Legal Tips For Dealing With Bankrupt Telecom Carriers

By Gregory Staple and Steven Abramowitz

When Global Crossing (GC), the world's largest supplier of fiber optic transmission capacity, filed for bankruptcy in January 2002, hundreds of customers and interconnecting carriers found themselves scrambling to review their legal rights.

Can GC suspend or terminate service on circuits covered by IRUs (Indefeasible Rights of Use)? Does a bankruptcy filing block an IRU holder's right to sell or swap capacity? And what about servicing a bankrupt carrier -- how can a vendor ensure payment? Also, can an existing supplier -- say, an interconnecting carrier -- set off monies due a bankrupt carrier against past or future fees that it is owed?

The participation of Vinson & Elkins in several recent telecom industry bankruptcy proceedings has helped to clarify the answers to these and related questions that typically arise. Our experience also yields a number of lessons for parties seeking to acquire core assets --transmission facilities, telehouses, customer contracts -- from the estate of a bankrupt carrier. Over forty bids for GC's assets have already been received, but final offers are not due until mid-June.

Let's look first at the status of IRUs sold by a carrier that petitions to reorganize its business under Chapter 11 of the Bankruptcy Code. The key issue is whether the IRU is to be considered (1) an "executory contract" which the debtor can reject (or effectively terminate) or assume and assign to another party; or (2) an absolute sale of capacity for which title has been vested in the purchaser. If the IRU is treated as an executory contract, a bankrupt debtor can reject its obligations leaving the counterparty with merely an unsecured claim for damages, notwithstanding the substantial purchase price already paid for the capacity. To date, however, the courts have not definitively resolved the legal status of an IRU which, in our experience, has triggered additional litigation and compromised settlement of IRU holders' interests.

What about payment for post-petition services and set-offs? It has become standard procedure in carrier bankruptcies for the debtor to treat all interconnecting carriers and other suppliers of telecom capacity as "utilities" under Section 366 of the Code and, accordingly, require continued services post-bankruptcy. The key issue is the level of security that the Court will require a bankrupt party to provide in exchange.

In a number of cases, Bankruptcy Courts have directed the debtor to provide deposits, liens on assets, accelerated billing and payment terms, and other security as a quid pro quo for continued service, but the specifics may well turn on the parties' negotiations. In addition, in some cases, a supplier has sought to set-off its pre-petition claims upon the debtor against amounts that it owes either to the same debtor or a related entity and for both pre-bankruptcy and post-bankruptcy periods. Well drafted supplier contracts can avoid such disputes because most Courts have been reluctant to permit supplier set-offs, except when they involve claims and debts that are all pre-petition with respect to the same entity.

In principle, a bankruptcy filing may offer a competitor a unique opportunity to acquire key assets or even an ongoing business at a fraction of its original cost, and several parties have seized that opportunity. For example, a group of investors acquired Iridium's $6 billion global satellite system for approximately $25 million, and WinStar, once a multibillion dollar wireless network, was sold to IDT in 2001 for about $40 million. Similarly, PSINet, the bankrupt Internet backbone provider, has said that it will sell its entire U.S. telecom business for $10 million despite the fact that, less than a year earlier, its Canadian business fetched almost $100 million.

In bidding for any bankrupt assets, careful legal, regulatory and financial due diligence is a must. These key concerns, amongst others, should be keep in mind:

** The status of any IRUs, including the financial health of the applicable counterparty given that an IRU can be rejected in a bankruptcy;

** Closing conditions, especially any "material adverse change" clause which must be carefully drafted;

** Escrows or holdbacks for unanticipated liabilities;

** The status of the financing on any equipment being purchased -- is it a "true lease" or secured financing;

** Bidding protection, including a court approved "break up fee" in the event an initial bid is used as a stalking horse for other higher bids;

** The potential for regulatory delays -- in some cases, FCC or state PSCs have successfully petitioned Bankruptcy Courts to block service cut-offs and delay or postpone asset sales to protect consumers, which may also give under-bidders a second chance.

The lessons from the current wave of carrier bankruptcies are becoming clearer, but vigilance is essential. Vinson & Elkins regularly monitors more than a dozen major insolvency cases including those concerning Global Crossing, 360 Networks, PSI Net, Viatel, Star Telecommunications, RSL Com, PT-1 Communications, Iridium, WinStar and Exodus Communications. Please contact us if you would like further information about any of these cases or would like to consult with us about your relationship with a bankrupt company or a carrier whose financial future may be uncertain.

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