Like many of you, I’ve been intrigued by the legal battle between the National Basketball Association and Donald Sterling, the long-time owner of the Los Angeles Clippers. By way of background, Mr. Sterling’s girlfriend (presumably “former” by now) secretly recorded a conversation with him in which he made disparaging remarks about African-Americans. After the recording was released and its authenticity verified, Adam Silver, the NBA’s Commissioner, rather swiftly announced that Mr. Sterling would be fined $2.5 million and indefinitely suspended from any activities related to the NBA. Further, Mr. Silver was going to ask the other NBA owners to force Mr. Sterling to sell the Clippers. Can he do that? Probably, but not definitely, and that’s where lawsuits come from.
The NBA Constitution and By-Laws
Before the Sterling situation arose, the rules governing the NBA’s owners and their legal relationships with each other were confidential. But, perhaps to show that it had the power to force the sale of Mr. Sterling’s franchise, the NBA decided to make its Constitution and Bylaws public. You can download your very own copy here.
Here’s what I’ve determined. Article 35 deals with misconduct committed by players. Presumably, their misconduct is dealt with separately because it is subject to collective bargaining. Article 35A deals with misconduct of persons other than players, including a “Member” (the person or entity that is a member of the NBA, e.g., the Clippers or the legal entity that operates the Clippers) and an “Owner” (including the Member and each individual or entity that, directly or indirectly, owns an interest in the Member). This is the portion of the NBA Constitution that governs misconduct by Mr. Sterling. Paragraph (c) provides as follows (emphasis added):
(c) Any person who gives, makes, issues, authorizes or endorses any statement having, or designed to have, an effect prejudicial or detrimental to the best interests of basketball or of the Association or of a Member or its Team, shall be liable to a fine not exceeding $1,000,000 to be imposed by the Commissioner. The Member whose Owner, Officer, Manager, Coach or other employee has been so fined shall pay the amount of the fine should such person fail to do so within ten (10) days of its imposition.
I think it would be fairly easy to make a case that Mr. Sterling’s disparaging remarks could constitute statements having an effect prejudicial or detrimental to the best interests of the NBA and the Clippers themselves. So chalk up $1 million of Mr. Sterling’s $2.5 million fine.
Next, Paragraph (d) provides as follows (emphasis again added):
(d) The Commissioner shall have the power to suspend for a definite or indefinite period, or to impose a fine not exceeding $1,000,000, or inflict both such suspension and fine upon any person who, in his opinion, shall have been guilty of conduct prejudicial or detrimental to the Association.
While Paragraph (c) deals with statements, Paragraph (d) deals with conduct. The Commissioner may have determined (and not that this provision is based on the Commissioner’s opinion) that merely making the disparaging remarks to his girlfriend also constituted “conduct” by Mr. Sterling that was prejudicial or detrimental to the NBA. So chalk up another $1 million of Mr. Sterling’s $2.5 million fine, plus his indefinite suspension.
But those two provisions only account for $2 million of Mr. Sterling’s $2.5 million fine. Other provisions deal with “rigging” the outcome of games, interfering with contractual relationships, involvement with betting, disclosure of confidential information, criminal convictions, and drug involvement. None of those appear to apply in the case of Mr. Sterling. I haven’t been able to find another provision that would justify the additional $500,000 fine. So we’ll accept it as a mystery for now (but see below for a possible explanation). The NBA also concluded that Mr. Sterling had destroyed relevant evidence, or had provided false or misleading evidence. Mr. Sterling subsequently announced his intention to fight these penalties, and refused to pay the fine.
Article 13 allows the membership of a member or the interest of any owner to be terminated by a vote of three-fourths of the Board of Governors (each team or member designates an individual owner or officer to serve as its representative on the Board of Governors). But they can’t do that without a reason. The article lists ten different reasons allowing termination. I will list three cited by the NBA in the charges it delivered to Mr. Sterling on May 19th. An interest can be terminated if the member or owner does any of the following:
(a) Willfully violate[s] any of the provisions of the Constitution and By-Laws, resolutions, or agreements of the Association.
* * *
(c) Fail to pay any dues or other indebtedness owing to the Association within thirty (30) days after Written Notice from the Commissioner of default in such payment.
(d) Fail[s] or refuse[s] to fulfill its contractual obligations to the Association, its Members, Players, or any other third party in such a way as to affect the Association or its Members adversely.
The NBA’s Charges
The NBA first contended that Mr. Sterling’s acts violated Article 13(d) because they constituted:
- the taking or supporting of a position or action which may have a material adverse impact on the league or its teams, in violation of an agreement made by LAC, Mr. Sterling, and Mrs. Sterling in favor of the NBA and its members;
- a failure to use best efforts to see to it that the sport of professional basketball is conducted according to the highest moral and ethical standards, in violation of the league’s joint venture agreement among LAC and all other NBA members; and
- a violation of the contractual duty of loyalty to support the league in the attainment of its proper purposes, which include among other things the league’s commitment to diversity and inclusion.
In addition, these acts breached the Clippers’ duty of loyalty under New York law to the other members because the acts “were injurious, harmful, and disruptive to the NBA”
Next, the NBA charged that the destruction of evidence and false and misleading statements violated Article 13(a).
And finally, when Mr. Sterling announced that he would not pay the $2.5 million fine, he violated Article 13(c).
Article 14 outlines the procedures for termination. First, a member or the Commissioner may charge in writing that a member or owner has violated one of the provisions of Article 13. In that case, the Commissioner is required to deliver a copy of the charges to the accused member or owner within three business days. As noted above, that took place on May 19th. Once the charges are delivered, the member or owner has five days to file a written response with the Commissioner.
Mr. Sterling’s Response
Mr. Sterling’s attorneys delivered his 32-page response on May 22nd. He claimed that the remarks were made during a “lovers’ quarrel,” and were illegally recorded. Basing charges on this recording violated Mr. Sterling’s constitutional rights under California law. His attorneys take the position that the violation of California law related to the surreptitious recording makes them unusable for any purpose, including the termination proceeding. However, while I suspect that the recording might be inadmissible in any judicial or state administrative proceeding, those rules do not usually extend to use by private parties in their private dealings.
The second ground for Mr. Sterling’s defense was based on the contention that none of Mr. Sterling’s actions violated any of the NBA’s rules, and therefore did not constitute a violation of Article 13(d). But further, since none of Mr. Sterling’s actions were “willful,” they couldn’t constitute a violation of Article 13(a).
And as for the Article 13(c) violation (failure to pay his fine), it was not yet “ripe” since thirty days had not yet passed since he received notice of the fine on May 14th. His response also claimed that the maximum fine was only $1 million under Article 35A(c).
Mr. Sterling’s response reveals that the $2.5 million fine was imposed under Article 24 of the NBA’s Constitution and By-Laws. So let’s take a look.
Article 24 outlines the authority and duties of the Commissioner. Paragraph (l) provides:
(l) The Commissioner shall, wherever there is a rule for which no penalty is specifically fixed for violation thereof, have the authority to fix such penalty as in the Commissioner’s judgment shall be in the best interests of the Association. Where a situation arises which is not covered in the Constitution and By-Laws, the Commissioner shall have the authority to make such decision, including the imposition of a penalty, as in his judgment shall be in the best interests of the Association. The penalty that may be assessed under the preceding two sentences may include, without limitation, a fine, suspension, and/or the forfeiture or assignment of draft choices. No monetary penalty fixed under this provision shall exceed $2,500,000.
So that’s where the $2.5 million fine came from! But Mr. Sterling’s response points out that since the penalties were imposed based on the recordings, they would constitute a violation of Article 35A(c). In that case, the catch-all penalty provision in Article 24(l) would not be applicable, since there was a rule that fixed the penalty.
Back to the additional defenses. Mr. Sterling claimed that his punishment was “arbitrary and capricious and … grossly disproportionate to past [NBA] punishments.” Further, the termination procedures in the NBA’s Constitution and By-Laws were unfair – both on their face and as applied to this situation. The hearing could not be fair since many owners had already announce their agreement with the Commissioner.
And finally, a forced sale would result in an “egregious forfeiture” because the family would be forced to pay an otherwise avoidable capital gains tax.
Taxes – Now You’re Talking!
As the title of this post implies, this post is completely different from the normal topics I address. But here’s the reason the Sterling’s are complaining. First, notice this complaint is by the “Sterlings,” not Mr. Sterling himself. There’s a reason for that. Mr. Sterling purchased the Clippers three decades ago – reportedly for about $12 million. That’s 12 followed by six zeroes. But recent estimates of a sales price range from just under $1 billion to almost $2.5 billion. As in nine zeroes. Let’s pick somewhere in the middle. Say Mr. Sterling sells the team for $1.5 billion. His “basis” for income tax purposes is his $12 million purchase price. Therefore, his gain is $1.488 billion. The federal capital gains rate is 20%. California apparently imposes an additional 13% tax. So Mr. Sterling would have to pay a combined 33% capital gains tax on his $1.488 billion gain, or $491,040,000. Leaving him with just over $1 billion in after-tax proceeds from the sale of his team for $1.5 billion.
But Section 1014 of the Internal Revenue Code contains one of the few tax breaks from dying. At someone’s death, the property taxable in that person’s estate for estate tax purposes receives, with limited exception, a new basis equal to its value on the date of the person’s death. Further, Mr. Sterling lives in a community property state. Section 1014 goes on to provide that if the property is community, not only the decedent’s half, but also the surviving spouse’s half of the property receives that new basis. The Clippers are reportedly community property of Mr. and Mrs. Sterling. Therefore, if they held on to the team until the first of them died, the basis in the entire team would explode from $12 million to whatever its value was at that spouse’s death. It could then be sold for that value at no capital gains tax cost.
And Speaking of Community Property …
Reports are that Mrs. Sterling contends that she has done nothing wrong, and that she shouldn’t (and can’t) be forced to sell her half of the team. Is this true? Probably not. I’m not an expert on California’s variety of community property law, but under Texas law, the Clippers, if purchased in Mr. Sterling’s name, would be his “sole management community property.” This means that while Mrs. Sterling owned half of the team from an economic standpoint, Mr. Sterling had the right to “manage” both his and her halves of the team. And by agreeing to the NBA’s Constitution and By-Laws, and apparently by being the person “approved” as the owner, he bound both his and her halves to the rules of the NBA.
But Let’s Go Back to Article 14
Now that Mr. Sterling has filed his response, the Commissioner has to call a special meeting of the Board of Governors no later than ten days after the filing of the response. That hearing is currently scheduled to begin on June 3rd. Note that it was critical that Mr. Sterling file some sort of response on time. Article 14(c) provides that willful failure to respond within the five day period, or to appear at the hearing, would be deemed an admission of the “total validity of the charges as presented.” While Mr. Sterling has the right to be represented by his lawyers at the hearing, Article 14(e) also provides that strict rules of evidence “shall not apply, and all relevant and material evidence … may be received and considered.” Remember Mr. Sterling’s argument that the California constitution prohibited the use of the recording as evidence? He was forced to make a “constitutional” argument by this language expressly allowing use of evidence that might otherwise be inadmissible in a court of law.
If the Board of Governors votes to terminate Mr. Sterling’s membership, Article 14A places the management of the team under control of the Commissioner. Further, it appears to give the Commissioner, not Mr. Sterling, the power to sell the team on behalf of Mr. Sterling.
More recent reports indicate that while Mr. Sterling is still publicly fighting the penalties, he has turned over the possible sale of the team to his wife, and she is actively seeking buyers. My prediction, based on absolutely nothing at all other than a guess, is that Mr. Sterling’s response is designed mainly to provide him negotiating leverage. He probably does not want his family to lose control of the sale. Therefore, I suspect that he will eventually reach a settlement, reducing his fine to only $1 million, and allowing him and his family, rather than the Commissioner, to control the sale of the team.
If I’m right, you heard it here first. If not, I probably don’t know what I’m talking about anyway. After all, I write wills for a living!