Understanding Why Salary Cap Circumvention Is Dangerous for the NBA

While tampering has become an issue in the NBA, a related issue has emerged: unauthorized compensation. Adam Silver and his leadership team are taking stock of both issues and exploring ways to address the problems.

NBA Investigating Whether Tampering Took Place Before Free Agency FlurryTampering has become a major problem for the NBA. Teams are forbidden from attempting to induce or persuade players who are under contract to other teams to join them. Under the league’s constitution, teams that are caught tampering face a potential range of punishments—including fines, forfeiture of draft picks and voidance of free agent signings.

Yet plenty of teams disregarded the rules and blatantly tampered before the start of free agency on June 30. Thus far, not one of those teams has been punished. Per reporting by ESPN and The New York Times, NBA commissioner Adam Silver and his leadership team are now exploring ways to address the problem. Better enforcement measures and tighter restrictions on communications are among the remedial steps under consideration.

As part of its tampering investigation, the league is assessing whether any teams might have tried to circumvent the salary cap. The conferral of financial benefits to players, or their representatives, in ways that extend beyond the terms of a player’s contract constitutes illicit compensation under league rules.

Unauthorized compensation is a similar and related problem to tampering. Both are about teams negotiating with players to gain an unfair advantage over rivals. Yet unauthorized compensation is more disturbing and consequential. It concerns money changing hands rather than mere communications.

As discussed below, the collective bargaining agreement between the NBA and the National Basketball Players’ Association contains multiple sections that prohibit compensating players outside of their contract. Any team that circumvents the salary cap can face franchise-altering sanctions.

There is no indication that the NBA is aware of any attempts by teams to circumvent the cap. However, there have been unsubstantiated media reports that Kawhi Leonard’s uncle and advisor, Dennis Robertson, demanded various benefits—including guaranteed sponsorship money—from teams as part of a deal to sign his nephew. If any team honored such a request, it would now be at risk of a massive punishment.

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Understanding why circumventing the salary cap is damaging

Why is conferring a benefit to a player in addition to those detailed in a contract and in collectively bargained documents so worrisome? It’s not simply because the rules say it is wrong. The prohibition lies at the heart of NBA competitiveness, transparency and order.

As a competitive sports league, the NBA is predicated on each team having a credible opportunity to compete. A credible opportunity doesn’t guarantee success. But it assures fans that their favorite franchise has the same opportunities to be successful as its rivals.

Credible opportunity to compete is a key ingredient that makes pro sports leagues different from other types of industries. Like other industries, such as software, aerospace and media, the NBA features competing businesses that are different in all sorts of ways. Unlike those other industries, the NBA gives its businesses—the franchised teams—a reason to exist. The New York Knicks and Chicago Bulls exist because they play games governed by the NBA; if there was no NBA, the Knicks and Bulls wouldn’t exist or they would operate in a radically different way.

Further, the value of NBA teams is inextricably tied to the value of the league as a whole. The NBA, in turn, is more valuable if each of its teams is perceived by fans, consumers and media as a viable competitor. To that point, if the NBA contracted franchises due to lack of fan interest, the league would generate less revenue in the sale of broadcasting rights, merchandise and tickets.

Consider that Donald Sterling bought the Clippers in 1981 for $12.5 million and, after Sterling’s ouster from the NBA, the team was sold for $2 billion in 2014. The massive increase in the Clippers’ value was hardly the result of Sterling’s management prowess. It reflected the NBA as a whole increasing in value due to, among other things, the introduction of cable TV and the broadcasting of NBA games on ESPN, TNT and NBA TV.

To that end, NBA teams agree to follow various constraints on competition that might otherwise hinder their own advantage. They do so to maximize the overall health of the league, which over the long-term benefits them.

For instance, certain teams would spend more on player salaries, particularly for star players, if there was no salary cap or a maximum player salary. How much money would teams have offered free agent Leonard in such an NBA? Presumably a lot more than the three-year, $103 million deal he signed with the Los Angeles Clippers. That’s not to say Leonard was motivated by a desire to maximize earnings. He could have remained with the Toronto Raptors and earned more. But a league without salary constraints would lead to teams trying to outbid one other. Such a dynamic would be an advantage for teams with the wherewithal and willingness to outbid rivals, but potentially make it impossible for other teams to compete.

Some teams would also pay rookie players higher salaries if there was no rookie wage scale—and some rookies would, in turn, be much more likely to hold out. The rookie wage scale, which the NBA collectively bargains with the NBPA, was first adopted in 1995. Prior to its adoption, rookie “holdouts” were a recurring problem for the NBA.

In 1994, the Milwaukee Bucks drafted Glenn Robinson first overall. He demanded a $100 million contract and refused to report. The Bucks eventually relented and signed Robinson to a 10-year, $68 million deal. Robinson wasn’t the sole rookie from the first round of the 1994 draft to holdout for salary demands. Juwan Howard, Carlos Rogers and Clifford Rozier did so as well.

The rookie wage scale is a blatant restraint on competition for player services. Yet by reducing the chances for disruptive holdouts, the scale enhances the competitiveness of the league as a whole. Since its adoption, Steve Francis is the only major rookie to holdout. He did so in 1999, when he refused to play for the Vancouver Grizzlies. Francis was then traded to the Houston Rockets.

The same kind of logic applies to the NBA draft itself. If there was no draft, the weakest teams would not be secured a chance to land the best new players. A high draft pick doesn’t guarantee that a particular team will succeed, but it makes it more likely that weaker teams will eventually become competitive. This helps to build lasting fan bases and is consistent with games being marketed to consumers as competitive contests.

Back to the problem of NBA teams paying players outside of their contract: Such a practice gives the team an unfair advantage over its rivals since the team pays a player beyond the reach of a salary cap that restricts all teams. Such a practice also betrays the need for transparency in player transactions. If NBA teams believed that other teams were negotiating secret contracts with players, teams might feel compelled to do the same. This would set off a snowball effect where more and more teams break the rules.

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How the NBA’s CBA stops salary cap circumvention

Article XIII is the CBA’s anti-circumvention clause. As an overarching concept, Article XIII forbids teams from compensating players outside of their contract and thus in circumvention of the team’s obligations under the salary cap.

As a result, a team can’t negotiate a “side deal” with a player so that he earns more from the team than is due under his player contract. A team, therefore, can’t sign a player to a contract and then separately hire him in some other capacity, such as a coach, scout or executive.

This prohibition also contemplates less obvious scenarios. A team can’t arrange for a sponsor or business partner to pay a player if such a payment would reflect compensation for basketball services—even when, as Article XIII notes, such compensation is “ostensibly designed” to reflect something other than playing. Article XIII includes a measurement tool to determine if a sponsor’s arrangement with a player runs afoul of this rule. The NBA reviews arrangements if a sponsor’s compensation to a player is “substantially in excess of the fair market value of any services to be rendered by the player” and if the player’s NBA team is paying him substantially below market value.

Article XIII also outlaws any kind of promise or inducement between a team and player—or any person acting on behalf of a player, including his agent or a family member. Investments and business opportunities bestowed to a player or any person “related to or acting with the [player’s] authority” are thus prohibited.

The NBA can identify a violation of Article XIII through direct evidence and circumstantial evidence. Tax records, which would shed light on team expenditures, may also be requested. The league can impose a range of penalties on teams, including a fine of up to $6 million, forfeiture of draft picks, suspensions of executives and voidance of unauthorized contracts. In addition, Article XIII contemplates that the NBPA, which licenses player agents, would impose a penalty of at least a one-year suspension on agents who partake in unauthorized pay schemes.

Article XIII also addresses any promises between a team and a player for after he retires. The NBA can challenge an arrangement where a retired player who played for a team within the previous five years is then annually compensated in excess of $10,000 by his former team. The league would assess if the player appeared to be paid less than market value while he was a player (if so, it could imply that his post-career job was part of an under-the-table deal to underpay him while he was an active player).

A team or player who is punished under Article XIII can appeal to the CBA’s system arbitrator, who is a neutral party. The arbitrator uses an “arbitrary and capricious standard,” which is highly deferential to the NBA and only requires the league to show the punishment is reasonably related to the facts.

Lessons to learn from the Wolves and Joe Smith

Article XIII had been used with force by the NBA. In January 1999, Minnesota Timberwolves executives and representatives for free agent forward Joe Smith negotiated an arrangement that violated both the spirit and letter of Article XIII. The contract was signed on January 22, 1999, two days after the NBA and NBPA had agreed to a new labor deal that ended a lockout.

Smith, who was 23 years old at the time, signed a one-year contract worth $1.8 million. The signing stunned other teams’ executives. Smith, a former University of Maryland star who was drafted No. 1 overall in the 1995 NBA Draft, could have landed a far more lucrative and longer-term deal. A year earlier, he reportedly turned down a six-year, $80 million offer from the Warriors. Smith had just completed a season with the Golden State Warriors and Philadelphia 76ers in which he was paid $3.2 million and averaged 15 points and six rebounds per game. It didn’t make sense that this promising young player would, as an unrestricted free agent, agree to a pay cut after a solid season.

The situation became even more perplexing after the ’98-’99 season when Smith once again became an unrestricted free agent. He had enjoyed a solid season with the Timberwolves, averaging 14 points and eight rebounds a game. As Jackie MacMullan wrote for Sports Illustrated at the time, three teams had offered Smith more than $5 million per season.

Yet Smith re-upped with the Timberwolves for $2.2 million and the guarantee of only year.

Why was Smith taking one-year deals at well below-market value?

Because he had agreed to take less in the short-term in exchange for the Timberwolves’ pledge to later sign him to a very lucrative, above-market-value contract. The Timberwolves benefited from this arrangement. The team enjoyed greater salary cap space to sign other players. It also gained “Larry Bird rights” in Smith so that they could exceed to salary cap to later sign him to a massive deal.

It was a win-win. It was also blatant cheating that undermined league competitiveness and fair play.

The plan didn’t materialize. Then-NBA commissioner David Stern and his leadership team—including future commissioner Silver—discovered the Timberwolves’ plot. The league then imposed a record punishment: forfeiture of five Timberwolves first-round picks and a $3.5 million fine.

Article XXIX and limitation on player ownership also relevant

Article XXIX of the CBA also pertains to assessing how teams recruit players. Like Article XIII, it prevents teams and players from negotiating collaborative business ventures that would compensate the player in excess of his contract.

Article XXIX focuses on ownership interests. It instructs that “no NBA player may acquire or hold a direct or indirect interest in the ownership of any NBA Team or in any company or entity, whether privately or publicly owned, that owns any interest in any NBA Team.”

The NBA used Article XXIX in 2012 to forbid an attempt by Boston Celtics forward Kevin Garnett to buy a stake in the Italian soccer team AS Roma. Although Roma was not owned by the Celtics, it was owned mainly by James Pallota, who also had equity in the Celtics.

Article XXIX explains why teams can’t offer equity, or future equity, to a player as a “side deal” to his contract.

Michael McCann is SI’s Legal Analyst. He is also an attorney and Director of the Sports and Entertainment Law Institute at the University of New Hampshire Franklin Pierce School of Law.