003).

The LFAs argued that the Pasadena Order should be reversed because it conflicts with two particular provisions of the Cable Act, 47 U.S.C. §§ 542 and 543. In particular, the LFAs contended that where the franchise fee is based on the percentage of the cable operator’s gross revenue, only the portion of that fee attributable to revenue from the subscribers may be passed through to subscribers. The LFAs argued that the Pasadena Order permitted an improper shifting of costs on to subscribers and that each class of the cable operator’s customers should bear a proportionate amount of the franchise fee (i.e., the portion of the franchise fee attributable to advertising revenue should be passed through to advertisers). The Fifth Circuit concluded that whether or not the court may have interpreted the statutes differently the FCC’s decision is entitled to deference and its order is not arbitrary and capricious.

The practical result for franchising authorities across the country is that cable operators can pass-through as a separate line item on subscribers’ bills all franchise fees due and owing the franchising authority. These franchise fees may include non-subscriber revenues, including home shopping and advertising revenues. In other words, cable operators are permitted to reap the benefits of growth in non-subscription revenue while subscribers must bear the financial burden of increased franchise fees.

By way of example, if a cable operator sells $100 worth of advertising to a local business to provide commercial spots on the cable system many franchises require the cable operator to pay a 5% franchise fee on that revenue. Prior to the Pasadena Order in 2001 cable operators paid the applicable $5 franchise fee on the $100 of revenue and/or assessed the $5 fee to the advertiser. Under the Pasadena Order this $5 franchise fee is now spread over all subscribers in that jurisdiction resulting in an increase (average increase from Pasadena case is approximately .25% per month) in the total franchise fee paid by a subscriber. In essence, the more advertising a subscriber watches, the higher the franchise fee on their bill.

The Fifth Circuit decision has not resulted in any reduction in franchise fee payments to LFAs although subscribers must now bear the burden of additional franchise fee payments even as cable operators increase non-subscription revenue.

b. Dallas Case

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.”

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, many operators substantially underpaid 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 have still not brought their billing systems into compliance.

6. Many subscribers in the community have expressed interest in receiving a specific channel of programming, during renewal can a city mandate that the cable operator carry a particular channel?

RESPONSE: At the time of franchise renewal, many franchising authorities believe they can require operators to change their programming lineup to include programming services not currently available on the system or to delete programming services they believe should not be on the system. This assumption is incorrect. Generally, operators have broad discretion to make editorial decisions regarding the programming to be carried on the cable system.

In some franchising authorities the debate on programming lineups revolves around the desire to reduce excessively violent programming or sexually explicit programming which may be available to children. While the franchising authority is entitled at the time of franchise renewal to make known the needs and interests of the community, the franchising authority can only require broad categories of programming as a specific requirement in the franchise. In other words, it is acceptable to identify sports, entertainment, music and movies as categories of programming. Franchising authorities may even specify a requirement for certain regional programming such as news and weather information from a particular region. However, a city cannot mandate that a particular programming service must be offered on the system.

7. Can the city obtain financial support for PEG access beyond the 5% franchise fee?

RESPONSE: Yes. The Cable Act at 47 U.S.C. § 542(g) provides a definition for “franchise fee.” This definition specifically excludes “capital costs which are required by the franchise to be incurred by the cable operator for public, educational or governmental access facilities.” Cable operators will emphasize that the Cable Act only permits the imposition of additional fees for “capital” and will argue that they cannot be obligated to pay additional support beyond the 5% franchise fee for “operational” costs. Capital costs generally include the cost of constructing a PEG access facility, cameras, decks, lights, editing equipment and related infrastructure. In addition, a franchising authority can include anticipated replacement costs for such capital over the life of the franchise.

Cable operators will generally oppose the imposition of any franchise obligations which exceed the 5% franchise fee cap on the basis that there is insufficient need in the community. Typically, franchising authorities will prepare for such an argument by conducting an assessment to document its future cable-related needs and interests including the capital costs associated with meeting PEG obligations.

8. Have there been any recent cases clarifying how the formal renewal procedure and administrative hearing is to be conducted?

RESPONSE: On September 29, 2003, the United States District Court issued an order denying Comcast’s motion for a preliminary injunction in a proceeding involving the city of San Jose, California. Comcast of California II, L.L.C. v. City of San Jose, California, NO. 5:03-cv-02532-RS (N.D. Cal. Sept. 29, 2003). The case involves a formal franchise renewal proceeding between San Jose and Comcast and the rules for the conduct of this hearing. On August 23, 2004, the court dismissed Comcast’s lawsuit against the city on the grounds that it was not ripe for adjudication given that the city had not yet denied Comcast’s request for franchise renewal.

The Cable Act at 47 U.S.C. § 546 requires a franchising authority to conduct an administrative proceeding if it preliminarily denies an operator’s formal renewal proposal. In this case the city adopted a resolution of preliminary denial which authorized the city manager to commence a formal administrative hearing. The city selected and appointed a hearing officer and established rules and procedures for the conduct of the administrative hearing. The city’s rules provided that the hearing officer would conduct the evidentiary phase of the administrative hearing and would then make a recommendation to the city council. Comcast argued that the procedure was improper because only the city council, as franchising authority, should conduct the hearing.

Unable to convince the city to change its rules, Comcast filed a complaint seeking declaratory and injunctive relief. Comcast argued to the court that the rules which the city intended to utilize were illegal because they 1) fail to provide adequate notice to Comcast of the city’s claims which support its preliminary denial of the renewal application; 2) are not grounded in any state or federal law; 3) improperly delegate authority to a hearing officer; 4) fail to establish a process which affords Comcast an opportunity to participate in a hearing before the city council; and, 5) fail to delineate the claims, evidence, and defenses which Comcast will be permitted to present at the hearing. Comcast also argued that its free speech and due process rights were violated as a result of the hearing procedure.

In its preliminary injunction decision the court carefully reviewed the requirements of Section 546 finding that the section requires the cable operator shall be afforded: 1) adequate notice; 2) fair opportunity for full participation, including the right to introduce evidence, to require the production of evidence and to question witnesses; and, 3) a transcript shall be made of the proceeding. The court held that Comcast could not show that it had been adversely affected by the city’s failure to follow the procedural requirements of the statute. The court found that “although Comcast is correct that it may loose its monetary investment, an event which will only occur if Comcast is ultimately denied renewal, Comcast has no entitlement to renewal. Therefore, its business decision to invest money into a San Jose cable system is just that – a business decision made by Comcast. Such decision cannot be used against the City to establish adverse impact.”

With respect to Comcast’s First Amendment argument the court held that the renewal requirements requested by the city were content-neutral, served the important government interests identified in the “needs and analysis report” provided to Comcast and appear to be narrowly tailored to achieve those needs. Moreover, with respect to Comcast’s due process arguments the court found that Comcast “is being provided with notice and an opportunity to be heard, both by a hearing officer and the city council, prior either to the acceptance or denial of its application for franchise renewal.”

9. Are there examples of franchise renewals which have been adopted in the last several years to provide a basis for comparison to our existing franchise?

RESPONSE: See chart attached hereto.

– END OF PAPER –

Brian T. Grogan is a shareholder with the Minneapolis law firm of Moss & Barnett. Brian represents municipalities throughout the country on franchise renewals, transfers of ownership, telecommunications planning, right of way issues, First Amendment issues, litigation and other related communication matters. Brian is a member of the American Bar Association (Forum Committee on Communications Law), National Association of Telecommunications Officers and Advisors, International Municipal Lawyers Association (Contracts, Franchises and Technology Section), and is Chair of the Communications Law Section of the Minnesota State Bar Association.

CABLE FRANCHISE RENEWAL PROVISIONS

PUBLIC, EDUCATIONAL AND GOVERNMENTAL SUPPORT*

Community	Population	Cable Operator/ Franchise Date/ Franchise Term	# of Access Channels	Cable Company PEG Funding
Cannon Falls, MN	3,795	Mediacom 3/03 – 5/9/15	1	$1.25 p/sub p/month $25,000
Moberly, MO	11,945	Comcast 3/01 – 12/31/10	1	35¢ p/sub p/month - beginning 1/1/03 $10,000
Savage, MN	21,115	Mediacom 9/99 - 10 years	5	50¢ p/sub p/month – maximum $1.50 $30,000
Stevens Point, WI	24,551	Charter 8/02 - 5 years	3	45¢ p/sub p/month
Carroll County, MD	35,000	Prestige Communications 5/00 - 10 years	5	Capital grant $500,000 due upon effective date Annually - $75,000 1^st anniversary thru term of franchise One-time grant - $300,000
Lakeville, MN	43,128	Charter 10/98 - 15 years	4	50¢ p/sub p/month - maximum 75¢ during years 1-5; 95¢ p/sub p/month years 6-10; $1.10 p/sub p/month years 11-15
Oshkosh, WI	62,916	Time Warner 11/01 - 15 years	3	35¢ p/sub p/month thru 10/31/05; 37¢ p/sub p/month thru 10/31/09; 39¢ p/sub p/month thru 10/31/13; 40¢ p/sub p/month thru end of term
NDC4 – Inver Grove Heights, Lilydale, Mendota, Mendota Heights, Sunfish Lake, South St. Paul and West St. Paul, MN	over 80,000	Comcast 4/00 - 15 years	7	83¢ p/sub p/month $250,000 – due 30 days after effective date; $250,000 on 1^st, 2^nd & 3^rd anniversaries; $100,000 2^nd anniversary $200,000 7^th anniversary $200,000 10^th anniversary
Eau Claire, WI	93,142	Charter 6/00 - 15 years	1	75¢ p/sub p/month thru 4/30/05; 85¢ p/sub p/month thru 4/30/09 95¢ p/sub p/month thru 4/30/13; and $1.05 p/sub p/month thru end of term
Reno, NV	180,480	Charter 4/04 - 15 years	5	Access capital grant - $250,000 due within 30 days of effective date; $100,000 due 1^st anniversary; $100,000 due 2^nd anniversary; $100,000 due 7^th anniversary; $100,000 12 anniversary Annual capital grant - $.24 p/sub p/month beginning Jan. 2005 w/CPI
Arlington County, VA	189,453	Comcast – 7/98 Starpower – 8/00	6	Initial capital grant - $850,000 Annually - $289,000 equipment and construction of new studio Operating support – 1% of gross revenues (4% franchise fee) 3% gross revenues (above 5% franchise fee) for PEG and I-Net (built by incumbent operator) One-time payment for PEG access support - $30,000
Montgomery Cty, MD	Approx. 200,000 subs	Comcast 6/98 - 15 years	13	$2,000,000 in 1^st year; $1,200,000 in 2^nd year; $200,000 each additional year, CPI adjusted
Tampa, FL	303,447	Time Warner 3/00 - 15 years	6	Initial capital grant - $500,000 upon acceptance Operational support - $1,750,000 upon acceptance and $1,250,000 upon 5^th and 10^th anniversaries Community grants - $250,000 upon acceptance and $250,000 upon 10^th anniversary
Tucson, AZ	486,699	Comcast – 2002/10 years Cox – 1997/10 years Transfer 1998	6 minimum 7 maximum 9	$0.4442 p/sub p/month plus CPI paid quarterly to the City 1997 Franchise requires $0.40 p/sub p/month paid quarterly to the City 1998 Transfer Agreement requires prepayment of $500,000 deduced from each quarter payment made to the City for the next 10 quarters
Denver, CO	554,636	Comcast 1/00 - 15 years	8	Access support - $500,000 on or before 1/31/00 $500,000 on or before 1/31/01; $500,000 on or before 1/31/02 $500,000 on or before 1/31/03; $170,000 on or before 1/31/04 Initial Capital Grants for Access or I-Net purposes – $825,000 on or before 1/31/00; $1,200,000 on or before 1/31/01;$850,000 on or before 1/31/02 Capital Contribution for Access or I-Net – 6/03 – $.63 p/sub p/mo; 6/04 $.87 p/sub p/mo;6/05 - $1.00 p/sub p/mo
Seattle, WA	563,374	Western Integrated Networks 1/01 - 10 years