With the August 4, 2010 auction of the division leading Texas Rangers looming and the memory of last year's bankruptcy sale of the Phoenix Coyotes fresh in our minds, there has been a lot of discussion among bankruptcy professionals about the unique issues that arise when a sports club files for bankruptcy. Generally, sports clubs file bankruptcy for the same reasons as other businesses — as a last resort to save going concern value and/or to avail themselves of some strategic advantage under the Bankruptcy Code. However, while many of the issues that sports franchises face in bankruptcy are the same as other businesses, there are unique challenges that arise primarily due to tension between the interests of the bankruptcy estate in generating the most money for its creditors, on the one hand, and the sports leagues within which the teams play and their unique and often outdated ownership rules, on the other. Given the relatively few sports clubs that have filed bankruptcy since the current bankruptcy laws were enacted in 1978, the law surrounding this tension is not completely settled.

By way of background, the Bankruptcy Code gives the trustee or debtor-in-possession relatively free reign to assume and assign contracts even though the language of the contract itself may specifically restrict or prohibit such assignment, though adequate assurance of future performance under the contract is required. Furthermore, ipso facto clauses — clauses which terminate a contract or lease based upon the insolvency of the debtor or some other financial condition — are usually unenforceable. Notwithstanding the foregoing, a franchise agreement (such as a club's agreement affiliating with a league) is generally not assignable by the debtor or trustee in bankruptcy where the franchise agreement is found to be either (1) non-delegable or non-assignable pursuant to applicable non-bankruptcy law or (2) a financial accommodation to the debtor.

An example of a non-delegable contract would be a personal services contract where an artist agrees to perform on a certain date. The artist cannot freely assign the personal service contract to another artist. In the sports context, a league seeking to block the assumption and assignment of a franchise agreement by showing that it is non-assignable must show that the franchise really has a unique aspect that the league is relying upon, or that the applicable nonbankruptcy law prohibits the assignment without the league's consent.

An example of a financial accommodation is where a father enters into a very favorable financing agreement with his son to help his son purchase a commercial property. Because this contract was a financial accommodation to a particular individual — the son — it is not freely assignable under the Bankruptcy Code. Sports leagues often make loans to their franchise clubs. If those loans are a key component of the franchise agreement itself, then the league may be able to threaten to terminate the franchise agreement of a club in bankruptcy. There may be other accommodations which trigger this analysis.

The outcome of the Phoenix Coyotes bankruptcy case may be instructive of what will happen at the upcoming Rangers' auction. In the Coyotes case, the bankruptcy judge approved a sale of the Coyotes' assets back to the NHL and rejected a higher bid offered by a Canadian businessman, Jim Balsillie, who wanted to move the team to Ontario against the league's wishes. Even though Balsillie's bid was higher and therefore would have likely provided a larger recovery to the Coyotes' creditors, the judge in the Coyotes case appeared uncomfortable with the idea that his courtroom could be used in order to circumvent the league's rules governing new owners and relocation of franchises and appeared to look for a way to invalidate the higher bid. The judge found a clause in the Coyotes franchise agreement that required the team to play games in Arizona particularly compelling and expressed concern that the proposed assignee — Balsillie — would not be able to adequately perform that clause of the contract if he moved the team to Ontario. The court further rejected Balsillie's argument that the particular clause was an unenforceable restriction on the free assignability of the contract.

If the trend of deferring to the league continues at the upcoming Rangers' auction on August 4, 2010 it will signal a settling of the law in the area and a big win for sports leagues in the United States. If, however, the Texas bankruptcy judge disregards the wishes of the league at the auction and decides to sell the club to the highest bidder instead of the league's preferred buyer, it could send the league scrambling and open up bankruptcy court as a useful tool for clubs struggling under heavy debt as they seek to move their club to new, more profitable, locations.

Arent Fox handles financial restructurings, recapitalizations, and bankruptcy-related and strategic litigation as well as distressed asset and corporate acquisitions throughout the country. Arent Fox represents distressed businesses, athletes, and high net-worth individuals facing financial distress, purchasers of assets, individual and corporate creditors, creditors' committees, trustees, and parties to out-of-court workout transactions with debtors, before, during and after bankruptcies.

For additional information, please contact:

Aram Ordubegian
213.629.7410
ordubegian.aram@arentfox.com

M. Douglas Flahaut
213.443.7559
flahaut.douglas@arentfox.com

Arent Fox's sports practice is one of the most experienced in the United States. Our attorneys have served as counsel to various professional teams, including the Washington Wizards, the Charlotte Bobcats, the Detroit Pistons, the Oklahoma City Thunder, the New Jersey Nets, the Tampa Bay Rays, the Washington Capitals, and the DC United. Arent Fox also has advised numerous purchasers and sellers of professional teams and events. In addition, we have advised entities on both sides of major naming rights and sponsorship transactions, such as the Barclays Center, Time Warner Cable Arena, AT&T Park, and PPL Park.

For more information about Arent Fox's Sports Practice, please visit us online or contact:

Richard L. Brand
202.857.6427
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Maidie E. Oliveau
213.443.7553
oliveau.maidie@arentfox.com