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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
v.
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

INTRODUCTION

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 Amendment.

PROCEDURAL HISTORY

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.

FINDINGS OF FACT

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.

The Parties

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.

8. The County was advised that CCI, the parent company, would manage the south county franchise area and was provided with information concerning CCI's technical qualifications to do so. The County did not ask for copies of employment contracts for CCI personnel or other evidence that CCI senior management would remain in place. The County did not ask any questions regarding the technical or financial qualifications of individual shareholders of CCI, or for a guaranty by individual shareholders, or for individual employment contracts. These omissions arguably stand in contrast to affirmative inquiries made by the County in the later CCI/Allen transaction.

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 Charter.

The CCI/Allen Sale

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.

19. On July 30, 1998, Charter and CCI notified the County of the transaction and represented that CCI's existing senior management would continue as the senior management of the newly-consolidated companies. Charter, CCI and Mr. Allen requested the County's consent to the change of control. Consent was required under the local cable ordinance, incorporated into the franchise agreement, but could not be "unreasonably withheld," a phrase that is the crux of the case (TX 2 at 900). They submitted an FCC Form 394 with attachments on August 18, 1998 (TX 6).

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 franchise area.
(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 million.
(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 purchase price.
(g) Mr. Allen had fabled wealth and sufficient assets to close the transaction and to operate the nationwide system including the south county franchise area.

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 shareholder.

The County's Response

23. One of the key issues in this case is whether it was lawful for the County to respond to the change-of-control request by launching a wide-ranging investigation into what Mr. Allen might or might not make as a return on his stock investment in CCI over the years and whether he would eventually have incentives to try to increase rates and cut services. The County insists that its concern arose out of the fact that Mr. Allen seemed to be paying a high price for the nationwide enterprise, i.e., a price at the high end of the market (or higher) for cable systems in general. If so, the County claims it feared Mr. Allen would cut back on local service or try to increase local rates as a way to earn an "acceptable" rate of return. In contrast, plaintiffs contend that these fears were fanciful and mere pretexts for a hold-up, i.e., the manufacturing of false or exaggerated concerns to trade off later for monetary or other illegal concessions.

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 employed.

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 ...

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