Auction Survival Guide

The NextWave saga is a cautionary tale. Here's how to avoid some common auction pitfalls.

Just as the FCC announced two major spectrum auctions, it took the extraordinary step of canceling 63 licenses of NextWave, a former PCS-auction winner. NextWave's travails point out the pitfalls of auctions and might provide savvy future bidders with important survival strategies.

In 1996, the FCC auctioned 493 C-block licenses, which were reserved to provide opportunities for small businesses offering PCS. As the high bidder for 63 of these licenses, NextWave, a start-up company, committed to pay $4.74 billion, with a 10%-down cash payment and the remainder in installments over a 10-year period. The FCC granted NextWave's licenses in February 1997 after it submitted a plan for making its capital structure comply with FCC regulations. NextWave subsequently executed a series of promissory notes for the balance owed.

By this time, C-block licensees were having problems securing financing for their licenses because their prices were more than four times greater than those of the D- and F-block licenses auctioned in August 1996. To provide relief, in October 1997, March 1998 and April 1999, the FCC issued orders that would allow C-block license winners to restructure their debt repayment and permit licensees to turn in some or all of their PCS licenses. Despite this additional latitude, the FCC refused to forgive any of their debt because, it argued, bid amounts were used to measure a bidder's commitment and ability to make the most of the license. Therefore, the FCC determined that adjusting any part of a licensee's obligation would not only undermine the FCC's license-allocation scheme but also could encourage insincere bidding.

Dissatisfied with the FCC's efforts and unable to meet its obligations, NextWave filed Chapter 11 in June 1998. In doing so, NextWave shifted the arena to the courts and sought to reduce its obligations to the FCC.

To Bankruptcy Court
The Bankruptcy Court proceedings focused on two primary issues: whether the court has jurisdiction to rule on NextWave's obligation to the FCC and if so, whether the conveyance of $4.74 billion for 63 licenses was constructively fraudulent. Under the bankruptcy code, if a debtor's payment obligation isn't "reasonably equivalent" in value to what it receives in return, the conveyance is considered constructively fraudulent, and the debtor's obligation can be avoided while it reorganizes.

The court held that it had jurisdiction and proceeded to treat the FCC as one of NextWave's creditors. It then held that the conveyance between NextWave and the FCC was constructively fraudulent. As a result, NextWave was allowed not only to keep its licenses but also avoided $3.7 billion of its obligation. The FCC appealed to the District Court, which affirmed the Bankruptcy Court's holdings.

More Legal Wrangling
The Court of Appeals for the Second District reversed the lower courts' judgment on both issues. The court reasoned that review of the FCC's regulatory conditions for licensees is reserved for federal courts of appeals and thus isn't in the Bankruptcy or the District courts' jurisdiction.

The Appeals Court agreed with the FCC's interpretation that under its auction rules, a successful bidder becomes obligated when a seller no longer can reject the bidder's offer "as a matter of discretion." Adopting this approach, the court determined that NextWave became obligated to pay the $4.7 billion for its 63 licenses when the C-block auction closed and not when the promissory notes became due. Because the obligation arose prior to the market value's plummeting, the court found that constructive fraud wasn't an issue. The court remanded the case to Bankruptcy Court.

"The problems that NextWave experienced were due in large part to the 9-month gap between the closing of the auction and the granting of the licenses and the FCC's announcement and the commencement of the wireless-communications-spectrum auction," said Deborah Schrier-Rape, NextWave attorney. "In light of these factors, the decision by the Second Circuit seemed harsh."

On Jan. 12, 2000, less than three weeks after the court's decision, the FCC canceled NextWave's 63 licenses. The FCC also filed an objection to NextWave's reorganization plan in Bankruptcy Court arguing that:

• NextWave's reorganization plan was predicated on Next-Wave's retention of its PCS licenses.

• The Second Circuit's ruling served automatically to cancel NextWave's licenses when Next-Wave didn't meet the FCC's terms and conditions.

• Thus, the automatic-stay provisions of the bankruptcy-code provisions aren't implicated by the licenses' cancellation.

In an angrily worded order, the Bankruptcy Court ruled that the FCC's cancellation of Next-Wave's licenses was null and void. It found that:

• The FCC's action violated the bankruptcy code.

• Without court permission, NextWave couldn't have made the payments expected of it during the bankruptcy proceedings.

• The FCC is barred from its cancellation action under the doctrines of equitable estoppel and waiver.

By nullifying the cancellation, the Bankruptcy Court has put itself at odds with the Court of Appeal's determination that the Bankruptcy Court can't interfere with the FCC's regulatory powers. The stage is now set for a new round of appeals.

Caveat Emptor
In May, the FCC will auction the 747MHz to 762MHz and the 777MHz to 792MHz bands for fixed, mobile and broadcast services. In July, it will auction licenses within the C and F blocks, which include NextWave's old licenses. Thus, the auctioning of spectrum will continue at a significant pace. Keep these tips in mind:

• Closely review the auction's terms and conditions. The Next-Wave litigation signals that the Court of Appeals will defer to the FCC's interpretations of its auction rules and procedures.

• Carefully and objectively evaluate the spectrum's value. When deciding whether to participate in an auction, avoid succumbing to "auction fever." Post-auction events can devalue spectrum, but the successful bidder will be held to have "assumed the risk" of subsequent market devaluation.

• The bankruptcy court is an expensive and uncertain harbor. The Court of Appeals and the Bankruptcy Court's wrangling over how much protection the bankruptcy code gives a licensee is far from over. According to the Bankruptcy Court, the parties have expended nearly $10 million to date to resolve how bankruptcy law and FCC regulations should interact.

The upcoming auctions offer opportunity as well as risk. The key to surviving and thriving in them is to understand the rules, objectively analyze the spectrum's value, develop a bidding strategy and then stick to that strategy.

We can only add that if recent history teaches us anything, it's that success purchased at too high a price is a Pyrrhic victory.

Sill (wsill@wbklaw.com) is a partner and Lin (clin@wbklaw.com) is an associate at Wilkinson Barker Knauer LLP.