Baseball superstar Shohei Ohtani recently agreed to a 10-year, $700 million contract with the Los Angeles Dodgers. While the headline number came as a shock to even sports business nerds like us, as always, the devil was in the details: $680 million of Ohtani’s contract is deferred until after Ohtani is no longer obligated to play for the Dodgers.
Our last post contemplated what might happen to Ohtani’s $680 million in deferred compensation if the Dodgers filed bankruptcy in 2034 (i.e., after Ohtani no longer has to play for the Dodgers, but before Ohtani’s deferred compensation kicked in) and ways Ohtani might protect himself. If you loved that post but were left wondering “what might happen if the Dodgers filed bankruptcy before the end of the 2033 baseball season? (i.e., while Ohtani is still required to suit up under the contract),” today is your lucky day because we take that issue head on.
Ohtani’s contract provides a unique illustration of an “executory contract,” a key term in most Chapter 11 bankruptcy cases. In essence, an executory contract is one where performance remains due on both sides of the contract. During the contract’s first 10 years (2024-2033), Ohtani’s contract is executory because both Ohtani and the Dodgers owe performance to each other – Ohtani is obligated to play baseball for the Dodgers and the Dodgers are obligated to pay Ohtani. After that, Ohtani’s contract is not executory because only the Dodgers owe performance to Ohtani – the Dodgers must pay Ohtani $680 million, but Ohtani owes no obligation to the Dodgers.
Thus, as discussed in our earlier post, if the Dodgers were to file bankruptcy after the 2033 season (i.e., once Ohtani’s contract is no longer executory), Ohtani would be like any other creditor to whom the Dodgers owed money. If the Dodgers were to file bankruptcy before then, however, Ohtani is a counterparty to an executory contract with a bankrupt debtor and the Dodgers (not Ohtani) would have the option to assume-and-assign, assume, or reject Ohtani’s contract. We will discuss those in reverse order.
Rejection: When a debtor rejects a contract, the rejection serves as a material breach of the contract by the debtor that occurred immediately before the debtor filed for bankruptcy. The debtor is no longer required to perform under the contract and the non-debtor counterparty receives a claim against the debtor’s estate for its damages from that breach.
In our scenario of a Dodgers bankruptcy while Ohtani is still playing, a rejection would mean that Ohtani would become a free agent because he would have no further obligation to play for the Dodgers. Additionally, Ohtani would have a claim against the Dodgers’ estate for the entire amount of his contract that had not yet been paid to him ($680 million-plus).[1]
Assumption: If a debtor assumes a contract, the contract continues just as it did before bankruptcy. A debtor must take the entire contract it is assuming — it cannot pick and choose which parts of the contract it wants and which parts it does not want. In addition, a debtor cannot assume a contract unless it promises to promptly cure any defaults under the contract (i.e., if the debtor is two months behind on payments, it must either make those payments or promise to make them promptly before it can assume the contract). Finally, a debtor must be able to give adequate assurance that it can promptly cure and continue to perform the contract going forward.
In our scenario of a Dodgers bankruptcy while Ohtani is still playing, to assume the contract, the Dodgers would have to: (1) agree to pay all its future obligations to Ohtani ($680 million-plus); (2) provide adequate assurance to Ohtani that it could meet all its future obligations; and (3) promptly cure any payment defaults to Ohtani under the contract. On the other hand, if the Dodgers chose to assume the contract, Ohtani would have to continue playing for the Dodgers – he cannot get out of his contract just because the Dodgers file for bankruptcy.[2]
Assumption and Assignment: In certain circumstances, a debtor can assume a contract and assign it to another party. This is particularly common with bankruptcy sales, where a debtor will sell its assets (instead of trying to reorganize). Since the assets might not be worth much without the executory contracts supporting them, the Bankruptcy Code authorizes debtors to assume the executory contracts and then assign them to a third-party (usually the purchaser of the assets). Certain contracts, including most personal service contracts, cannot be assigned without the consent of the counterparty.[3]
In our scenario of a Dodgers bankruptcy while Ohtani is still playing, the Dodgers possibly could not assign Ohtani’s contract without his consent because it is a personal services contract.[4] Thus, if the Dodgers were sold to a third-party through bankruptcy, Ohtani would have to consent to that sale before the new Dodgers owner could guarantee fans that Ohtani would play.
At this point you might be thinking, “great summary Eric and Mack, but what happens before a debtor decides to assume or reject the contract?” Excellent question!
The short answer is that the debtor has no obligation to perform, but the counterparty to the executory contract must continue performing. Although the debtor has no obligation to perform, counterparties to executory contracts are entitled to compensation from the debtor for the reasonable value of the goods and services they provide during the debtor’s bankruptcy case. Moreover, their compensation is entitled to an “administrative priority” claim against the debtor, which means their compensation will be paid ahead of most other creditors. In a recent bankruptcy case concerning baseball,[5] a bankruptcy judge ruled (as have most bankruptcy judges that have faced similar issues) that the “reasonable value” of the services provided by MLB teams to a media company that licensed the MLB team’s rights to broadcast MLB games was the rate provided for in the contract.
Going back to our scenario of a Dodgers bankruptcy while Ohtani is still playing; Ohtani would be required to play for the Dodgers while they decided whether to assume or reject his contract. That said, while the Dodgers would not have any “formal” obligation to pay Ohtani his contract rate during this time, the Dodgers would have to pay Ohtani the “reasonable value” of the services he provided, which most courts would say is his “contract rate” (circular, we know).
If you find yourself as a party to an executory contract with a bankruptcy debtor, you should contact counsel. Team Shohei – give us a shout if the front office starts to use words like “restructuring” or “right-sizing the balance sheet” in the future. We’d love to help you out!
[1] It is worth noting that since 1993, four MLB franchises have filed bankruptcy (the Baltimore Orioles in 1993, the Chicago Cubs in 2009, the Texas Rangers in 2010, and the Los Angeles Dodgers in 2011) and not a single player contract was rejected.
[2] Even if his contract says he can walk away if the Dodgers file for bankruptcy, federal law says that provision in the contract is void and unenforceable.
[3] See 11 U.S.C. § 365(c)(1). This exception is one of the many arcane nuances to executory contracts in bankruptcy, which is partly why, despite their outsize importance in bankruptcy, executory contracts have been called the most “psychedelic” area of bankruptcy law. See Jay Lawrence Westbrook, A Functional Analysis of Executory Contracts, 74 Minn. L. Rev. 227, 228 (1989).
[4] We say possibly because most MLB contracts explicitly require the player to agree that the contract can be freely assigned (without such a clause, trades would be impossible). Ohtani, however, has a full “no-trade” (i.e., no assignment) clause in his contract.
[5] In re Diamond Sports Group, LLC, et al. (Bankr. S.D. Tex. 23-90116).