Lenders to borrowers in the broadcast media and telecommunications industries understand what electromagnetic spectrum is and its critical importance to the operations of such borrowers. Understanding how and when security interests in spectrum rights are perfected, however, is another matter, but one that is essential for lenders doing business in this constantly growing space. A recent decision by the U.S. Court of Appeals for the Tenth Circuit in Valley Bank & Trust Co. v. Spectrum Scan, LLC (In re Tracy Broadcasting Corp.)[1] has clarified the legal status of such security interests, providing lenders with greater certainty and comfort when lending to spectrum licensees.

Legal Background

According to the Federal Communications Commission (FCC), spectrum is the “range of electromagnetic radio frequencies used to transmit sound, data and video across the country.”[2] Spectrum is managed by the FCC and licensed to individuals, business and governmental entities for a variety of uses on many frequency bands. Without rights to use spectrum, radio and television broadcasters and mobile telecommunications providers would be of limited value and, correspondingly, without security interests in the value attributable to spectrum licenses — secured lenders to these companies would have very little downside protection.

Because spectrum is a public good regulated by the FCC, lenders cannot obtain a security interest in spectrum itself. Further, as a regulated property right, the FCC retains sole discretion to approve spectrum licensees and manage such licensee’s rights. These considerations have informed the legal treatment of security interests in spectrum, which has most often been adjudicated in the bankruptcy cases of spectrum licensees.

In bankruptcy, the validity of security interests in spectrum licenses takes on heightened importance because much if not all of the value of a secured lender’s claim will hinge on the validity of the security interests in the significant value attributable to underlying spectrum licenses.

Two competing theories have emerged on this issue and they essentially turn on when the initial security interest in the value of a spectrum license attaches. The public-private rights theory, relying on a 1994 FCC declaratory ruling,[3] treats security interests related to spectrum licenses as severable into a public right in favor of the FCC and a private right in favor of the secured creditor. Under this theory, courts have viewed the underlying security interest as one in the debtor’s general intangibles (akin to a liquor license), which legally attaches upon the grant of the security interest and would be preserved in the context of the licensee’s bankruptcy case. Prior to Spectrum Scan, the majority of courts considering the treatment of spectrum-related security interests favored this theory.

The second theory — for purposes of this article, dubbed the proceeds theory — is premised on the proposition that the only operative security interests that can be obtained with respect to spectrum licenses are in the licenses themselves, but, rather, in the proceeds to be derived from the sale of such licenses. From this proposition, it follows that, under §9-203 of the Uniform Commercial Code (UCC), such liens do not legally attach upon the initial grant of security, but only when such licenses are sold with FCC approval. Bankruptcy Code §552(a) adds an important wrinkle to this theory, providing that these security interests would not be enforceable in bankruptcy if the sale occurred after the commencement of the licensee’s bankruptcy case because this provision cuts off security interests in any property acquired by the debtor after the petition date. It only preserves security interests in proceeds under §552(b) to the extent the underlying collateral to which such proceeds relate existed on the petition date. Thus, under the proceeds theory, absent a pre-petition sale of a license, upon a licensee’s bankruptcy, a secured lender would not have a ripe security interest in, and would be deprived of, the substantial value attributable to a debtor’s spectrum license.

The Lower Court Decision

In Spectrum Scan, the debtor, radio station operator Tracy Broadcasting Corp., granted to its lender (the bank) a security interest in all of its general intangibles and related proceeds. After the debtor commenced its bankruptcy case, an unsecured creditor, espousing the proceeds theory, contended that the bank’s security interest did not legally attach before the petition date to the proceeds of the debtor’s post-petition sale of its spectrum license and could not attach thereafter by operation of Bankruptcy Code §552(a). In response, the bank relied on the public-private rights theory and cited to the adoption of that theory by other bankruptcy courts.[4]

The bankruptcy court acknowledged the conflicting theories as well as the dearth of case law applying §552(a) to this issue. However, the bankruptcy court ultimately agreed with the unsecured creditor and held that the bank’s security interest in the proceeds of the spectrum license had not yet attached under UCC §9-203, which provides that a security interest in proceeds only comes into existence upon the debtor’s attainment of rights in the property from which such proceeds are derived. In reaching this conclusion, the bankruptcy court ruled that “anything received by the debtor on account of a transfer of the license post-petition would not be ‘proceeds’ under the UCC because the license itself could not be pledged as ‘collateral.’ ”[5]

The bankruptcy court, in rejecting the public-private rights approach, held that “the right to receive value for a transfer of its license did not exist prior to the filing of its Chapter 11 case because any such ‘right’ was too remote and was subject to two contingencies”[6] — specifically, the lack of a pre-petition sale agreement and FCC approval of the sale. The bankruptcy court concluded that, since “neither contingency had occurred pre-petition (and, indeed, neither has occurred to date), the debtor did not have a sufficient property interest in this contingency in order to transfer a security interest in it to the bank.”[7]

The bank appealed the bankruptcy court’s decision to the U.S. District Court for the District of Colorado, which affirmed the lower court’s ruling. The bank then further appealed the district court decision to the U.S. Court of Appeals for the Tenth Circuit.

The Appellate Decision

The Tenth Circuit reversed the lower court decisions, resolving the inherent conflict between the public-private rights and proceeds theories, joining the majority of courts and all other federal courts of appeals in favoring the public-private rights theory.^[8]

In arriving at its conclusion, the Tenth Circuit broke down its determination of the issue into two steps: first, it determined the nature of the security interest the debtor conveyed to the Bank and then turned to whether such security interest could attach before a sale of the underlying license.

Taking the first step, the Tenth Circuit, in reliance on the FCC’s 1994 declaratory ruling in Cheskey, found that the FCC recognizes that “permitting security interests [in the proceeds of the sale of a spectrum license] will improve licensees’ access to capital”[9] and that the Federal Communications Act “does not prohibit private interests or rights in value created by the licensee’s use of the airwaves.”[10] Based on these and other FCC pronouncements, the court then limned the precise security interest in question, describing it as “one in the licensee’s right to the proceeds of a license sale and in the proceeds of that right”[11] as opposed to merely a security interest in the proceeds of a license sale, which would not attach until the occurrence of such sale.

On the decisive question of if and when the security interest in question attached, the Tenth Circuit rejected the bankruptcy court’s holding that the security interest was one in the sale proceeds of the license that could not attach under UCC §9-203 in the absence of a sale. Instead, the court held that the security interest was in the licensee’s right to such proceeds — that is, a general intangible under the UCC that existed and attached at the time of the debtor’s initial grant of security. The Tenth Circuit then bolstered this conclusion with supportive FCC statements recognizing licensees’ need to provide security in such economic rights to raise capital.

In addition, the court alluded to UCC §9-408, which, among other things, overrides any state statute or regulation that prohibits the creation or attachment of a security interest in a contract or license. The court held that this provision, while not expressly overriding federal law, “implicitly recognizes the propriety of creation, attachment and perfection of such security interests in federal licenses when, as here, no federal law is thereby violated.”[12]

Conclusion

The Tenth Circuit’s decision demonstrates an acute understanding of the “commercial realities”[13] attendant to media and telecom financing and harmonizes the complex interplay between FCC policy and the interests of secured lenders as set forth in the UCC and Bankruptcy Code. Spectrum Scan is a well-reasoned precedent that lifts the cloud on media and telecom lenders’ expectations that existed since the underlying bankruptcy court’s decision in 2010. The decision is a boon to lenders and legal practitioners in the media and telecom space, bringing much-needed certainty to the question of the validity and attachment of lenders’ security interests in spectrum licensees’ economic rights and entitlements related to their underlying licenses.