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White Paper - Update on the WorldCom Bankruptcy: The Enterprise Customer's Perspective

Date: Mar 14, 2003


Introduction

This White Paper assesses the WorldCom bankruptcy,1 focusing on the interests of WorldCom's current enterprise customers in the continued availability of the carrier's services during and after the resolution of the bankruptcy proceeding. We describe the possible outcomes of the bankruptcy case on the continuity of services provided by WorldCom, and highlight the efforts of the Incumbent Local Exchange Carriers ("ILECs"), principally Verizon, SBC, Bell South and Qwest, to minimize their exposure due to WorldCom's bankruptcy.

To date, WorldCom has succeeded in minimizing significant enterprise customer defections - aided by substantial early termination liability in enterprise customer agreements, and maintenance of pre-bankruptcy service levels generally. Consistent with the Bankruptcy Code, WorldCom continues to terminate agreements for unneeded circuits and capacity and to rationalize its real property leases.

On the other hand, WorldCom has endured indictments and arrests of former officers and managers, and has restated earnings in billion dollar multiples. On March 13, 2003, it announced a multi-billion dollar write-down of goodwill, property and equipment and other intangibles. WorldCom's management and accounting practices and corporate ethics are being reviewed by an Examiner appointed by the U.S. Bankruptcy Court judge, a Corporate Monitor appointed by the District Count judge presiding over the securities fraud lawsuit brought by the Securities and Exchange Commission and a special investigator appointed by WorldCom's directors.

In early March, the District Court judge took the highly unusual step of directing that estimates of fees for services to be rendered by WorldCom's investment bankers, lawyers and other advisers during the bankruptcy proceeding be submitted in advance to the Corporate Monitor to ensure such fees are not excessive or otherwise relate to work that other WorldCom advisers perform. 2

Key Developments in the WorldCom Bankruptcy

    • July 22, 2002, Order Granting Motion of the United States Trustee for Appointment of Examiner. 3 The bankruptcy judge directed that an Examiner investigate allegations of fraud, mismanagement, irregularities, or dishonesty on the part of the debtor's current and former management, and later named former Attorney General Dick Thornburgh as Examiner. 4


    • Verizon Petition for Emergency Declaratory and Other Relief (Pending at FCC). 5 Verizon filed its petition on July 24, 2002 (three days after WorldCom filed for protection under Chapter 11) to secure "clear guidelines" the ILECs could rely on to minimize the financial impact of WorldCom's and other telecommunications carriers' bankruptcies. Verizon's position is that any bankrupt interexchange carrier or Internet service provider or any successor thereto (hereinafter "service provider") must cure all debts (both pre- and post-petition amounts) owed for ILEC Services. The Verizon petition is problematic for enterprise customers because provisioning new special access service arrangements is often unpredictable and time consuming.


    • August 14, 2002, Order Directing WorldCom to Provide Adequate Assurances to Utility Companies. 6 The ILECs sought priority status and additional assurances of payment because WorldCom purchases approximately $750 million per month in ILEC Services, 7 principally switched access, special access, unbundled network elements and wholesale local exchange services. Largely agreeing with the ILECs on the risks posed by WorldCom's compromised financial position, 8 the bankruptcy judge imposed numerous conditions on WorldCom pursuant to Section 366(b) of the Bankruptcy code to "furnish adequate assurance of payment" for ILEC Services.
    • September 25, 2002, Procedural Order for Rejecting Executory Contracts and Unexpired Leases. 9 In this Order, the bankruptcy judge granted WorldCom the flexibility typically granted to bankrupt debtors to reject agreements that in the debtor's reasonable business judgement are unnecessary and/or burdensome to its ongoing businesses. The decision is noteworthy because in its underlying request to the court, WorldCom expressly excluded services agreements with customers from the scope of agreements subject to rejection procedures.


    • October 15, 2002, Final Order Authorizing DIP Financing. 10 Among other things, the Order permits WorldCom to borrow up to $1.1 billion. This amount is less than the maximum preliminary commitment of $2 billion established in a July 2002 interim order. 11 In July 2002, the bankruptcy judge let WorldCom borrow as much as $750 million while the company awaited the outcome of the final DIP hearing.


    • November 4, 2002, Examiner's First Interim Report. 12 In this report, the Examiner made observations concerning WorldCom's management, compensation plan, relationship with investment bankers, and accounting and financial reporting systems. The Examiner noted "substantial concern" with the company's past practices, especially with regard to the integrity of its accounting practices. 13 In addition, the Examiner predicted substantial additional restatements in WorldCom's earnings. 14


    • November 15, 2002, Order Extending Exclusive Periods for Filing and Soliciting Acceptances of its Reorganization Plan. 15 WorldCom now has until April 17, 2003 to file a reorganization plan and until June 16, 2003 to secure the creditors' approval of its reorganization plan.


    • November 15, 2002, Michael D. Capellas Named Chairman and CEO of WorldCom, Inc. 16 Formerly of Compaq and Hewlett-Packard, his appointment is seen as an essential step in establishing a new leadership untarnished by the recent past. His position was reinforced in mid-December as the Bankruptcy Court approved his compensation package and imposed ethics-based management principles at the behest of the District Court's Corporate Monitor. 17 Shortly thereafter, he accepted the resignations of many longstanding WorldCom Directors, including acting CEO John Sidgemore and former MCI Corp. CEO Bert Roberts. 18


    • November 26, 2002, SEC v. WorldCom, (S.D. N.Y.) Enters Judgment Enjoining WorldCom from Violating Antifraud Provisions of Federal Securities Laws; Defers Setting Civil Penalties. The judgment was entered as a result of settlement negotiations between the SEC and WorldCom. The District Court ordered an extensive review of WorldCom's corporate governance and its internal accounting practices, deferring a decision on civil monetary penalties. 19


    • January 14, 2003, WorldCom Announces Key Initiatives for First 100 Days. 20 In addition to setting out the Company's near term business strategy, WorldCom management affirms its commitment to submitting its Reorganization Plan to its creditors on or before April 17, 2003, consistent with the Bankruptcy Court's extension, noted above.


    • March 13, 2003, WorldCom Announces Write-Offs of Goodwill ($45 Billion) and Property and Equipment and Other Intangibles (Approximately $34.8 Billion). 21 WorldCom had projected these write-offs for several months.

Important Milestones in the WorldCom Bankruptcy

    • March 2003 (Projected timeframe for Examiner's Final Report).


    • April 17, 2003 (Deadline for filing reorganization plan) and June 16, 2003 (Deadline for soliciting creditor acceptance of reorganization plan). Barring a future extension by the bankruptcy judge, these deadlines remain.


    • Other Major Events, Dates to be Determined:

    • Bankruptcy Court's approval of the WorldCom reorganization plan.


    • Examiner's Final Report filed with the Bankruptcy Court.


    • Assessment of a civil penalty, if any, by District Court in Securities and Exchange Commission v. WorldCom, Inc.


    • WorldCom announces final results of "re-audit" of recent years' financial reports.


    • WorldCom emerges from Chapter 11 or Plan of Liquidation initiated.

Possible Outcomes of the WorldCom Bankruptcy

At this time, a primary focus of WorldCom's customers is WorldCom's reorganization plan. Broadly speaking, this reorganization plan will provide for either (1) the restructuring of WorldCom's ownership and capital structure, and describe the core businesses and assets of the New WorldCom ("NWC"), or (2) the liquidation of WorldCom. Below, we describe three potential outcomes of the bankruptcy case based on the general nature of the reorganization plan that may ultimately be adopted. 22 These are provided for purposes of illustration; multiple variations are possible.

Best Case Scenario

The WorldCom reorganization plan is a restructuring plan, setting forth the revised capital structure and ownership of NWC and providing for the retention of WorldCom's core businesses and assets. 23 Under this scenario, the telecommunications services agreements of business customers are "assumed" by NWC, and NWC pays pre-petition and post-petition debts for ILEC Services. Current multi-year services agreements with business customers remain in effect, and the existing WorldCom services and associated ILEC Services continue to be provided without significant interruption.

A variation on this scenario suggested by industry observers is that NWC is purchased by Verizon, SBC or Bell South as it emerges from Chapter 11 or shortly thereafter. In terms of risks to service continuity, such an acquisition could be viewed as a positive for WorldCom's customers.

Such an acquisition is given more credence today than eight months ago because Verizon, SBC and Bell South either have secured or are expected to secure shortly InterLATA service authority under 47 U.S.C. § 271 in all states in which they are ILECs. Bell South has completed the process. Verizon is expected to conclude the process before the end of March 2003. Being guardedly optimistic, SBC should be in a similar position by the end of 2003. 24 While antitrust and public interest-based reviews of such a merger would still apply, eliminating the Section 271 hurdle positions these ILECs to move rapidly should a WorldCom acquisition prove attractive.

Intermediate Case Scenario

The reorganization plan calls for the liquidation of WorldCom, but uncertainties associated with the continuity of existing WorldCom services are resolved favorably. Under this scenario, major telecommunications carriers or outsourcing companies acquire WorldCom's respective core businesses and assets, keeping those core assets largely intact, such as through the acquisition of the UUNet network by one carrier. Also, the acquiring companies agree to pay pre-petition and post-petition debts incurred by WorldCom for ILEC Services, ensuring existing ILEC Services are not disrupted.

Under this scenario, the acquiring carriers and WorldCom's business customers must either agree to partial assignments of the existing WorldCom multi-year services agreements or develop more narrowly focused, service-specific agreements. Among the issues to be negotiated are the elimination or adjustment of a customer's minimum purchase obligations typically included in WorldCom's services agreements, and the acceptability of the acquiring carriers.

The bankruptcy court may drive such a resolution. According to some bankruptcy law experts, in the event of a liquidation, the bankruptcy judge might be persuaded to rule--in order to maximize the benefit to the creditors--that customer-specific services agreements are severable, stand-alone agreements, based on the discrete prices paid for and the distinct networks utilized to provide WorldCom's services. Such a resolution could prove problematic for WorldCom enterprise customers.

Worst Case Scenario

Under this scenario, the reorganization plan calls for the liquidation of WorldCom and, through liquidation, WorldCom's core assets are purchased on a disaggregated basis by various carriers (major, secondary and tertiary), and not all the acquiring carriers agree to pay for WorldCom's debts owed for ILEC Services. In addition, WorldCom or a bankruptcy trustee rejects WorldCom's telecommunications services agreements with its business customers.

Except for the period during which the FCC requires WorldCom to continue to provide service prior to discontinuance (and the ILECs to continue to provide ILEC Services to WorldCom), 25 the chances for service continuity beyond the FCC's prescribed period under this scenario are uncertain and challenging, at best.

Indicia of Serious Risks to Service Continuity

Despite WorldCom's "success" in stabilizing its business, reducing its obligations and rationalizing its facilities, the potential for an undesirable outcome remains. We believe certain events could be viewed as creating substantial risks to service continuity:

    • The bankruptcy judge appoints a trustee, replacing WorldCom management.


    • WorldCom's revenue falls substantially below current levels of $2.2-$2.3 billion per month. 26


    • The "re-audit" of WorldCom's recent years' financial statements is delayed indefinitely.


    • However unlikely at this time, creditors providing DIP financing petition the bankruptcy judge to enforce covenants in the DIP Loan Agreement allegedly breached by WorldCom.


    • Its principal creditors vote to reject WorldCom's reorganization plan.


    • The reorganization plan calls for the liquidation of WorldCom.


    • The Examiner's Final Report is so damaging that the creditors announce they will push for a liquidation to minimize potential losses.


    • The District Court in the SEC's action against WorldCom imposes a substantial civil penalty on WorldCom.
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1 This White Paper relies on documents that WorldCom posts on its unofficial website.  See In Re WorldCom, Inc. et al., Chapter 11, Case No. 02-13533 (AJG) (Jointly Administered), Case Management Order Establishing, Among Other Things, Notice Procedures (Including by Electronic Means), Omnibus Hearing Dates, and Alternative Methods of Participation at Hearings and Authorizing WorldCom, Inc., et al., to Establish an Independent Website (Bankr. S.D.N.Y. 2002).

2 Securities and Exchange Commission v. WorldCom, Inc., Chapter 11, Case No. 02-13533 (AJG) (Jointly Administered), Order Establishing Budgeting Procedures for Professional Fees (S.D.N.Y. 2003).

3 In Re WorldCom, Inc. et al., Chapter 11, Case No. 02-13533 (AJG), Order Granting the Motion of the United States Trustee for the Appointment of an Examiner (Bankr. S.D.N.Y. 2002).

4 In Re WorldCom, Inc. et al., Chapter 11, Case No. 02-13533(AJG) (Jointly Administered), Order Approving Appointment of Dick Thornburgh as Examiner (Bankr. S.D.N.Y. 2002).

5 Wireline Competition Bureau Seeks Comment on Verizon Petition for Emergency Declaratory and other Relief, Public Notice, DA 02-1859 (rel. July 31, 2002).

6 In Re WorldCom, Inc. et al., Chapter 11, Case No. 02-13533 (AJG) (Jointly Administered), Order Pursuant to Sections 105(a) and 366(b) of the Bankruptcy Code authorizing WorldCom to Provide Adequate Assurance to Utility Companies (Bankr. S.D.N.Y. 2002).

7 See In Re WorldCom, Inc. et al , Chapter 11, Case No. 02-13533 (AJG) (Jointly Administered), Objection of Verizon Communications Inc. to the Debtors Motion Pursuant to Sections 105(a) and 366(b) of the Bankruptcy Code to Provide Adequate Assurance to Utility Companies (Bankr. S.D.N.Y. 2002), at para. 1.

8 See id paras. 8-13. In the event WorldCom were to default on it is post-petition DIP financing, "Verizon and other telecommunications services providers would be forced [because of regulatory obligations] to continue providing hundreds of millions of dollars in post-petition service to WorldCom on a wholly involuntary basis for a minimum of an additional thirty days with no realistic prospect of receiving payment for such services." Id. See also Financial Turmoil in the Telecommunications Marketplace: Maintaining the Operations of Essential Communications: Before the Senate Committee on Commerce, Science, and Transportation (2002) (Statement of Michael K. Powell, Chairman, Federal Communications Commission).

9 In Re WorldCom, Inc. et al., Chapter 11, Case No. 02-13533 (AJG), Order Establishing and Authorizing Procedures for the Rejection of Certain Executory Contracts and Unexpired Leases and Abandonment of Related Personal Property (Bankr. S.D.N.Y. 2002).

10 In Re WorldCom, Inc. et al., Chapter 11, Case No. 02-13533 (AJG) (Jointly Administered), Final Order Authorizing Postpetition Secured Super-priority Financing Pursuant to Sections 105(a), 362, 364(c)(1), 364(c)(2), and 364(c)(3) of the Bankruptcy Code and Granting Intercompany Super-priority Claims and Junior Liens Pursuant to Sections 361, 363(e), 364(c)(1), 364(c)(3) and 507(B) of the Bankruptcy Code Pursuant to Bankruptcy Rules 4001(b), 4001(c) and 4001(d) (Bankr. S.D.N.Y. 2002).

11 In Re WorldCom, Inc. et al., Chapter 11, Case No. 02-13533 (AJG) (Jointly Administered), Interim Order Authorizing Postpetition Secured Super-Priority Financing Pursuant to Sections 105(a), 362, 364(c)(1), 364(c)(2), and 364(c)(3) of the Bankruptcy Code, Granting Intercompany Super-Priority Claims and Junior Liens Pursuant to Sections 361, 363(e), 364(c)(1), 364(c)(3) and 507(b) of the Bankruptcy Code, and Scheduling a Final Hearing Pursuant to Bankruptcy Rules 4001(b), 4001(c) and 4001(d), (Bankr. S.D.N.Y. 2002).

12 In Re WorldCom, Inc. et al., Chapter 11, Case No. 02-13533 (AJG) (Jointly Administered), First Interim Report of Dick Thornburgh, Bankruptcy Court Examiner (Bankr. S.D.N.Y. 2002) (hereinafter First Interim Report), available at http://www.kl.com/whatsnew/worldcom_examiner_report.pdf.

13 The report disclosed that former WorldCom CEO Bernard Ebbers personally pledged company stock in return for millions of dollars in personal and business loans from WorldCom. WorldCom Implements Program to Restore Confidence, Rebuild Integrity and Business Practices, Nov. 4, 2002

14 See First Interim Report, supra note 13.

15 In Re WorldCom, Inc. et al., Chapter 11, Case No. 02-13533 (AJG) (Jointly Administered), Order Pursuant to Section 1121(d) of the Bankruptcy Code Extending Exclusive Periods During Which the Debtors May File Chapter 11 Plan and Solicit Acceptances Thereof (Bankr. S.D.N.Y. 2002).

16 Press Release, WorldCom, Michael D. Capellas Named Chairman and CEO of WorldCom, Inc., Nov. 15, 2002

17 In Re WorldCom, Inc. et al., Chapter 11, Case No. 02-13533 (AJG) (Jointly Administered), Order Pursuant to Sections 105(a) and 366(b) of the Bankruptcy Code authorizing WorldCom to Provide Adequate Assurance to Utility Companies (Bankr. S.D.N.Y. 2002).

18 Press Release, WorldCom, WorldCom Board Members Offer Resignation to Chairman and CEO Michael Capellas, Dec. 17, 2002

19 U.S. Securities and Exchange Commission, Litigation Release No. 17866, November 26, 2002, available at http://www.sec.gov./litigation/litreleases/lr17866.htm (last visited March 12, 2003).

20 Press Release, WorldCom, WorldCom Announces Key Initiatives for First 100 Days, Jan. 14, 2003

21 Press Release, WorldCom, WorldCom Completes Preliminary Review of Goodwill, Intangibles and Property Equipment, March 13, 2003

22 Any reorganization plan would have to be approved by WorldCom's creditors and confirmed by the bankruptcy judge. For purposes of discussion, we assume the creditors will approve, and the bankruptcy judge will confirm, the reorganization plan.

23 These core businesses and assets include: (1) WorldCom's domestic data and voice networks; (2) the UUNet IP backbone ; (3) its metropolitan area networks; (4) its international telecommunications infrastructure and businesses; (5) its established network management systems such as those maintained at the Cary, North Carolina facility; and (6) its experienced network operations, billing and account management staff.

24 For the latest in Regional Bell Operating Company Section 271 approvals, see www.fcc.gov/Bureaus/Common_Carrier/in-region_applications/.

25 In order to discontinue service under Section 214 of the Communications Act of 1934, 47 U.S.C. § 214(a), WorldCom must give at least thirty days written notice to its end user customers. See 47 C.F.R. § 63.71; see also Financial Turmoil in the Telecommunications Marketplace: Maintaining the Operations of Essential Communications: Before the Senate Committee on Commerce, Science, and Transportation (2002) (Statement of Michael K. Powell, Chairman, Federal Communications Commission).

26 See footnote 21, supra.

For further information, please contact C. Douglas Jarrett at 202.434-4180, jarrett@khlaw.com or Tracy Marshall at 202.434.4234, marshall@khlaw.com.