ARBITRATION, CONTRACTS, AND QUIRKS IN AMERICA’S PASTIME

By Matthew D. Batista

It has been about three months since the Major League Baseball (MLB) baseball season ended. Only about 2 months of darkness remain until the next MLB season officially begins. There is no law school offseason to find revitalization. However, hope springs eternal during the MLB offseason. So, as a brief break from the reality that we are all back in the swing of legal education, here are some interesting legal notes from the world of baseball for law students, baseball nerds, casual fans, and anyone that needs some baseball knowledge to drop on a client while attending a game.

Leading off, this article will detail MLB’s unique arbitration process. On deck, the article will look at the small contracts in baseball. In the hole, the article will look at the big contracts in baseball. Hitting clean-up is Bobby Bonilla’s legendary MLB contract (with a Bernie Madoff cameo).

I. Navigating the Unique MLB Arbitration Process:

MLB Service Time:

MLB rosters are only allowed a maximum of 26 players on the active roster (formerly 25 until the upcoming 2020 season). For each day a player spends on the active roster, or each day on the injured list while serving as a member of the active roster, the player earns one day of “Service Time.” Despite a total of 187 days in the MLB season, one year of Service Time is calculated as 172 days on the active roster or on the injured list.[1] So, any player sufficiently on the active roster for between 172-187 days gets a maximum of 1.000 service time.

Team Control and Contract Renewals:

MLB teams have significant control over their young players. Generally, minor league baseball players and young major leaguers without the requisite Service Time play on one-year contracts. Until these players reach 3.000 years of Service Time in MLB or the player and team reach a one-year or multi-year contract, the team has the option to renew the player’s contract for another year at a similar level of compensation.[2] Players generally have very little bargaining power in their year to year compensation until accruing 3.000 in MLB Service Time.

Teams can, however, choose to negotiate with their young star players rather than renewing their contract. Though teams can renew a player’s contract and are under no obligation to negotiate and agree to a higher level of compensation, it can be advantageous for both sides to do so. This often takes the form of a multi-year agreement, buying out the player’s arbitration eligible years. By avoiding arbitration and reaching a multi-year agreement, players lock in guaranteed compensation while teams hope to retain the player’s services at a discounted rate over time.

Salary Arbitration:

If a player does not have a contract in place for the next season but has reached at least 3.000 but less than 6.000 years of MLB Service Time, the team and player can enter the MLB arbitration process.[3] This process is otherwise known as “File and Trial.”[4] The team loses the ability to simply renew the player’s contract once the player falls within this 3.000-6.000 Service Time bracket. The player has increased, though not absolute, power to negotiate a salary commensurate with their on-field performance.

The first requirement is that the team “Tender” a contract to the player. Tendering a contract means the team agrees to give a contract to the player for the upcoming year.[5] Tendering a contract is essentially a place holder, where the team and player negotiate a one-year or multi-year deal with the understanding that if they fail to reach an agreement by the mid-January deadline, the player and team will go through the MLB salary arbitration process. Arbitration hearings are generally set for February each offseason. In arbitration, the team and player each submit a desired player salary to a panel of three arbitrators. Both the team and the player get to advocate for their submitted salary figure before the arbitration panel. Finally, the panel of arbitrators select which salary figure is most appropriate for the upcoming season, based mostly on comparable players and their respective contracts. This process is known as “Final Offer Arbitration.”[6]

Generally, players receive a modest salary increase in arbitration. However, it is possible for a player to have their salary reduced, though the most a salary can be reduced is 20% from the previous year’s contract.[7] There is no maximum increase in arbitration salary, and it is commonplace that such increases are substantial.

Super Two Status:

There is always an exception to the rule. Now entering the game, “Super Two” status. Super Two status means a player is eligible for salary arbitration despite not reaching the requisite 3.000 year Service Time threshold.[8] Potential Super Two qualifiers in this bracket consist of players with between 2.000 and 2.171 years of Service Time (representing 2 full years and 171 days of MLB Service Time). But, only the top 22% of players in this bracket achieve Super Two status. Someone surely had fun at their desk making up this system.

Super Two status is also a source of agony amongst fans. Sometimes, a young minor league prospect makes a strong case to make the Major League roster before the start of the regular season. Frequently, however, that player will get sent back down to the minor leagues and will not be called up to the major leagues again until later in the season. Why? The team wants to avoid Super Two status! For a player, getting to arbitration a year earlier than normal can mean a very substantial raise in salary. Additionally, when the team and player negotiate salary in arbitration proceedings, a major factor, in addition to player comparables, is the prior year’s salary. The prior year salary is thus the initial, mutual anchor where negotiations begin. Thus, reaching arbitration a season earlier than usual can be of great benefit for the player.

Free Agency:

Players can reach free agency in one of two ways.[9] The first way is by reaching 6.000 years in MLB service time. Provided the player has no contract already in place for the next season after reaching this milestone, the player becomes a free agent and can sign with any team, for any compensation, so long as the contract meets certain league minimums. The second way for players to reach free agency is to be “Non-Tendered.” Being Non-Tendered means the player’s team did not Tender the player a contract (either by contract renewal, agreeing to contract, or going through arbitration proceedings) following the season. The player can thus sign with any other team, generally on a one-year contract, but retains his eligibility for contract renewal or arbitration with his new team following the season, should they apply.

Case Study, The Bringer of Rain:

Josh Donaldson, aka the “Bringer of Rain” in baseball circles, provides a nice summation and case study.[10] Breaking into MLB with the Oakland A’s in 2012, Donaldson earned $480,000. His contract was renewed by Oakland for $492,500 in 2013. His contract was renewed again in 2014, for $500,000. Following the 2014 season, during which he was traded mid-season to the Toronto Blue Jays, Donaldson earned Super Two status, with 2.158 Service Time, and became arbitration eligible.

Donaldson and Toronto failed to negotiate a new contract and entered the MLB arbitration process, with Toronto’s salary submission ultimately prevailing over Donaldson’s. Toronto’s salary submission to the panel of arbitrators of $4,300,000 was selected over Donaldson’s submission of $5,750,000.[11] Still, however, this illustrates why teams try and avoid Super Two status with their young stars. Super Two eligibility earned Donaldson roughly $3,800,000 more for the 2015 season than he would have earned had he not been arbitration eligible. Further, his $4,300,000 becomes that initial anchor for arbitration negotiations for the following year. After an excellent year in 2015, Donaldson and Toronto were again headed for arbitration for his 2016 salary, Donaldson’s second year of arbitration eligibility. To avoid arbitration, Donaldson and Toronto agreed on a two-year contract for a total of $28,650,000, thus buying out Donaldson’s second and third year of arbitration eligibility. Following the 2017 season, Donaldson, with 5.158 years of Service Time, was eligible for arbitration for a fourth time. Avoiding arbitration again, Donaldson and Toronto agreed to a one-year contract for $23,000,000. At the time, this was the most lucrative contract for an arbitration eligible player in MLB history.[12]

Following the 2018 season, with a Service Time of 6.158 years, Donaldson became a free agent. Donaldson eventually signed with the Atlanta Braves for the 2019 season, coincidentally for one-year and $23,000,000. On January 15, 2020, Donaldson, again a free agent, agreed to a contract with the Minnesota Twins for four years and $92,000,000.[13]

II. Notes on the Small Contracts in Baseball:

The MLB Minimum and Average Contract:

The arbitration process detailed above and minimum salaries for MLB players are negotiated with the aid of the Major League Baseball Players Union (MLBPA). Relatively speaking, MLB players do quite well in terms of annual compensation. The MLB minimum salary for 2020 is set at $563,000.[14] The average MLB player salary for 2019 was $4,360,000.[15] This average salary was actually the lowest since 2015. However, these highlight figures can be misleading. Professional baseball careers generally do not last very long, and length of career and career earnings can generally be a pretty skewed distribution. A rookie who actually reaches MLB can only expect to play an average of about five a half seasons.[16] One in five rookie position players (non-pitchers) will not play more than a single season.[17] Just about one in one-hundred players have a shot at a twenty-year MLB career.[18] For most who play professional baseball, playing at the highest level and navigating the peculiar contract world of MLB lasts only a short period of their lives.

Minor League Contracts and Associated Conundrums:

In the 2015 movie, The Big Short, Jared Vennett, played by Ryan Gosling, said “[B]anking [didn’t used to be] a job you went into to make large sums of money.”[19] The same still holds true for most professional baseball players, who largely reside in the minor leagues. While players in MLB, and some minor leaguers who qualify, enjoy the terms of the Collective Bargaining Agreement as negotiated on behalf of the players by the MLBPA, most minor leaguers have no such union and no such protections. MLB sets the fixed salary figures for minor leaguers, which can vary somewhat significantly. Average salaries for players in the lowest levels of the minor leagues average around $1,300 per month and only during the regular season.[20] Monthly salaries for the highest levels of the minor leagues can average about $10,000 per month. However, there are no overtime payments in minor league baseball where players can expect to work far more than forty hours per week. Additionally, calculating the hours a minor league baseball player puts into his work, at least at some levels of the minor leagues, often yields compensation that is less than federal minimum wage.

MLB gets around these federal employment rules, in part, based on legislation such as the “Save America’s Pastime Act of 2016” (SAPA).[21] SAPA essentially absolves MLB teams, who pay the salaries of their minor league players, in addition to the salaries of coaches, support staff, and executives, from complying with certain minimum wage and overtime employment laws. Further, the 2016 passing of SAPA in Congress ensured the continued pay scale for minor leaguers as set by MLB. Contrarily, MLB recently announced a plan to restructure the minor leagues. This restructuring calls for the removal of over 40 minor league teams, leading to, in part, potentially increased salaries for minor leaguers. However, localities where these potentially removed teams reside and their representatives in Congress fiercely oppose the plan. Over one-hundred members of the United States House of Representatives, in a bi-partisan fashion, sent a letter to MLB stating their disapproval of the proposed restructuring while threatening to revoke some of the protections Congress has afforded MLB, including like those of the SAPA.[22] As MLB Hall of Famer Bob Lemon said, “baseball is a kid’s game, grown-ups just screw it up.”

Contract Pooling:

A recent phenomenon is the advent of player pooling. The idea itself is not necessarily a novel one, but for some minor leaguers, contract pooling provides a significant financial hedge against never making it to MLB. A Palo Alto startup named Pando currently runs such a venture, having more than 150 baseball players in their clientele to this point.[23] The structure is almost entirely player run. Players agree to form their own pools and negotiate their pool terms. Pools consist of players with a similar probability of making it to MLB in order to equalize the risk/reward ratio. Players who reach MLB salary arbitration eligibility (and beyond), as outlined above in this article, generally provide 5-10% of their earnings for equal sharing amongst the remaining pool members. Any single pool member’s total contribution is capped at $20,000,000. Pando takes 10% of the pool funds before distribution.

An example provided by Sports Illustrated is of Pat Neshek, a relief pitcher originally drafted in 2002.[24] Nine college pitchers, including Neshek, were drafted in the 6^th round of the MLB Amateur draft in 2002. Two of the nine pitchers reached MLB salary arbitration or beyond, including Neshek. To this point, Neshek has made roughly $44,000,000 in career earnings. If the nine similar prospects from that draft would have formed a Pando style pool, each pool member could have enjoyed the fruits of Neshek’s MLB success, in spite of their never having made it to MLB, to the tune of about $500,000. In sum, Neshek still would have taken home a career treasure chest of $40,000,000.

III. Notes on the Big Contracts:

Mike Trout and the Largest Contract Ever:

If you ever need to say something baseball savvy, just say “Man, that Mike Trout can do it all huh?” While most players do not ever strike it really big, some do, and the numbers get pretty wild to look at. Mike Trout recently signed a contract for twelve years and nearly $430,000,000.[25] The contract is actually worth $428,170,000, making his contractual rounding error more than what most people will make in a lifetime. Nevertheless, the three-time Most Valuable Player’s (MVP) salary makes for some interesting, fun notes. Trout’s annual salary through 2030 will be $34,450,000. If MLB teams paid their minor leaguers $50,000 per season (far outpacing the actual average), for which there are roughly two-hundred-fifty per team, a team’s annual cost for their entire minor league player payroll would be roughly just $12,500,000. Over his eight seasons in MLB, excluding 2011 when he only played 40 games, Trout has averaged 145 games per season (out of a possible 162) and about 527 plate appearances. If Trout continues that pace throughout his remaining years under this contract, he will earn about $65,370 per plate appearance or $237,586 per game played. Not a bad day skipping the fishing trip Mr. Trout.

The MLB Salary Cap and Luxury Tax:

Any competent attorney accounts for taxes. For teams who traffic in the luxury items that are Mike Trout-ian in nature, they must also account for potential luxury tax implications. Baseball has a salary threshold of $208,000,000 for 2020.[26] Teams that spend above the salary threshold are subject to luxury tax penalties. First time offenders must pay 20% of the total overage in penalties. If over the tax for a second year, the team must pay a 30% overage rate. For a third, or more, consecutive year overage, the team must pay a 50% overage rate. Additionally, when a team is between $20,000,000-$40,000,000 in cap overages, there is an additional 12% surtax. For overages in excess of $40,000,000, first time payors must pay 42.5% while second and beyond payors must pay an additional 45%.

A perfect illustration of the real world implications of the luxury tax involve the recent trade of Mookie Betts, formerly of the Boston Red Sox. For the last two years, the Red Sox have been subject to the luxury tax. Heading into 2020, the Red Sox are again over the $208,000,000 threshold, by a projected $20,000,000 and facing a luxury tax penalty of 50% of the overage amount, in addition to surtaxes.[27] To counter such a large bill from MLB, the Red Sox agreed to a three-team trade that involved trading both Mookie Betts, a four-time All-Star and 2018 American League (AL) MVP and David Price, a five-time All-Star and 2012 AL Cy Young Award Winner (given to the best pitcher in each league).

Betts, with 5.070 years of Service Time, avoided arbitration with the Red Sox by agreeing to a one-year deal for $27,000,000 for the 2020 season.[28] Price, a veteran with 10.164 years of Service Time, has three years remaining on a seven-year $217,000,000 deal. That contract will pay Price $32,000,000 per year for the next three seasons. Betts, one of the best players in the league, was seeking a large multi-year extension, with an annual salary likely north of $35,000,000 per year. In shedding the two contracts in a three-team trade with the Los Angeles Dodgers and Minnesota Twins, the Red Sox shed $59,000,000 in salary. Further, the Red Sox go from $20,000,000 over the salary threshold to $39,000,000 under it, roughly shedding an additional $12,500,000 in luxury tax penalties. So, by shedding the contracts of Betts and Price, for which they received two prospects in return, the Red Sox will save nearly $72,500,000 in 2020.

IV. The G.O.A.T. of Fun Baseball Contracts:

Bobby Bonilla Day:

If you are still reading, thank you. The payoff, in addition to becoming a more informed baseball fan, is a funny story about creating value for a client. Bobby Bonilla, his agent Dennis Gilbert, and Bernie Madoff are all at the center of the greatest baseball contract in MLB history. Bobby Bonilla was an excellent baseball player. Bonilla even signed what was, at the time of signing, the richest contract ever in organized sports with the New York Mets following the 1991 season.[29]

Bonilla would eventually sign with the Florida Marlins (now Miami Marlins) before the 1997 season. During the 1998 season, Bonilla was traded to the Los Angeles Dodgers before ultimately being traded back to the New York Mets. However, Bonilla struggled significantly with the Mets in 1999 and though he was still owed $5,900,000 for the 2000 season, the Mets released him before the season. Instead of paying Bonilla his $5,900,000 for the 2000 season, Mets owner Fred Wilpon agreed to a deferred payment plan negotiated with Bonilla’s agent, Dennis Gilbert. Sparing the detailed math, the arrangement called for deferment of the $5,900,000, which would accrue annual interest before equal payouts from 2011-2035! At the time, Wilpon was heavily invested with Ponzi scheme extraordinaire Bernie Madoff. Wilpon figured that his investment returns with Madoff would offset the annual interest on the Bonilla contract. Obviously, this turned out to be a bad gamble for Mr. Wilpon once Bernie Madoff’s fraudulent scheme was unveiled.

The ultimate result for Bonilla was an increase in total value from $5,900,000 to $29,750,000, paid out in annual installments of roughly $1,200,000.[30] Every year until 2035, on July 1, “Bobby Bonilla day,” Bobby Bonilla receives a large check from the New York Mets despite not playing in an MLB game since 2001. Talk about creating value for your client. Bravo Mr. Gilbert!

[1] http://m.mlb.com/glossary/transactions/service-time

[2] http://m.mlb.com/glossary/transactions/contract-renewal

[3] http://m.mlb.com/glossary/transactions/salary-arbitration

[4] http://m.mlb.com/glossary/idioms/file-and-trial

[5] http://m.mlb.com/glossary/transactions/contract-tendered

[6] https://www.sportingnews.com/us/mlb/news/mlb-salary-arbitration-process-breakdown-spring-training-2016/4jkawqkczi8i17cb4rhqjxseh

[7] http://m.mlb.com/glossary/transactions/salary-arbitration

[8] http://m.mlb.com/glossary/transactions/super-two

[9] http://m.mlb.com/glossary/transactions/free-agency

[10] https://www.baseball-reference.com/players/d/donaljo02.shtml#all_br-salaries

[11] https://legacy.baseballprospectus.com/card/56185/josh-donaldson

[12] https://www.baseball-reference.com/players/d/donaljo02.shtml#all_br-salaries