SBJ/November 12 - 18, 2001/Opinion

Salary deferral may put bite on players

Throughout the Arizona Diamondbacks' playoff run to World Series victory, reports of the pending collective-bargaining negotiations between Major League Baseball and its players association and of the financial situation of the Diamondbacks permeated the media coverage of the World Series. Stories in the sports section were dominated by talk of the upcoming collective-bargaining talks and of the potential contraction of two or more franchises.

With the Diamondbacks winning the World Series in only their fourth year of existence, reports resurfaced concerning the team's financial situation and, in particular, the agreement by several Diamondbacks players to defer huge portions of their salary.

Back in March, it was reported that 10 Arizona players had agreed to defer nearly $20 million in salary owing to them for the 2001 baseball season. This amount was reportedly in addition to $37 million in salaries previously deferred by Diamondbacks players.

These deferrals may be a risky proposition when examined against the backdrop of the overall financial situation of the Diamondbacks franchise. In March, it was reported that Diamondbacks ownership had already spent upwards of $350 million on the franchise, including its $110 million share for Bank One Ballpark and a $130 million franchise fee.

Managing partner Jerry Colangelo has reportedly made cash calls on the team's limited partners totaling $55 million to $60 million in the team's first three seasons in order to fund operations. It had also been reported that the Diamondbacks borrowed $20 million to support their operations in the 2000 season and that this loan had to be guaranteed by Major League Baseball. Operating losses for the 2001 season were avoided only when the Diamondbacks advanced to the World Series.

Before their World Series run, the Diamondbacks' 2001 season saw a drop in attendance to approximately 2.75 million fans from the 2.9 million, 3.1 million and 3.6 million fans that the franchise drew in 2000, 1999 and 1998, respectively. This steady decline in fan support makes the team's financial situation all the more troublesome.

Faced with a payroll in excess of $80 million for the 2001 season and potential cash shortfalls in ongoing operations, the Diamondbacks turned to the players. The 10 players who agreed to defer salary for the 2001 season reportedly did so out of respect and friendship for Colangelo. Colangelo was quoted as saying, "This is a team, and we are in the trenches together. ... I was there for them and they are now happy to reciprocate." Diamondbacks third baseman Matt Williams was quoted as saying, "I have never had an owner I respect as much as Jerry. It was a no-brainer."

The players and their agents should have viewed Colangelo's request for salary deferrals as anything but a "no-brainer."

First, the Diamondbacks did not buy annuities to fund future player salary obligations. Essentially, the deferred salaries are unsecured obligations of the Diamondbacks.

Sophisticated creditors do not typically accept unsecured promises to pay in the future where several million dollars are owing. In a typical arm's length transaction involving a deferral of such scope, a creditor ordinarily shows more prudence in structuring the deferral to protect against the risk of nonpayment.

One needn't look far to find parallels in the sports industry. The Pittsburgh Penguins franchise in the National Hockey League spent generously in the early 1990s in order to win a championship, the Stanley Cup. During that time, many Penguin players agreed to defer large portions of their salaries. The most prominent, Mario Lemieux, ended up deferring in excess of $30 million over the course of his playing career with the Penguins. Penguins players, not unlike the Diamondbacks players, had a very friendly relationship with their owner, Howard Baldwin.

When the NHL locked out its players for 104 days during the 1994-95 season, the Penguins were hit hard by the disruption in their operations and never recovered financially. Ownership of the franchise changed and the "friendly" circumstances under which the players agreed to defer their salaries altered dramatically.

Ultimately, the Penguins filed for bankruptcy protection under Chapter 11 in October 1998, and players who were owed deferred salary were forced to file claims in the bankruptcy just like every other creditor. Lemieux himself had to spearhead an ownership group to buy the franchise out of bankruptcy in order to protect his huge financial interest. In doing so, Lemieux agreed to convert his claim for deferred salary into an ownership interest in the franchise.

In the course of the Penguins' bankruptcy, no party to the proceedings supported the claims of both former and current players for preferred payment of the deferred salaries owing to them. Under the terms of the Penguins' bankruptcy reorganization, those players (excluding Lemieux) are scheduled to be paid over time, along with the claims of unsecured creditors; payments remain unsecured obligations and are subject to the Penguins' ability to pay over the next several years.

In ordinary commerce, when it is known that businesses are highly leveraged and have been required to take extraordinary steps to secure financing to continue ongoing operations, prudent third parties providing services to these businesses take steps to ensure they are paid for services provided. Rather than granting concessions to these businesses, security for payment or payment on delivery is often required.

Given the Diamondbacks' highly leveraged situation and the unpredictable impact that a labor disruption in 2002 may have on the franchise and the game of baseball in general, there may be a very real risk that Diamondbacks players who have agreed to defer salary into the future may not be paid.

With millions of dollars at stake, players and their agents need to treat requests for salary deferrals as sophisticated business transactions instead of "no-brainers."

Jeffrey Citron (jcitron@goodmans.ca) is a sports and corporate finance lawyer with Goodmans LLP in Toronto.

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