Federal Court Dismisses City of Chicago Claim for Franchise Fees on Cable Modem Revenues As “Neither Logical Nor Fair”

In yet another court decision rejecting the efforts of municipalities to regulate the delivery of Internet access service over cable television systems (“cable modem” service), on Sept. 4, 2003, the United States District Court for the Northern District of Illinois dismissed a complaint filed by the City of Chicago in which it sought a declaratory ruling that it was entitled to franchise fees on revenues derived from cable modem services provided by the three cable operators within the City.

The dispute in City of Chicago v. AT&T Broadband, et al. arose after the FCC issued a Declaratory Ruling in March 2002 holding that cable modem service is not a cable service, but rather is an interstate information service delivered via a cable system. As the Court noted in City of Chicago, prior to the FCC’s Declaratory Ruling, cable operators and municipalities both treated cable modem service as a cable service, and cable operators routinely paid franchise fees on the revenue derived from the provision of this new service.

In its Declaratory Ruling, however, the Commission recognized that Section 542 of the Communications Act limits the franchise fees paid by a cable system to 5 percent of “cable service” revenue and thus would preclude the payment of franchise fees on cable modem service revenue. The Commission explained: “Given that we have found cable modem service to be an information service, revenue from cable modem service would not be included in the calculation of gross revenues from which the franchise fee ceiling is determined.” As a result of the FCC’s decision, cable operators across the country discontinued payment of franchise fees on revenues earned from providing cable modem service.

The City of Chicago sued Comcast (successor to AT&T) and the other cable franchisees in the City on grounds that the franchise documents not only contemplated and authorized the delivery of services over the cable system other than “cable service,” but required the payment of franchise fees on any revenues derived from these ancillary services. In the litigation, all parties agreed that the language of the franchise agreements was broad enough to encompass cable modem service revenue for purposes of paying franchise fees. Because federal law supersedes any conflicting state law or franchise provisions, the Court noted that “the sole question before [it] is whether Section 542 of the Communications Act prohibits the collection of franchise fees for cable modem service.”

Comcast filed a motion to dismiss the case, on grounds that the FCC’s Declaratory Ruling precludes the payment of collection of cable franchise fees on cable modem service. The City argued that the fees it claimed were not unlawful cable franchise fees under a general savings provision in the Act (Section 541), and were outside the statutory definition of cable “franchise fees.” The Court rejected both arguments. The Court held that the specific statutory provision governing cable franchise fees controls, and found that the City’s interpretation of the definition of franchise fees “defies logic.” The Court also found that even without the prohibition in Section 542, the City’s efforts to collect franchise fees would violate the Internet Tax Freedom Act.

The City also raised constitutional claims to try and defeat the statutory limit on cable system franchise fees. It argued that if it could not collect franchise fees on cable modem service as a result of the FCC’s Declaratory Ruling, then it would suffer a taking of its property in violation of the Fifth Amendment. The Court dismissed the City’s claim, finding that “the cable system is already in the right of way pursuant to an existing franchise agreement, which requires defendants to pay 5 percent of its gross revenues derived from cable services for that system’s use of the rights of way.” The Court added that “[t]he City’s argument that it is entitled to more money simply because the defendants [cable operators] provide a new kind of service over existing lines is neither logical nor fair.” Finally, the Court also dismissed the City’s claims that the FCC’s ruling violated the City’s Tenth Amendment rights.

This is the second case in which a court has dismissed a local government’s claims seeking cable modem franchise fees, following Parish of Jefferson v. Cox Communications of La., LLC, 2003 WL 21634440 (E.D. La., July 3, 2003). In Parish of Jefferson, the court found that even where a cable franchise specifically contemplates the payment of franchise fees on cable Internet service, such a provision is pre-empted by Section 542, and dismissed the parish’s claims.

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