Grants of Television Rights, Not Increased Exit Fees, Are The Solution To Realignment Frenzy

A number of Division I conferences have recently increased the fees a member school must pay when it withdraws from the conference.  These fees are commonly referred to as exit fees.  The ACC is one of the conferences that recently increased its exit fees.  And its exit fee provision has been receiving a lot of attention lately because of Maryland’s departure to the Big Ten.

The ACC actually increased its exit fees twice in the span of a year.  The ACC first upped the fees from around $12-14 million to $20 million in September 2011 when it announced it would add Syracuse and Pittsburgh.  The fees were then upped again this September after the conference added Notre Dame (in all sports except football and hockeyl).

The ACC’s current exit fee calls for a withdrawing member to pay an amount equal to three times the conference’s total operating budget at the time of withdrawal.  Based on the ACC’s 2012-13 operating budget, this equates to an exit fee of more than $52 million.  It is this amount that the ACC is seeking in its lawsuit against Maryland for the school’s move to the Big Ten.

When the ACC and other conferences increase their exit fees, the general thinking is that it further discourages members from leaving the conference.  But, because of how courts analyze the legality of these exit fee provisions, increasing the amount of the fee can actually increase the chances of the exit fee provision being deemed unenforceable.  So, instead of discouraging schools from leaving, it can actually embolden them to do so.

In legal terms, conference exit fees are known as liquidated damages.  Liquidated damages provisions are commonly added to contracts.  They set the amount a party to the contract must pay in the event it breaches the contract.  Liquidated damages provisions are useful because they theoretically save the parties the time and expense of litigating the amount of damages caused by the breach.

But, the amount of liquidated damages specified in a contract cannot be randomly selected.  Courts will generally only enforce liquidated damages provisions if (1) the anticipated damages in the event of a breach are difficult to ascertain at the time of contracting, and (2) the amount of liquidated damages is a reasonable estimate of the actual damages that would likely be caused by a breach.  If a liquidated damages provision does not meet this test it is deemed a penalty and is unenforceable.

Assuming that the ACC’s liquidated damages provision fulfills the first element of the test, it is questionable whether it would meet the second element.  The requirement to pay three times the conference’s operating budget does not appear to be related in any way to the actual amount of damages the ACC would suffer if a member withdraws.  It just seems like an easy way to ensure that the exit fee continues to grow without having to continually vote on it.  This makes it look like a penalty.

And the actual number that results from this provision, $52 million, is not a reasonable estimate of the ACC’s actual damages.  For example, Maryland’s departure will not result in the ACC’s tv deal being reduced by $52 million.  A good argument can be made that the ACC actually suffered no damage when Maryland left.  Maryland’s departure allowed the conference to add Louisville.  And the general consensus is that the ACC is now stronger athletically as a result (at least in the two sports that matter for tv revenue purposes, football and men’s basketball).

This is consistent with recent realignment history.  Over the past two years the Big 12 lost Nebraska, Colorado, Texas A&M, and Missouri.  Yet, after adding TCU and West Virginina, the Big 12 signed the most lucrative tv deal in the conference’s history this year. (The one exception to the no damage upon withdrawal argument would be the Big East.  The defections in that conference have definitely hurt the value of its tv rights).

When a liquidated damages provision is determined to be invalid, the party attempting to enforce the provision is allowed to instead seek its actual damages from the breaching party.  But, as discussed above, conferences often suffer minimal damage when a member withdraws, either because the member added little value to the conference or because the conference quickly replaces it with a new member of equal value (at least in tv executives’ eyes).

As a result, exit fees often leave conferences in a tough position.  They have to be high enough to discourage a member from leaving the conference.  But, if they are too high they could be declared an invalid penalty.  And, if the exit fees are invalid, the conference would then have to prove its actual damages, which are usually much less than the amount of the exit fee.  As a result, exit fee disputes have always settled without a court deciding the validity of the liquidated damages provision.  Recent examples include the Big 12 settling with Nebraska, Colorado, Texas A&M, and Missouri for less than the mandated amount of exit fees.

So, what is the solution to the problems with exit fees?  Grants of television broadcast rights.  In these agreements, all of the conference members grant their television broadcast rights to their athletic contests to the conference for a certain period of time.  If a member leaves the conference during that time, the conference retains the member’s television rights.  Because the value of a school to a conference is the television revenue it can help generate, a grant of rights agreement makes the members essentially worthless to another conference that is looking for new members.

While grant of rights agreements do have potential issues (sovereign immunity issues being the biggest), they are not subject to a subjective test like liquidated damages provisions.  Thus, they are much more likely to hold up in court as valid contracts.

Currently, only the members of the Big Ten, the Pac-12, and the Big 12 have executed grant of rights agreements.  Other conferences that want to ensure stable membership would be wise to insist on their members signing similar agreements.  (Yes, even the mighty SEC should have its members sign grants of rights).  If the ACC had one in place, Maryland likely would not be joining the Big Ten.