The Dodgers, Investors, and the Business Judgment Rule

Before the 2018 season, two previously big-spending teams had plans to drop below the luxury tax threshold and reset their tax rates. The first, the Yankees, nonetheless had a successful season, winning 100 games en route to a Wild Card win and Division Series berth. The other, the Dodgers, had a more successful season, making it to the World Series for the second consecutive year before succumbing to the Red Sox (themselves big spenders) and Ryan Madson. In both cases, however, we have teams with young talent that look to be contenders for years to come, so the conventional thinking going into 2018 was that both franchises would drop below the tax limit for one year to reset their rates and then be active in what was long thought to be one of the most coveted free agent class of the decade.

So though the Dodgers have already accomplished their major offseason business – inking Clayton Kershaw to a contract extension, thereby avoiding the lefty ace hitting free agency – many expected them to return to something more closely resembling their 2017 ways, when the team spent a whopping $290 million between payroll and taxes.

But earlier this month, Bill Shaikin of the Los Angeles Times, reported that may not actually be in the offing.

The Dodgers plan to keep their player payroll below the level that would require a luxury tax payment for at least the next four years, according to a document prepared for potential investors that was reviewed by the Los Angeles Times.

. . .

Under the projections prepared for potential investors, the Dodgers would spend $185 million on salaries in 2019 and 2020, $191 million in 2021 and $196 million in 2022.

Shaikin’s report caused a ripple throughout baseball, not the least of which because sticking to the investor prospectus would seem to limit the Dodgers’ ability to spend in free agency unless they unload a high-priced player. And it’s difficult to see who the team would trade for salary relief. The most obvious candidate based on salary alone would be Kershaw, but he just got re-signed, so he’s not going anywhere. Justin Turner is too big of a bargain to move. Matt Kemp could be a candidate, but it’s hard to see how the Dodgers could get a team to take on a significant part of his salary. Players like Yasiel Puig, Corey Seager, Max Muncy, and Austin Barnes all make less than they would on the open market and wouldn’t provide much salary relief. Maybe Joc Pedersen? Even still, the idea of playing in the shallow end of the money pool just doesn’t seem plausible given the current construction of the Dodgers’ roster.

There’s a reason people took for granted that the Dodgers would try to keep to the payroll forecasts in the investor pitch document. Under some circumstances, courts have found them to be legally binding contracts between investors and the company, as in a case called Northstar Financial Advisors Inc. v. Schwab Investments. In other words, it’s a really bad (and likely illegal) idea to lie to your investors, because you can end up getting sued for breach of fiduciary duty and breach of contract. However, the circumstances in those cases are generally quite different than what we have with the Dodgers. Why? First, because the payroll forecasts were just that: forecasts. They were predictions, and predictions can change based on changes in circumstances.

You see, the disclosures the Dodgers made to their prospective investors regarding payroll forecasts were made (presumably) with the best information the Dodgers had at that time. Since then, the Dodgers have obtained additional capital. That’s because the investor pitch documents predated the Dodgers’ 2017 playoff run. Two consecutive runs to the World Series tend to fill a team’s coffers, and this change in circumstances is probably more than sufficient for the Dodgers’ front office to say that they can run higher payrolls, because they have more money than expected.

As such, the Dodgers themselves have been acting as though the forecasts weren’t binding. According to Shaikin, “[o]ne high-ranking team official called the figures a ‘forecast,’ and another said he would be ‘shocked’ if the player payroll did not top $200 million next season.” This is an example of something called the Business Judgment Rule. Basically, the business judgment rule says that if a person acts in good faith and in a reasonably prudent manner with the goal of furthering the best interests of the corporation, that person can’t be sued by investors or shareholders even if their efforts resulted in loss of money. There are always exceptions, of course, but it seems pretty clear that reinvesting additional monies into the team that weren’t anticipated in the original investor disclosures is protected by the business judgment rule.

In other words, the Dodgers’ payroll forecasts from two postseasons ago probably aren’t binding on the team at this point. Now, if the Dodgers end up unloading a bunch of payroll this offseason, it’ll be a different story. But as of now, it seems Howard Cole is right: this really is much ado about nothing.

We hoped you liked reading The Dodgers, Investors, and the Business Judgment Rule by Sheryl Ring!

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Sheryl Ring is a litigation attorney and General Counsel at Open Communities, a non-profit legal aid agency in the Chicago suburbs. You can reach her on twitter at @Ring_Sheryl. The opinions expressed here are solely the author's. This post is intended for informational purposes only and is not intended as legal advice.

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Brad Lipton
Member
Brad Lipton

I know this is an article, but it seems as though it could have been a much shorter and more concise answer to a useful chat question.

The above comment is a segue to a request: Can you host a chat? I think it would be very informative for the readership and, for you, it is likely to bring up some interesting ideas for future articles.

Thank you.

Shauncore
Member
Member
Shauncore

I disagree with the first point but very much agree with the second one. A chat would be splendid.

Jonathan
Member
Jonathan

To the first point, I think this article lays the background well for folks not otherwise familiar with either the potential legal implications or specifics of the Dodgers’ situation.