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Telecom bankruptcies: a high price to pay for competition.

The beleaguered telecom industry was dealt a harsh blow on July 21 when WorldCom Inc., the nation's second largest long-distance carrier, filed for Chapter 11 bankruptcy. WorldCom's filing, and the precipitous announcement that company auditors had found approximately $7 billion in overstated earnings, was eerily similar to the collapse last December of energy giant and former Wall Street darling Enron.

To many, WorldCom personified the new breed of telecommunications companies, whose potential for growth seemed almost limitless. Unfortunately, WorldCom now is renowned for filing the largest bankruptcy claim in U.S. history. The impact of the WorldCom filing was compounded by other bankruptcies in the telecom sector, including Winstar, Global Crossing and many smaller startup Internet and competitive service providers.

The total impact of the recent bankruptcies is difficult to calculate. It is estimated that WorldCom alone owed incumbent local exchange carriers (ILECs) hundreds of millions of dollars for services provided at the time it filed bankruptcy. Such uncollectible amounts were almost unheard of prior to the passage of the 1996 Telecommunications Act. Unfortunately, unpaid intercarrier compensation has become all too common in recent years. This new reality is even more distressing for rural 1LEes that rely heavily on interstate and intrastate access.

Bracing for the Future

while the bankruptcy court debates and rules on LEe issues of WorldCom's filing, many carriers are taking steps to protect themselves from further telecom fallout. This switch, from reactive to proactive action, represents a sea of change within the industry regarding concern over the financial health of certain companies and market segments.

While small, rural ILECs remain financially sound, lost revenues from multiple bankruptcies in the industry can directly affect companies' bottom lines and negatively impact reinvestment in rural networks.

To date, the National Exchange Carrier Association (NECA), Verizon, SBC Communications, BellSouth and Iowa Telecom have filed interstate tariff revisions with the FCC seeking expanded authority to require security deposits from customers-carriers with questionable credit history. If approved, the changes will provide carriers with additional assurances of payment in the event of future bankruptcies.

The revisions would allow ILECs, in the event of a future bankruptcy, to require a security deposit or advanced payment for services from the carrier-customer filing bankruptcy. The ILEC also could discontinue service to a carrier-customer, within criteria established by the tariff revisions, that fails to pay its post-bankruptcy bills. NECA's filing is the only one that will directly impact NTCA members. However, since each of the tariff revisions address the same issues, the FCC almost certainly will rule correspondingly on each proposed revision.

Deregulation Takes Its Toll

In 1996, Congress passed the Telecommunications Act, the first major rewrite of telecom law in more than 60 years. The act sought to deregulate the industry and open it to competition under the bell that competition would lead to improved service a lower cost. Numerous Internet service providers (ISPs) and competitive carriers sprouted up to take advantage of the new opportunities.

After passage of the act, venture capital poured into the telecom sector as these startups began reselling services and overbuilding new high-tech networks to take customers from the incumbents.

But the telecom industry entered a downturn in late 1999 to early 2000. Many new startups and competitive carriers, who entered the market to take advantage of deregulation, declared bankruptcy or went out of business. It became evident that the "build it and they [customers] will come" philosophy was not coming to fruition.

In addition, massive overbuild of networks in urban areas caused a capacity glut and led to price wars that reduced rates to below cost, making it difficult for any company to make a profit. As a result, telecom industry stocks have plummeted, erasing an estimated $2 trillion in investments.

As these start-up companies went bankrupt, the survivors saw acquisition of the faltering companies as easy ways to expand their networks and customer bases. Many companies, some of which were barely profitable, assumed mass amounts of debt in the acquisition process.

WorldCom Sets the Stage

No company was more aggressive in acquisitions than WorldCom, which completed more than 65 mergers. Among the many companies acquired by WorldCom were UUNET Technologies, MFS Communications, Intermedia, Brooks Fiber Properties, Compuserve Network Systems, ANS Communications, SkyTel Communications, Wireless One, WilTel and, of course, MCI.

The number of telecommunications carriers soared after the industry was deregulated and competition was created by the 1996 Act. The lure to capture as big a piece of the enormous and rapidly growing telecommunications market proved to be a mirage.

The frenzy to be first to market resulted in massive over expenditures; capacity far exceeded demand and revenues were insufficient to support all of the investments became a reality of doing business, and bankruptcies followed.

Unfortunately, FCC regulations and interstate tariffs governing the payment for services among carriers have not been updated to deal with the realities of telecom competition. Defaults of carriers and nonpayment of intercarrier bills had never been a concern. Now, the rush is on to address the new reality.

Bankruptcy Basics

There are basically two types of bankruptcy filings: Chapter 11--reorganization, under which WorldCom filed, and Chapter 7--liquidation.

The Chapter 11 reorganization filing allows a company to remain in business as it develops and implements a viable reorganization plan to emerge from bankruptcy as a financially solvent company. Chapter 11 provides the company or debtor, the opportunity to restructure its debt, capital structure and operations. Bankruptcy law sets out the many requirements a Chapter 11 filer must meet, and the bankruptcy court must approve the petition. One requirement of the filer is that it remains current on all its post-bankruptcy obligations.

The goal of a Chapter 7 bankruptcy filing is liquidation of the company and its assets to maximize the monetary return to be distributed to creditors. Normal business operations are suspended when a Chapter 7 claim is filed.

When a debtor files a bankruptcy claim, either under Chapter 11 or Chapter 7, an automatic stay of pre-petition debts is initiated. This stay is one of the most beneficial provisions in the Bankruptcy Code and preserves the integrity of the debtor's estate. As the U.S. Supreme Court pointed out in its 1934 decision in Local Logan v. Hunt, "[bankruptcy] gives the honest but unfortunate debtor ... a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of pre-existing debt."

While this provision is beneficial to debtors, it can be devastating to shareholders, creditors and companies doing business with the debtor. At the time of its bankruptcy claim, WorldCom owed independent local exchange carriers millions of dollars. The question of payment of pre-petition debts is at the discretion of the bankruptcy court, but it is unlikely that carriers will receive full payment of pre-bankruptcy debts, and there is no assurance of even partial payment.

In late September, NECA announced that it had Crossing, which filed for Chapter 11 bankruptcy in January, oil pre-bankruptcy debts. Under the settlement, Global Crossing agreed to pay rural ILECs 30 cents on the dollar for undisputed pre-bankruptcy debts and 7 cents on the dollar for disputed pre-bankruptcy debts.

As of this writing, the bankruptcy court had not approved the settlement amount. while 30 cents on the dollar may not seem like a fair payout, a settlement of such an amount is almost unheard of in bankruptcy proceedings. If approved by the court, it will be a tremendous victory for rural ILECs.

A Rush for Protection

As noted earlier, in response to the rash of bankruptcies and the financial stress gripping the telecommunications industry, NECA, Verizon, SBC Communications, BellSouth and Iowa Telecom have filed revised interstate tariffs with the FCC seeking expanded authority to require security deposits from customers and carriers. The revised tariffs are aimed at mitigating the fallout from future bankruptcies and delinquent payment practices of other financially troubled carrier-customers.


On August 21, NECA filed with the FCC Tariff FCC No. 5, Transmittal No. 951 seeking to modify the provisions regarding refusal and discontinuance of service and payment of rates, charges and deposits. Specifically, NECA seeks to expand the conditions under which its pool members may request a security deposit from both new and existing carrier-customers whose credit worthiness dips below a set threshold in order to protect its interests and guarantee payment for services provided.

NECA's deposit provisions have not been modified since their creation in 1984. NECA noted that the changes are necessary because common carrier regulations require ILECs to provide all carriers with service, including access service, on a nondiscriminatory basis, regardless of their financial condition.

In its filing, NECA stated that, due to the current economic environment, and particularly the state of turmoil in the telecommunications industry, NECA tariff participants are at greater risk of not being able to collect payment for services rendered.

In fact, NECA noted that uncollectibles for its tariff participants increased 800% for the 24-month period beginning in May 2000. Uncollectibles directly attributable to the WorldCom and Global Crossing bankruptcies amounted to $70 million in the first half of 2002, NECA stated.

Small Carriers Hit Hard

The problem of uncollectible access charges is particularly acute for small, rural carriers. These carriers rely heavily on access payments from interexchange carriers (IXCs). In some cases, access from IXCs accounts for more than 50% of a rural ILEC's revenues.

NEGA's tariff proposes requiring that carrier-customers whose debt ratings fall below a commercially acceptable level be required to post a security deposit. The threshold for requiring security deposits would be defined as: a corporate debt securities rating of BBB or higher by Standard & Poor's or its equivalent; a composite credit appraisal rating from Dun & Bradstreet of at least "good"; or a Paydex score, as published by Dun & Bradstreet, of at least "average."

Any security deposit would not exceed two months of the carrier-customer's actual billing for the service calculated using an average of the most recent three-month billing cycle. A carrier-customer may have its deposit returned to them by establishing a one-year history of prompt payments and attaining commercially acceptable credit. In addition, interest accrued on a carrier-customer's deposit would be credited annually to its account. The FCC on September 2 issued an order suspending NECA's tariff transmittal for five months and initiated an investigation.

In a related filing on August 30, NECA proposed raising the interstate access rates that rural ILECs charge IXCs to help carriers absorb additional uncollectibles from struggling long-distance carriers. The recent bankruptcies and jump in uncollectibles prompted NECA to re-examine the reserve for uncollectibles built into its access tariff rates. NECA proposed a 2% across-the-board increase in rates.

This increase, estimated to total $15 million, could provide NECA pool members with a minimum level of protection from anticipated nonpayment of access charges going forward. The tariff revisions were scheduled to go into effect September 14, but the FCC suspended this tariff transmittal for five months before it took effect.


Verizon was the first to file revisions to Tariff FCC Nos. 1, 11, 14 and I6 in its July 25 Transmittal No. 226 to expand its authority to require security deposits and introduce provisions allowing for advance payment for services in certain circumstances.

Verizon's current tariff mandates that it may only require deposits from a carrier-customer with a proven history of late payments or lacking established credit. The recent rash of telecom bankruptcies has led Verizon to establish new criteria under which security deposits and advanced payments may be required.

The proposed criteria include circumstances in which a carrier-customer or its parent has: fallen into arrears in any two months out of any consecutive 12-month period; is 30 days or more back-due an amount of $250,000 or more; started voluntary or involuntary receivership or bankruptcy; has senior debt securities below investment grade, as defined by the Securities and Exchange Commission; or is rated the lowest investment grade rating category by a nationally recognized statistical rating organization, and is put on review by the rating organization for possible downgrade.

A carrier-customer would be refunded its security deposit after one year of prompt payment and without triggering any of the above criteria. Verizon also has asked for the authority to require advanced payment, with no interest, calculated using the customer's average monthly balance over the most recent three months. The average would be recalculated every six months.

Verizon stated that its tariff modifications are necessary and justified in the post Telecom Act environment. As evidence, Verizon noted that in 2001, its interstate uncollectible revenues more than doubled from the previous year. It also remarked that it is a party to 92 separate bankruptcy proceedings. As it did with NECA, the FCC on August 22 issued an order suspending Verizon's tariff revisions for five months and initiated an investigation.

In conjunction with its revised tariff filing, Verizon also filed a petition for emergency declaratory ruling and other relief. In its July 24 petition, Verizon urged the FCC to expeditiously approve tariff revisions expanding ILEC authority to request security deposits to work with the bankruptcy court on behalf of ILECs and other industry segments that must do business with bankrupt carriers. The company also asked the commission to direct competitive LECs to provide information required to successfully coordinate carrier-to-carrier transfers. Comments and reply comments on Verizon's petition were filed in August, with no action taken by the FCC as of the writing of this article.

SBC Communications

On August 2, SBC filed several tariff transmittals on behalf of its companies to modify its provisions regarding the requirement of security deposits from carrier-customers with questionable credit history. SBC's filing outlines similar conditions to that of Verizon's, under which it states it should be allowed to request deposits or advanced payments from customers.

SBC also proposed shortening the notice period For it to begin refusing to process new orders and discontinue service when customers fail to pay bills on time. If a carrier-customer subject to a two-month deposit requirement fails to pay its bills on time, SBC would shorten its notice period from 30 days to 15 days. If a carrier-customer subject to a one-month deposit fails to pay its bill on time, SBC would shorten the notice period to 10 days.

Carrier-customers that refuse to pay a required security deposit within 21 days would be given 10-days notice before the company stopped processing new orders or discontinued existing service. In addition, SBC proposed that it be allowed to terminate or refuse to process new service requests on a 15-day notice to carrier-customers that fail to make required payments to the Universal Service Fund.

In its justification, SBC estimated that WorldCom owes it in excess of $300 million in past due bills, most of which is for services provided pre-bankruptcy. SBC added that within the last two years, it has participated in 53 separate bankruptcy proceedings in an effort to receive payment for services provided.

SBC's tariff transmittals were scheduled to go into effect August 17. As in other cases, the FCC again issued an order on August 16 suspending SBC's tariff revisions for five months and initiated an investigation.

The BellSouth and Iowa Telecom tariff revisions address the same issues and basically outline similar conditions as those proposed by NECA, Verizon and SBC. As it did with the others, the FCC suspended these tariff transmittals for five months as well.

Intrastate Ramifications

The tariff revisions filed with the FCC by NECA and the others mentioned only apply to interstate access. The same problems exist on the intrastate side. In fact, lot many rural ILECs, uncollectibles from intrastate access are higher than for interstate access.

The smaller calling area of rural ILECs means consumers must make a higher quantity of intrastate long-distance calls than their more urban counterparts. The more long-distance traffic, the more access revenue a LEC should receive and, thereby, the more devastating the affect when that revenue is lost. As such, the actions proposed by NECA and the other carriers on the federal level would have to be replicated on the state level.

On the federal level, NECA's access tariff and pooling allows participating ILECs to spread the loss of interstate access across all pool members. Such pooling is not prevalent on the state level, however, and each state has its own rules and system for dealing with intrastate access. This leaves individual carriers to fend for themselves.

The immense increase in uncollectibles on both the intrastate and interstate sides may result in increased rates. If the expanded authority to require security deposits and advanced payment from troubled carrier-customers is not approved, ILECs will be forced to make allowances for uncollectibles in their rates. This will result in price hikes for carrier-customers, which ultimately will be passed along to the consumer.

The issue of uncollectibles is the same for competitive local exchange carriers (CLECs). However, CLECs, even rural ones, do not have the option of sharing risk through participation in the interstate NECA tariff and pooling process. (This also is true for ILECs that do not participate in the NECA interstate tariff and pooling.

ILECs and CLECs that want to modify their intrastate tariffs to expand their ability to require security deposits and advanced payments from carrier-customers, or to raise rates to make up for uncollectibles, will have to work within their particular state tariff mechanisms.

Unrealized Dream

The turmoil in the telecommunications industry may well be a direct result of over enthusiastic competition introduced after passage of the 1996 Telecom Act. The ensuing "gold rush" to get into the market before it was too late was an investment in a dream that could not be realized.

As this turmoil grows and larger and more established telecom players begin to feel the impact, the FCC must allow the backbone of our national communications systems--the incumbent LEC--to take steps to ensure their continued financial stability.

As common carriers, required to provide service to interconnecting carriers, regardless of their financial situation, rural ILECs serving high-cost, sparsely populated areas are more vulnerable to fluctuations in revenue that can result from industry bankruptcies. Therefore, they must be given flexibility to mitigate detrimental revenue loses.

FCC Chairman Michael Powell recently acknowledged the possible federal rod in telecom's downturn, saying, "the FCC may have erred in the past by implicitly encouraging the formation of hundreds of Bell [ILEC] competitors without realizing how few of them would ultimately be able to survive."

The FCC and the bankruptcy courts must offer ILECs and other affected carriers the flexibility provided other industries to deal with economic uncertainty and disorder. Rural ILECs are financially sound, but they, and the Universal Service Fund they rely on to maintain their high level of service to rural America, are being pinched by the downturn in the telecom industry and the glut of bankruptcies.


Regina McNeil, director and senior counsel for the National Exchange Carrier Association (NECA), offered the following recommendations to rural carriers, as NECA and NTCA members prepare for the fallout from the recent WorldCom bankruptcy. McNeil spoke at NTCA's Fall Conference in September.

Telcos should:

* monitor reports from the press to keep tabs on other telecom bankruptcies in their district. Once a company files for bankruptcy, creditors cannot collect amounts owed them prior to the filing.

* make sure to file proof-of-claims by the designated deadline. If telcos fail to file by the deadline, they lose their right to state claims against WorldCom for debts incurred prior to its filing for bankruptcy.

* keep informed of developments; direct any questions to NTCA or NECA.

* understand that bankruptcy laws are written to protect the debtor. "We're at a disadvantage. We have to do the best we can up front to get the little bit we can."

--Shary Denes


Marie Guillory vice president of NTCA's legal and industry division, outlined the points below as they relate to the WorldCom and Global Crossing bankruptcies in a presentation at the September NTCA Fall Conference in Las Vegas.

1. WorldCom and Global Crossing bankruptcies are tragedies of the companies' own makings.

2. Rural companies should not have to pay for the irresponsible behavior of these companies, but unfortunately will, because bankruptcy laws are tilted to allow the debtor to get back in business.

3. Rural companies should not be saddled with new accounting requirements or data reporting when they are not the bad actors.

4. Rural companies will necessarily lose money as a result of the bankruptcies. Losses on the intrastate side may be as great as the interstate and could require local rate increases.

5. Universal service will remain critical to keeping local rates affordable and to ensuring comparable service in rural areas.

6. Besides universal service, continued interstate tariff revisions and access charge rate increases will be needed to keep the companies whole on a going-forward basis.

7. IXCs should not be allowed to use the WorldCom and Global Crossing bankruptcies to gain sympathy or as excuses to avoid their obligations to contribute their share to universal service on an equitable and nondiscriminatory basis.

JANUARY 28 Global Crossing files for Chapter 11 bankruptcy with the
 U.S. Bankruptcy Court for the Southern District
 of New York.

JULY 21 WorldCom files for Chapter 11 bankruptcy with the U.S.
 Bankruptcy Court for the Southern District
 of New York.

JULY 25 Verizon files tariff revisions seeking expanded
 authority to require security deposits and advanced
 payment from financially troubled carriers (suspended).

AUGUST 2 SBC Communications files tariff revisions seeking
 expanded authority to require security deposits and
 advanced payment from financially troubled carriers

AUGUST 2 Bankruptcy Court for Southern District of New York
 appoints examiner to assist in the financial
 reorganization of WorldCom.

AUGUST 14 Court issues order on WorldCom adequate assurance
 protections in response to request by NECA and other
 industry representatives.

AUGUST 21 NECA files tariff revisions seeking expanded authority
 to require security deposits and advanced payment
 front financially troubled carriers (suspended).

AUGUST 23 NECA sends letter to U.S. trustee requesting local
 exchange carrier (LEC) representation on the Creditors

SEPTEMBER 13 Global Crossing and NECA reach agreement on payment for
 pre-petition debts. Under the agreement, rural ILECs
 will be paid 30 cents on the dollar for undisputed
 claims, and 7 cents on the dollar for disputed
 claims. Must be approved by the bankruptcy court.

SEPTEMBER 30 Deadline for carriers to file Global Crossing
 proof-of-claim forms.

--Brian O'Hara

RELATED ARTICLE: The cost of Worldcom's woes to rural telecos.

By Shary Denes, NTCA editorial manager

While rural carriers should not have to pay for the "irresponsible behavior" of WorldCom and Global Crossing that led to the companies's financial downfall, the fact is that they will pay for it, because bankruptcy law is slanted toward the recovery of the bankrupt company, according to Marie Guillory, vice president of NTCA's legal and industry division.

Guillory, along with Regina McNeil, director and senior counsel for the National Exchange Carrie Association (NECA), discussed the impact of the recent telecom bankruptcies on rural carriers September 24 at NTCA's Fall Conference in Las Vegas.

Guillory said rural companies will lose money as a result of the bankruptcies. "We already know won't receive 100% of collectibles that WorldCom accrued before bankrupcy. Your company is in queue with other companies for these uncollectibles," she told the audience. (Global Crossing declared bankruptcy on January 28, 2002, followed by WorldCom on July 21).

NECA's McNeil agreed, saying that in filling for Chapter 11, WorldCom and Global Crossing are working to reorganize, rather than to liquidate, as would have been the case under a Chapter 7 filing. Bankruptcy under Chapter 11 "wipes out prior debt to bankrupcy prepetition debt," McNeil said. "That means ... you can't collect until they come out with a plan."

And while that may seem glum, Guillory noted that NECA had negotiated with Global Crossing a palatable 30 cents on the dollar for the amount the company owed NECA members. The bankruptcy courts must approve the settlement before it can move forward (see related WorldCom article).

"Thirty cents on the dollar may not make you happy," Guillory told the audience, "but [the settlement] is considered to be good in the world of bankruptcies," particularly when compared to other recent bankruptcies where the stock owners received nothing.

She cautioned, however, that there is no guarantee that NECA will be able to negotiate such a favorable rate with WorldCom.

A Pricey Outcome

The overall impact on rural telcos could be considerable. Guillory said that interstate losses may be as great as those on the interstate side, and the result may be carriers having to raise their rates. She noted that universal service is particularly critical at this time to keep services affordable.

NECA already has filed a tariff revision with the FCC proposing a 2%, or $15 million increase in rates for interstate access charges that participants charge IXCs. NECA filed the tariff revision August 20 to offset the financial instability of the IXC industry and the resultant jump in uncollectibles.

"We're still fighting to have the rate increased," McNeil said. She also counseled audience members to "make sure you watch interstate amounts. You need to know your rights under local tariffs, and if you have to increase your rates."

She added that NECA also is arguing in bankrupcy court that its members provide a utility service, and, therefore, deserve a higher priority for payment.

McNeil cautioned telcos from disconnecting service from WorldCom, saying that the company is "still a good customer," and the industry will not benefit from the company's having to move from Chapter 11 reorganization to Chapter 7 liquidation. "WorldCom doesn't have that much money. We need to get them back so they can play what they owe," se said.

Brian O'Hara is regulatory analyst for NTCA. He can be reached at
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Author:O'Hara, Brian
Publication:Rural Telecommunications
Article Type:Cover Story
Geographic Code:1USA
Date:Nov 1, 2002
Previous Article:How have the recent telecom bankruptcies impacted your business?
Next Article:Top 20 things to know about the WorldCom bankruptcy.

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