Deferred Payments in Professional Sports

A few weeks ago, we celebrated a national holiday.  People rejoiced and exclaimed at others’ good fortune and the freedom gained by Americans to earn a passive income.  I’m talking, of course, of July 1st, also known as Bobby Bonilla day!

For those who don’t plan vacations around this day, Bobby Bonilla day is the day we celebrate his decision to defer a $5.9 million buyout in 1999 into 25 yearly installments of $1.19 million, or $29.8 million.

In professional contracts, there are two types of deferred money – those related to a buyout or contract restructuring and those stemming from contract negotiations.

Bobby Bonilla received a buyout.  In order to forego salary that the Mets owed him in 2000, they opted to pay him an annuity from 2011 to 2035.  The fact that the payments did not start until 2011 is important.  As those straddled with debt understand, the longer the principal sits outstanding, the more interest that accrues.  Essentially, the Mets bet that the money they would save by not paying Bonilla in 2000 would earn a return higher than the 8 percent interest rate offered to Bonilla (after applying a discount rate to account for the time value of money).  Unfortunately, the Mets placed their bet with Bernie Madoff.  Not a great idea.

In recent years, other teams have used deferred payments to sign free agents.  Ken Griffey Jr, or the Kid, signed a nine year deal in 2000 with half of the money deferred.  Max Scherzer and Chris Davis are two more recent examples of deferred payments in contract agreement in free agency.  They signed their contracts before the 2015 and 2016 seasons, respectively.  Rather than pay Scherzer $210 million over seven years, the life of the deal, they will pay him $15 million over the next 14 yearsThe Orioles will keep Davis on the payroll for the next 22 years with the majority of the money over the life of the deal, seven years, and small payments over the next 15.

With no salary cap, baseball teams have more freedom to throw cash at players.  The only concern is paying luxury tax and maintaining sufficient cash flow so that the owner can afford to buy his seventh yacht in the offseason.

Unlike baseball, basketball, hockey, and football teams are limited by a salary cap (a soft cap in the case of the NBA) and have to be much more creative in order to retain players and sign players in free agency.

The idea of deferred payments started in the ABA.  When the ABA first started, it was a fledgling league struggling to survive.  The teams didn’t have a lot of money, essentially a loan.

The current NBA has Bird rights and different types of exceptions which allow teams to go over the salary cap.  Only 12 NBA teams currently have salary cap space for the upcoming season.  Similar to baseball, basketball teams face luxury tax charges after a certain cost threshold.  This has a large effect on team construction and long term planning.  The Raptors, for example, maneuvered this offseason to retain two of its best players (Serge Ibaka and Kyle Lowry) while also shedding salary to remain under the luxury tax threshold.

The Raptors did not buy out any players this offseason, but other teams use buyouts to maintain roster flexibility, especially to get rid of older players on struggling teams.  The Mavericks bought out/released the aging Deron Williams late in the 2016-17 season after they couldn’t find a trade partner.  The buyout allowed the Mavericks to apportion more minutes to younger players, such as the undrafted Yogi Ferrell.

In order to structure these buyouts, the NBA has even created rules around how teams can offer players deferred money through buyouts.  Team can apply the stretch provision so that, for salary cap purposes, the money remaining on a contract is spread over twice the remaining length of the contract plus one year.  It’s a great tool to for short term planning, thought it can offer headaches in the long term.  The Detroit Pistons used the stretch provision on Josh Smith, which allowed them to sign players like Greg Monroe and Reggie Jackson to ridiculous contracts.  However, when other moves don’t work out, though when the team resides in mediocrity and reaches the edge of the luxury tax threshold, it hampers potential flexibility needed for long term planning.

As teams spend out of control, the NBA has offered teams relief on two occasions.  New collective bargaining agreements instituted an amnesty clause in 2005 and 2011, allowing teams to release one player and receive luxury tax relief.  The 2005 amnesty clause (often called the Allen Houston rule though the Knicks did not use the amnesty clause on him) required that the contract still count for salary cap purposes.  However, contracts waived under the 2011 amnesty clause did not count toward the luxury tax or the salary cap. Unless there are nine teams who think they have never made a roster building mistake over the last six years, it astounds me that only 21 teams used the amnesty granted in 2011.

Hockey teams signed players to contracts that spanned into their 40s with the idea of spreading the salary cap charge out over time.  The players receive large contracts, but teams don’t need to book the entire annual sum on the salary cap each year  The majority of these contracts have not aged well whether it’s due to injuries (e.g., Rick DiPietro whose contract the Islanders deferred), returning to Russia (Ilya Kovalchuk), or an unfortunate illness (Marian Hossa).  The NHL views these contracts as a violating the sanctity of the salary cap and responded by implementing strict cap recapture penalties.  If a player retires before the end of the contract, the team is hit with punitive salary cap charges.  Teams that signed players to these type of contracts (e.g., the Wild with Zach Parise and Ryan Suter) may be in a tough salary cap position in a few years if the NHL does not relent on the new rules.

Given the lack of guaranteed money in the NFL, teams are constantly restructuring contracts that create deferred payments, usually in the form of signing bonuses.  Part of this is to create shortsighted salary cap relief (e.g., Tamba Hali and the Chiefs).  Teams desire to retain flexibility and not commit to agreements with guaranteed money spanning more than two years.  Consider the case of Derek Carr.  His “monster” $125 million contract includes only $40 million in guaranteed money.  The Raiders could easily escape the deal after two years with only $7.5 million in dead money spread out over the following three years.  That $7.5 million is future signing bonuses owed to Carr with $2.5 million owed each year.  Even though signing bonuses don’t span longer than the life of the deal, they are essentially one form of a deferred payment, given that they span longer than the guaranteed life of the deal.  If the Raiders released Carr after two years, all they would owe him is $7.5 million.  These payments are deferred payments built into a contract.  They offer teams cap flexibility and offer players guaranteed money and a small hedge on maintaining a roster spot after the guaranteed base salary expires.  While Carr most likely doesn’t have to worry too much about his job security unless the injury bug hits, it is quite common for other less heralded players who sign long term (on the surface) contracts.

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