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CHARTER COMMUNICATIONS, INC. v. COUNTY OF SANTA CRUZ
March 7, 2001
CHARTER COMMUNICATIONS, INC., A DELAWARE CORPORATION; CHARTER COMMUNICATIONS PROPERTIES, LLC A COLORADO LIMITED LIABITITY CORPORATION; AND PAUL G. ALLEN, AN INDIVIDUAL
COUNTY OF SANTA CRUZ, DEFENDANT.
The opinion of the court was delivered by: William Alsup, United States District Judge.
FINDINGS OF FACT AND CONCLUSIONS OF LAW AFTER BENCH TRIAL
In this case of first impression concerning the application of
the 120-day rule under Section 617 of the Cable Television Consumer
Protection & Competition Act of 1992, 47 U.S.C. § 537, the issue is
whether the County of Santa Cruz, California, unlawfully and unreasonably
refused to consent to a change in ownership for a local cable franchise.
Also presented is the question whether its refusals violated the First
This action commenced in early 1999. On November 12, 1999, the Court
granted in part and denied in part the County's Rule 12 motion,
dismissing plaintiffs' takings claim as unripe and their direct claims
under Section 617 of the 1992 Cable Act, 47 U.S.C. § 537, for lack of
a private right of action. Plaintiffs were allowed to proceed on their
claim for infringement of their constitutional free-speech rights under
42 U.S.C. § 1983 and their contract claim to enforce a franchise
agreement promise not to "unreasonably refuse" to approve such
transactions, a claim that indirectly takes into account any violations
of the 120-day rule. Charter Communications, Inc. v. County of Santa
Cruz, 74 F. Supp.2d 937 (N.D.Cal. 1999). On January 11, 2001, the Court
denied cross-motions for summary judgment. A bench trial began in late
January. The trial concluded on February 15, 2001. The Court now makes
the following findings of fact and conclusions of law.
The parties have submitted voluminous proposed findings, and the Court
has considered all of them. In the interest of clarity, however, this
order focuses on the essentials. A number of proposed points, while
arguably relevant and accurate, have been omitted as too distracting.
That a finding has not been incorporated into this order does not mean
that the Court rejected its accuracy. This order will cite the record as
the exception and not the rule. For some exhibits, page cites are to the
original page numbers and for others to Bates numbers, as convenient.
1. Formed in 1992, Charter Communications, Inc. ("CCI"), has
been at all relevant times in the cable-television business, providing
service through one or more operating subsidiaries, including Charter
Communications Properties, LLC ("Charter"). The latter acquired a group of
cable businesses in California in 1997-98, one of which operated in Santa
Cruz County, namely, the so-called "south county franchise," covering
unincorporated areas surrounding the cities of Capitola and Watsonville. By
1998, CCI was a nationally-ranked cable operator and had acquired 22 cable
systems in the United States. In 1998, Paul G. Allen purchased CCI,
including its subsidiaries, in a $4.5 billion nationwide transaction. Mr.
Allen was the co-founder of Microsoft Corporation and is
wealthy. He paid cash for the Charter stock. Mr. Allen, CCI and Charter
are the plaintiffs herein. They sued Santa Cruz County when it refused
to approve the change in control for the local franchise in question.
Whether that refusal was reasonable and lawful is the question
presented. The County is the sole defendant.
The History of Cable in Santa Cruz County
2. Topography has long made cable important in Santa Cruz County. The
area is surrounded by mountains that block reception of over-the-air
signals from major metropolitan areas such as San Jose and the Bay Area.
Until recently, the quality of service of cable providers in the area has
lagged behind other parts of the country.
3. To operate a cable business in Santa Cruz County, it was (and
remains) necessary to obtain a franchise from the local franchising
authority, as elsewhere in the United States. Here, that franchising
authority was the county government. From time to time, the county
government had been frustrated over the cable service in the area. In
dealing with cable operators, the County had even been threatened with
termination of cable services. At least one operator told local officials
that it could not continue providing services due to financial stress.
4. One troublesome prior operator was Sonic Cable Television. Prior
to May 19, 1998, it had the south county area. Its franchise had actually
expired in or about 1982, but thereafter Sonic had continued to operate
as a holdover tenant. Under its franchise, the County's consent was
required for a transfer of ownership (TX 3).
The Charter/Sonic Transaction
5. In 1997, an opportunity arose to improve conditions for the
franchise. On August 19 of that year, Charter purchased Sonic's cable
assets, including the south county operation. The Charter/Sonic
transaction involved over forty cable television franchises located in
two states, serving over 100,000 subscribers. Although the Charter/Sonic
transaction is not at issue herein, it serves as important foundation,
both sides assert, for the events that followed a few months later in the
transaction that is at issue. By way of prelude, consequently, the
following findings have relevance.
6. In September 1997, Charter and Sonic requested the County's
consent to the transfer of the franchise. Federal law recognizes the
power of local franchising authorities to approve or disapprove transfers
but imposes certain restrictions discussed hereinafter. The FCC has
promulgated a specific form to be used to seek approvals from local
franchising authorities called Form 394. 47 C.F.R. § 76.502. In the
Charter/Sonic transaction, the parties submitted a Form 394 plus
attachments to the County, which then requested and received additional
voluminous supplemental information.
7. In the consent process, two individuals were the main actors for the
County. One was Mr. Pat Busch, the assistant county administrative
officer. He was schooled in cable issues. The County also retained Attorney
William Marticorena, a private lawyer in Costa Mesa, California, to act as
its special counsel. Mr. Marticorena was a graduate of Harvard Law School
and specialized in cable law. For Charter, the individual primarily
involved was Ms. Trudi Foushee, a vice president and senior counsel of the
parent company CCI. All three were later leading actors in the CCI/Allen
transaction. All three testified at trial.
9. Two of the items provided to the County were a five-year projected
income statement for Charter nationwide and a ten-year projected income
statement for Charter allocated specifically for Santa Cruz County (TX 58
and TX 60). These projected income statements contained projected capital
expenditures, including rebuild costs, and a footnote explaining how
revenue, expense and capital items were allocated. The County did not ask
any questions regarding the revenue-growth assumptions used therein.
10. Through Mr. Marticorena, the County served Charter with extensive
information requests. After the County served on Charter its second
information request (TX 30), the discussions shifted to what concessions
the County wanted. Messrs. Busch and Marticorena made clear that any grant
of a cable franchise to Charter would have to include, at a minimum, the
following: (a) a commitment by Charter to construct or rebuild a
state-of-the-art cable system (750 MHZ, two-way system), which would ensure
a minimum of 61 channels; (b) an immediate reduction of existing subscriber
rate levels plus a rate freeze until the system rebuild was completed, plus
significant restrictions on Charter's ability to increase rates in the
future; and (c) cash payments for what the County believed had been
franchise violations by Sonic. The proposed rate order would have limited
Charter's ability to increase rates as might otherwise be permitted under
the applicable FCC rate regulations. Charter demurred.
11. Mr. Busch then sent Ms. Foushee a "draft staff report" and
draft county board resolution recommending denial of the transfer (TX 20).
Among other things, they stated that Charter had failed to provide critical
information regarding its ability to receive an acceptable rate of return
and that Charter did not have the qualifications to own or operate the
cable system. Viewed in the overall context of the negations, it seems
clear that the County utilized the threat of a denial as a way to get
Charter to accept its demands.
12. In the face of this threat, Charter acquiesced. An agreement
resulted. On or about May 19, 1998, the County's board of supervisors
adopted a resolution approving the transfer to Charter (TX 3). The
parties entered into the following, which reflected various conditions
imposed by the County for its consent: (a) a new franchise agreement; (b)
a rate order; and (c) a transfer agreement.
13. The hard bargain was excellent for the County. The new franchise
agreement required Charter, among other things, to construct, within 24
months, a two-way state-of-the-art cable system, and to offer a
61-channel "basic service tier," including 23 channels not previously
available. It further required Charter to put up a $500,000 letter of
credit and a one-million-dollar performance bond. It also provided for
the County's recovery of liquidated damages of up to $2,500/day for
material breaches (TX 3).
14. The rate order had, and still has, the effect of restricting
Charter's ability to increase rates that might otherwise be permitted
under applicable FCC rate regulations (TX 3 at 1864-71). The rate order
included provisions requiring a basic-service rate plan which provided
for an immediate rate reduction to subscribers, a ten-percent discount
for low-income senior citizens and the disabled, a rate freeze for
approximately two years during completion of the rebuild, a low "basic
service rate" when the system rebuild was completed, lower than Sonic's
former rates, on a per-channel basis, and a provision restricting
Charter's ability to increase rates thereafter to the greater of either
(a) 95% of the increase in basic service rates (weighted by system and by
tier) in Los Angeles and Riverside systems (where there was "intense over
the air competition") owned and operated by Charter entities or (b) 95%
of the TCI regulated basic
service rates, plus $2.00 (TX 3 at 1864-65). Another effect of the rate
order was that Charter was required to maintain its "cable programming
service tier" as a part of the "basic tier," and to waive the federal
deregulation of the "cable programming service tier" that went into
effect in 1999. As a result, the County has further regulated an area of
cable services that is not normally regulated in the country.
15. Piling guarantees on assurances, the transfer agreement finally
included a further unconditional guarantee by parent CCI of Charter's
performance of its obligations under the franchise agreement and County
ordinance, and included an agreement to pay the County $75,000 (TX 3 at
1852, 1858). It also provided that a breach of the rate order or the
transfer agreement would constitute a breach of the franchise agreement.
The transfer agreement set forth, among other things, (a) a specific
requirement that Charter submit a cost-of-service filing to the County,
(b) the parties' agreement, in advance, to the County's adoption of the
rate order (which, in the interim, Charter agreed to treat as a valid
mutual contract), (c) Charter's waiver of any right to challenge or
appeal the rate order, (d) Charter's agreement to accept the rate order as
a lawful and fully binding cost-of-service rate order, (e) Charter's
agreement to waive any right to file any further cost-of-service forms
for the remainder of the franchise term (TX 3 at 1855-57).
16. At trial, the County asserted that the draft denial report had
been no threat at all, but was legitimate ambivalence. It advanced
reasons for its sending the draft and then reversing course. For
example, the County knew, it claims, that Sonic had been levying a bogus
possesssory interest tax on its bills and collecting it from subscribers,
even though no such tax in fact existed. The County also argued it had
discovered that the acquisition would be routed through a Norwegian
company. These were, the County claims, the real reasons for the denial
recommendation. These were marginally plausible considerations.
Ordinarily, a court should give the benefit of the doubt to the County on
this point. Considering all the evidence and considering carefully the
entire course of conduct, however, the Court finds that these
considerations were make-weights and that the real reason for the denial
recommendation was to use the County's power to deny as a basis for
extracting concessions illegal under federal law, particularly as to the
rate order. This also explains why Mr. Marticorena and Mr. Busch insisted
on the extraordinary waivers in the final language, acquiesced in by
17. With the foregoing history, we now turn to the transaction at
issue, which followed the foregoing by only a few months. On July 29,
1998, Paul G. Allen contracted with CCI and others to purchase
approximately 94% of the outstanding shares of CCI and certain of its
affiliates as part of an approximately $4.5 billion acquisition
(approximately $2.26 billion in cash and $2.2 billion in assumed debt)
that would (and later did) result in a common ownership of all cable
properties then managed by CCI under a single umbrella company. As a
result, the ultimate corporate control of Charter was held by Mr. Allen,
as the new majority shareholder of CCI.
18. Through the CCI/Allen transaction, Mr. Allen acquired controlling
ownership interest in legal entities holding over 473 cable television
franchises in eighteen states, serving over 1.2 million subscribers and
more than 38,000 plant miles of coaxial and fiber-optic cable. In
addition to being a co-founder of Microsoft, Mr. Allen was a director of
various technology-related companies involved in the development of new
technologies and the deployment of new services.
20. The cover letter from Charter's president and CEO, Mr. Jerald Kent,
stated in part (TX 6 at 0762):
You will be pleased to know that there will be
no increase in debt-to-equity ratios of the
entities as a result of this transaction. Mr.
Allen will assume the current debt and in many
instances liquidate some debt instruments.
Notwithstanding the consumer benefit of this
transaction, the effect of this transaction on
you and your subscribers should be transparent
for the most part. The current corporate staff
and system management will remain under my
leadership. And of course, Charter will retain
its commitment to superior customer service.
21. The materials provided to the County as part of the Form 394
submissions supported the following facts:
(a) As a result of the transaction, Mr. Allen
would become a majority shareholder and a chair of
Charter's corporate parent, CCI.
(b) Following the close of the transaction,
Charter (and not Mr. Allen or CCI) would continue,
as before, to be the legal entity holding the
franchise for the south county franchise area with
no change in Charter's obligations thereunder.
(c) Charter would still be the legal title
holder for the cable system serving the south county
(d) The transaction was to be financed from Mr.
Allen's personal assets, required no new debt to the
Charter or CCI entities, and would not result in any
increase in the debt to equity ratios of either
Charter or CCI. In fact, the submission stated that
Charter's existing debt would be reduced by $34
(e) Charter and CCI had substantial experience
owning and operating cable systems, and the
management of the systems was to remain under Mr.
Kent's personal direction.
(f) Mr. Allen and the sellers were contractually
required (assuming the other conditions were
satisfied) to close the transaction, if and when
consents to the transfer of control had been
obtained from local franchising authorities of
franchises representing ninety percent of the total
number of subscribers of the Charter entities, taken
as a whole. Any delay of the closing past December
31, 1998, required a $100,000,000 reduction of the
(g) Mr. Allen had fabled wealth and sufficient
assets to close the transaction and to operate the
nationwide system including the south county
22. In sum, the transaction was structured without any increase in
the debt-to-equity ratios of the Charter entities, CEO Kent represented
he and other management would remain in place, and the
previously-negotiated rights and obligations of the parties remained the
same. The applicants simply wanted approval of the new majority
24. In this context, the same teams acted for the parties as before.
Mr. Marticorena and Mr. Busch were the primary bargainers for the
County. Ms. Foushee negotiated for Charter.
25. Out of the approximately 497 local franchising authorities who
received FCC Form 394 applications in connection with the CCI/Allen
transaction, no more than ten percent requested additional information.
Of those franchising authorities that did request additional
information, the ones jointly represented by Mr. Marticorena, including
Santa Cruz County, propounded the most lengthy requests. His was the only
information request that sought information to determine what rate of
return Mr. Allen would receive on his equity investment.
26. The Santa Cruz cable system had sold only months before (during
the Charter/Sonic transaction) for a price of approximately $1,564 per
subscriber, according to the Kagan financial data book, an industry
publication read and relied on by those in the cable business. In
contrast, the price per subscriber for the CCI/Allen transaction, as
indicated in the Kagan financial data book, was $3,600. According to the
Kagan financial data book, the $3,600 value per subscriber established
for the transaction was the highest or most expensive price paid for any
franchise nationwide. Also, the cash-flow multiplier for the CCI/Allen
transaction was higher than industry averages at the time. The cash-flow
multiplier for the transaction as indicated in the Kagan financial data
book was fourteen, the highest cash-flow multiplier reported in 1998.
This data was published by the time of the events in question.
27. Although it came to light only during discovery herein, a
pre-transaction due diligence study prepared privately for Mr. Allen
showed the same conclusions. It stated that the price for CCI was "above
the high end" of the range of prices of comparable cable systems and that
the purchase price per subscriber for the CCI/Allen transaction was the
highest purchase price of any cable transaction in 1998, and one of the
highest ever. It placed the cash-flow multiplier at fourteen as well.
This study was done by NationsBanc Montgomery Securities and will be
referred to herein as the NMS report (TX 65).
28. Up to a point it would have been reasonable, therefore, to
wonder, based on reliable industry sources, whether Mr. Allen was paying
somewhat more than market value for the national cable system. It is true
that a counter argument can be made, as Charter does, that Mr. Allen paid
substantially less for the Charter subpart of the acquired enterprise (TX
55). Still, it was not unreasonable for the County to rely on the Kagan
data. Whether, however, that concern should have translated into the
far-ranging investigation that developed is a different question.
The Demand for a Due Diligence Study
29. Under FCC regulations, the Form 394 submission was "complete" as
filed and the County has never contended otherwise. And, the Form 394
submission was thorough compared to the general practice in the cable
industry. The FCC Form 394 materials submitted for the CCI/Allen
transaction specifically informed the County that it had 120 days under
FCC regulations (47 C.F.R. § 76.502) to take action on the transfer
application (TX 10).*fn1
31. It must be emphasized that this meeting and subsequent negotiations
until December 1998 proceeded on a "group LFA" basis, i.e., Mr. Marticorena
acted for six California local franchising authorities with respect to the
parallel change-of-control requests pending before each on the acquisition.
At no time before December 1998 were there any specific communications
limited to Santa Cruz County (except, of course, the initial Form 394
filing). Neither party ever objected to proceeding in this manner. Both
sides evidently felt it was more efficient to proceed on a "group LFA"
basis. For this reason, plaintiffs' argument that the County should have,
on its own, pored over the earlier Charter/Sonic transaction filings in
order to find answers to its CCI/Allen questions is simply unfair. Mr.
Marticorena was acting for a group of LFAs. The entire group did not have
the Charter/Sonic information. Prior to December, Charter never made
reference to any Sonic filings as having the information requested.
32. During the August 26 meeting, Ms. Foushee explained the CCI/Allen
transaction. She asserted that the CCI/Allen transaction would not affect
rates. She further explained that, unlike many other transactions, because
the transaction was required to close by year-end 1998, Charter and CCI
could not agree to extensions of the time for the franchising authorities
to complete their review of the consent requests. She stated that the Form
394 was complete and provided more than sufficient information.
33. During the meeting, Mr. Marticorena requested that Charter and Mr.
Allen agree to pre-fund (i.e., pay in advance) the costs of a "due
diligence study" to be performed by a consultant hired by him to address
the financial feasibility of the proposed transaction and the impact of the
transaction on future rates. The consultant was William Morgan of Diehl,
Evans & Co., LLP. He had performed at least one prior due diligence study
for Mr. Marticorena.
34. At no time did Charter ever affirmatively agree, either at the
meeting or thereafter, to provide or to fund such a report, or that it
would be necessary, reasonable or lawful to require Charter to perform or
fund such a report as a condition for its consent. Ms. Foushee, however,
said she would "consider" the request. In follow-up conversations, Ms.
Foushee equivocated. Although she told Mr. Marticorena that such a study
was unnecessary, she also said that if one was going to be done, it
should be done by someone other than Mr. Morgan, who she said was biased
in favor of Mr. Marticorena. Asked to submit the resume of an alternate
candidate, she said she would but never did.
35. Prior to Mr. Marticorena's request, neither Charter nor CCI had
ever been asked to pay for a consultant to review its books and business
plan to see if a transaction was economically viable, or even to
participate in or cooperate with such a study. Such a request was
inconsistent with the practice and custom in the cable industry for
transfers or changes of control.
36. Under the terms of its franchise, Charter was (and remains)
required to pay a five-percent franchise fee to the County, the maximum
fee permitted by federal law (TX 3 at 1798). The County could have used the
franchise fee paid by Charter to fund a due diligence study if it had
chosen to do so.
37. These findings will return to the story of the proposed due
diligence study but, to maintain events in approximate chronological
order, we must now turn to the so-called first information request.
The First Information Request (September 1)
38. On September 1, Mr. Marticorena mailed Ms. Foushee a massive
information request, sometimes referred to herein and by all parties as
the "first information request" (TX 8).
39. The letter was nine pages long, single spaced. It requested
seventy items, including subparts. The specifics show that Mr. Marticorena
spent little or no time actually reviewing the Form 394 submissions before
sending the letter (TX 6) or trying to determine the applicability of the
questions to the actual deal. Instead, he printed out admittedly
boiler-plate information demands. For instance:
(a) The first fifteen standardized questions (TX
8 at ~~ 2-5) related to the impact of the
transaction on future cable rates and whether
plaintiffs would seek to use the acquisition costs
to justify future rate increases. Even the County
concedes these were form inquiries with little or no
application to the problem at hand.
(b) Many of the other questions referred to
"lenders" and "credit facilities" despite the fact
that the Form 394 submissions and Ms. Foushee's
August 26 meeting with the County's special counsel
made clear that no such loan agreements were to be
40. Beyond this, the request was broad and burdensome, asking, for
example, for "any and all agreements . . . or any other document which
exists in the hands of Charter, Paul Allen, or any related entity, or
both, regarding the System or Transfer" (TX 8 at 6), i.e., asking for every
sliver of data on the deal. The letter stated that the LFAs were "concerned
whether the Transfer, considering its totality of its economic impacts,
will preclude or impede Charter from realizing a reasonable return . . ."
(TX 8 at 1).
Charter's Supplemental Information
41. On September 17, 1998, Charter responded with a two-inch thick,
written response with back-up documents (TX 10). These materials included
financial statements, ten-year projected income statements, information
on the cable systems in which Mr. Allen then owned a controlling
interest, an explanation of Mr. Allen's anticipated role in the company,
and information on the calculation of the acquisition price (TX 10).
These materials included, among other things, (a) further assurance that
no new debt would be incurred by the Charter corporate entities in order
to finance the transaction, (b) information that Charter's debt would, in
fact, be reduced by approximately $38 million, and (c) a reassurance that
the purchase price would not and could not, under federal rate
regulations, be used to justify a later increase in regulated rates.
Regarding the latter, the submission stated:
Finally, as noted above, as Charter understands
the applicable FCC rules, the recording of
acquisition-related intangible assets for accounting
purposes in connection with the pending acquisition
will not have any impact whatsoever on the Form 1220
maximum permitted rate for the franchises at issue
here, for the simple ...