On December 15, 2011, Chief Judge Gross of the U.S. Bankruptcy Court for the District of Delaware issued a much anticipated memorandum opinion in the Los Angeles Dodgers’ bankruptcy case.1 In the ruling, Judge Gross approved the Dodgers’ plans to market the television rights for the team’s games beginning with the 2014 season. The decision came after a two-day trial a week earlier and with the strong opposition of Fox Sports Net West 2, LLC (“Fox”), the holder of telecast rights for 100 of the Dodgers’ games per year through the 2013 season.
The television rights at issue are for baseball seasons beyond Fox’s current contract term. Still, Fox argued that allowing the Dodgers to begin marketing would deprive Fox of important rights “designed to increase the likelihood that Fox would be able to maintain the telecast rights for [the Dodgers] to the 2014 season and beyond.”2 The telecast agreement requires the team to negotiate exclusively with Fox for a fixed period and, if an agreement is not reached, gives Fox the right to match other offers in some circumstances. Essentially, if the contract were enforced as written, the Dodgers would be unable to negotiate with anyone other than Fox until November 30, 2012.
The Dodgers proposed, and the Bankruptcy Court approved, marketing procedures that would have accelerated the exclusive negotiation period by approximately 10.5 months. The Bankruptcy Court’s order would allow the Dodgers to begin negotiating with other parties on January 19, 2012, rather than waiting until after next Thanksgiving.3
This change in timing is critical. Pursuant to a settlement agreement with Major League Baseball, Frank McCourt, the team’s owner, must sell the Dodgers by April 30, 2012. By that same date, McCourt must pay his former wife, Jamie McCourt, $131 million under a divorce settlement.4 The winning bid for the Dodgers arguably will be much higher if the team is accompanied by a more lucrative television contract. Because creditors are likely to be paid in full―a prerequisite for owners to receive any return on their investment―McCourt stands to benefit from any increase in the Dodgers’ price tag. Unless McCourt is allowed to market the future television rights quickly, the team sale will proceed on its own.
Fox quickly filed an appeal to the U.S. District Court for the District of Delaware, which entered an order staying the Bankruptcy Court’s ruling pending resolution of the appeal.5 In its accompanying opinion, the District Court signaled that it likely will reverse the Bankruptcy Court’s ruling.6 Oral argument is scheduled for January 12, 2012.
The outcome of the appeal will be noteworthy in several respects. The Bankruptcy Court ruled that Fox’s “back end” rights are not enforceable against a debtor in bankruptcy, i.e., the Dodgers. Any guidance offered by the District Court will no doubt affect contracting parties’ expectations going forward. Another issue, which is not expressly addressed in the Bankruptcy Court’s opinion, lurks below the surface. The Fox telecast agreement is an executory contract that has not yet been assumed or rejected by the Dodgers. According to Fox, marketing the television rights in a manner contrary to the parties’ agreement would constitute a material breach, effectively preventing the contract from being assumed. If true, Fox may have significant damages that could negate any benefit the Dodgers hope to obtain from the early marketing process. The Bankruptcy Court made clear that it was not ruling on issues of assumption or rejection. Even so, the matter almost certainly will be addressed on appeal.
THE TELECAST AGREEMENT
When Frank McCourt purchased the Dodgers in 2004 (from Fox’s parent company) he renegotiated and extended the team’s existing telecast agreement with Fox. Under the agreement, as amended several times since then, Fox has the right to televise 100 Dodgers games per year through the end of the 2013 season. Fox also has the following “back end” negotiating rights:7
In the spring and early summer of 2011, McCourt and Fox attempted to amend the telecast agreement again. Although the Dodgers had been recently valued at $800 million8 (nearly twice McCourt’s purchase price seven years earlier) the team claimed to be experiencing liquidity problems. The situation was so dire that in April 2011, Allan H. “Bud” Selig, the Commissioner of Major League Baseball, appointed a monitor to oversee the team’s day-to-day operations and financial affairs.9
The deal with Fox would have addressed the team’s liquidity problems, albeit temporarily and by sacrificing revenue in future years. Fox’s television rights would have been extended 17 years from the 2013 season. In exchange, Fox would advance $385 million of the approximate $1.7 billion in license payments to the Dodgers up front.10
As with many agreements involving big league teams, the deal was subject to the approval of Major League Baseball. Selig rejected the transaction, citing among other reasons the lack of a marketing process to ensure the team received full market value and the alleged allocation of $173.5 million of the advance payments to satisfy McCourt’s personal obligations that were unrelated to the Dodgers (the Dodgers contend this provision was later removed).11
The Dodgers filed for bankruptcy on June 27, 2011, citing Selig’s rejection of the proposed Fox deal a week earlier as a major contributing factor.12 In mid-September, the Dodgers first requested authority to market future telecast rights.13 Although McCourt had recently sought approval of the deal with Fox, the Dodgers now were attempting to find more lucrative offers. Major League Baseball quickly emerged as a fierce opponent of McCourt’s attempt to sell the media rights. Despite his veto of the Dodgers/Fox deal a few months earlier, Selig was now citing the Dodgers’ obligations to Fox as a basis for denying the Dodgers’ marketing request.14
By November, the landscape once again had changed. After participating in mediation, the Dodgers and Major League Baseball issued a joint press release on November 2, 2011 stating:
The Los Angeles Dodgers and Major League Baseball announced that they had agreed today to sell the team and its attendant media rights in a manner designed to realize maximum value for the Dodgers and their owner, Frank McCourt. The Blackstone Group LP will manage the sale process.15
The Dodgers filed an amended telecast marketing motion16 10 days later and Major League Baseball withdrew its objection, as well as a number of other pleadings adverse to the Dodgers.17 Fox suddenly found itself in the opposite corner from McCourt and Selig and became the only party opposing the Dodgers’ attempt to market the telecast rights.
THE BANKRUPTCY COURT’S OPINION
Judge Gross held the “back end” rights were unenforceable against the Dodgers under bankruptcy law.18 The Bankruptcy Court added that this type of “no shop” clause is unenforceable under Delaware law if it would prevent the Dodgers from exercising their fiduciary duties. Even if the Dodgers were solvent, as represented by the Dodgers on several occasions, the “Debtors are obligated to maximize the value of the estate.”19 The Bankruptcy Court found that accelerating the exclusive negotiating timeline was consistent with this goal. The back end rights, on the other hand, would inhibit the Dodgers’ ability to comply with the fiduciary to maximize value by preventing the Dodgers from negotiating with other parties. Despite Fox’s protests that McCourt would personally benefit from the marketing process at Fox’s expense, the Bankruptcy Court was “more concerned that creditors receive their promised full recovery than that Mr. McCourt might receive money for his equity interest.”
The Bankruptcy Court also found the Dodgers’ decision to market the television rights was a proper exercise of business judgment. Fox warned that modifying its “back end” rights would create a substantial damages claim to the detriment of other creditors. The Bankruptcy Court found this argument unconvincing.20 Granting the marketing motion would not deprive Fox of its right to continue televising games through the 2013 seasons. Only Fox’s back end rights were being affected―and they were only being accelerated, not nullified. In any event, the Bankruptcy Court was not persuaded that the rights had significant value. Judge Gross found the absence of a “time is of the essence” clause in the contract significant, suggesting little harm would result from providing Fox with nearly identical rights ten and a half months earlier.21
The Bankruptcy Court made a point of noting the irony in Fox’s objection to McCourt possibly receiving a return for his equity in the case. Before the bankruptcy filings, Fox was willing to advance “in excess of $300 million to Mr. McCourt without restriction and without any apparent concern [for creditors] and regardless of how Mr. McCourt was going to use such a small fortune.”22 Judge Gross found Fox’s expression of concerns for creditors after its own rights were at stake disingenuous.
Finally, the Bankruptcy Court waived the 14-day stay provided by the Federal Rules of Bankruptcy Procedure, explaining that the exclusive negotiating period must continue to run in light of the short time period before the April 30 sale deadline.
THE DISTRICT COURT’S STAY ORDER AND OPINION
Strictly speaking, the District Court’s opinion addressed a very narrow topic: whether the Bankruptcy Court’s order approving the marketing procedures should be stayed until the conclusion of the appeal. The applicable legal test required the District Court to evaluate whether Fox had a strong likelihood of succeeding on the merits, however.23 By issuing the stay, the District Court gave a strong signal that it agreed with Fox’s position and was likely to reverse the Bankruptcy Court’s ruling.
The District Court cast doubt on the Bankruptcy Court’s holding with respect to the central issue in dispute: whether the “back end” rights in Fox’s telecast agreement were enforceable against the Dodgers. In holding those provisions were unenforceable, the Bankruptcy Court relied on a single case, In re Big Rivers Elec. Corp.24 The District Court noted that Big Rivers is not binding precedent, did not apply the law of any state relevant to the dispute, and did not arise within the Third Circuit. “More importantly, Big Rivers does not stand for the proposition that a no shop provision [such as the “back end” rights] is per se unenforceable against a bankrupt entity.”25Instead, Big Rivers merely held that the particular no shop provision at issue, which was executed in anticipation of a bankruptcy filing, was unenforceable under the specific facts of that case. Agreeing with Fox and quoting its brief, the District Court stated that Big Rivers “merely reflects the Revlon-like principle that ‘no shop’ provisions are invalid only if at the time they were adopted they were in violation of a board’s fiduciary duty.”26
Absent any qualifying or contrary provisions of bankruptcy law, the District Court reasoned, state law generally governs a creditor’s substantive rights. The District Court recognized that California law, the law chosen by the parties in the television rights agreement, was tolerant of no shop provisions, suggesting the “back end” rights would be enforced by a California court. The District Court predicted that the “back end” rights would even be enforced under the laws of Delaware, the state of the Dodgers’ formation. The “back end” rights only required the Dodgers to negotiate with Fox exclusively for 45 days, an “ordinary contractual [limitation] on an entity’s future freedom.”27 Such provisions are generally enforceable under Delaware law.
To the extent the Bankruptcy Court found the “back end” rights unenforceable because their enforcement would prevent maximizing value to the estates, the District Court was skeptical that the Bankruptcy Court had applied the correct legal standard. The District Court cited several decisions by or within the Third Circuit admonishing courts from rewriting parties’ contracts merely because the bankruptcy estates would benefit. 28
Ultimately, the District Court found that Fox had “demonstrated a strong likelihood that the Court will disagree with the Bankruptcy Court’s conclusion that the ‘no shop’ provision is unenforceable.”29 The District Court also found the other factors of the applicable legal test weighed in Fox’s favor. Fox would suffer irreparable harm in the absence of a stay. The Dodgers and the creditors’ committee, on the other hand, would not be significantly harmed if a stay was granted. Finally, issuing a stay was consistent with the public policy of enforcing parties’ contracts.
Neither the Bankruptcy Court nor the District Court addressed one of Fox’s more interesting arguments. According to Fox, modifying its “back end” rights would constitute a material breach of the parties’ contract. In order to assume the telecast agreement, the Dodgers would be required to cure all existing defaults. Marketing the television rights in violation of the parties’ agreement, according to Fox, would create a material default that could not be cured. Therefore, Fox argued, once the marketing commenced the telecast agreement could no longer be assumed.30 With rejection being the only available option, approving the marketing procedures would subject the bankruptcy estates to significant damages claims. Viewed in this light, Fox contends, the Dodgers’ decision to market the telecast rights is not a valid exercise of business judgment.
Although Judge Gross did not expressly address this particular legal argument―addressing every argument advanced by Fox would have required a much longer opinion in a short time―the issue was not lost on the Bankruptcy Court. Judge Gross hinted that the mere approval of the marketing procedures would not impact Fox’s “back end” rights. Until the Dodgers actually negotiate with other parties, which could not occur until after January 19, 2012 under the Bankruptcy Court’s ruling, Fox’s “back end” rights would remain unaffected. Even if the marketing phase were to begin, the Dodgers could cease those efforts if it appeared Fox’s damages would be substantial.31 While the Bankruptcy Court did not rule on the amount of Fox’s potential damages from the modification of the “back end” rights, it did suggest the harm to Fox would be minimal.
While the District Court addressed the importance of enforcing parties’ contractual agreements as written, it did not discuss the effect altering the agreement would have on the Dodgers’ ability to assume the contract. The District Court likely will deal with this issue, among others, when it has the opportunity to fully analyze and opine on the merits of the case.
Prior to assumption or rejection, executory contracts are generally said to be enforceable by, but not against, a debtor.32 When viewed in isolation, therefore, it is not entirely surprising that the Bankruptcy Court would relieve the Dodgers of their obligation to strictly comply with their contract with Fox. This case presents a more interesting issue, though. Even if the Dodgers are not bound by the contract before its assumption or rejection, can the Dodgers’ noncompliance with the “back end” rights create an incurable breach preventing assumption? The answer to this question would provide some guidance regarding the rights and obligations of parties during the limbo period after a bankruptcy filing and before assumption or rejection.
THE STORY IS NOT OVER
The District Court apparently has placed Fox’s appeal on a fast track, with oral argument scheduled for January 12. Even if the Dodgers prevail, including a new television agreement in the sale of the team may be impossible absent an extension of the April 30, 2012 deadline―which presumably would require the consent of both Major League Baseball and Jamie McCourt. Considering what is at stake, however, an extension of that deadline is by no means out of the question.
The battle between McCourt and Fox will be fought in other contexts as well. The Bankruptcy Court is scheduled to hear Fox’s request to dismiss the Dodgers’ bankruptcy cases on January 25, 2012, based on Fox’s assertion that the filings were in bad faith. In February, the parties will be back in court, this time addressing the Dodgers’ request to disallow Fox’s claims.
Regardless of whether Fox or McCourt emerge victorious, one thing is for certain: the Dodgers and television will continue to be bound with one another. Their fate was sealed on August 26, 1939, when the Dodgers took the field against the Cincinnati Reds at Ebbets Field in Brooklyn, New York (the Dodgers’ home field at the time). A few thousand people followed the contest while squinting at blurry screens. It was the first ever televised major league baseball game.
Brian Jennings is a partner in Perkins Coie’s business practice. Brian focuses on restructuring and bankruptcy matters as well as commercial transactions. He has served as bankruptcy counsel to commercial debtors, creditors’ committees, secured creditors and asset purchasers in Chapter 11 reorganizations.
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