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Tuesday, October 18, 2016

In Perpetuity: The Story of the Silna Brothers

When I took the Transactional Drafting class at University of Dayton School of Law in Spring 2015, one of my assignments was to write a brief paper and make a five minute presentation about a real-life transactional drafting issue. I chose to examine the "in perpetuity" clause of the agreement that the Silna brothers signed in exchange for relinquishing the opportunity for their Spirits of St. Louis franchise to participate in the 1976 ABA-NBA merger. Here is the paper as I wrote it, along with some expanded additional notes that I summarized during my oral presentation to the class:

We are going to enter a time machine and go back to before LeBron James, before Kobe Bryant, before Michael Jordan, before Magic Johnson and Larry Bird—and before the National Basketball Association enjoyed multi-billion dollar media rights deals.

From 1967-76, the American Basketball Association (the ABA) operated as a rival professional basketball league to the older, established National Basketball Association (the NBA). The ABA featured a red, white and blue basketball, the three point shot and, at the league’s final All-Star Game, a Slam Dunk contest.

The ABA also had a host of future Hall of Fame players with colorful nicknames, including Julius "Dr. J" Erving, George "Iceman" Gervin, Artis "A-Train" Gilmore and David "Skywalker" Thompson. What the ABA did not have was financial stability or a national television contract.

In 1976, the leagues entered talks to merge operations. The leagues needed to come to terms with each other and also resolve several lawsuits that had been filed against one or both leagues by various parties. As a result of the negotiations, it was decided that four ABA teams--the champion New York Nets and the runner-up Denver Nuggets plus the Indiana Pacers and the San Antonio Spurs--would join the new league, while the remaining two ABA teams--the Kentucky Colonels and the Spirits of St. Louis--would be bought out in a settlement.

The owner of the Kentucky Colonels, John Y. Brown, accepted a cash settlement worth a little more than $3 million.

The NBA had previously had a franchise in St. Louis and that team eventually moved to greener pastures in Atlanta, where they still exist today as the Hawks. The NBA did not see a viable future for a franchise in St. Louis but the owners of the Spirits of St. Louis, Dan and Ozzie Silna, rejected the cash settlement offer. They really wanted to own an NBA team but, failing that, they wanted to remain part of the league in some fashion, hoping to eventually buy a team or be awarded an expansion franchise.

The NBA and ABA owners could not proceed with their plans unless they settled with the Silnas, so the Silnas enjoyed some leverage. The Silnas and their lawyer Donald Schupak negotiated to receive a 1/7th share of each of the surviving ABA teams' visual media revenue in perpetuity.

The Silnas received about $2.2 million in compensation for their former players who were signed by NBA teams. Since the Silnas' deal was supposed to be comparable in value to the settlement that Kentucky Colonels' owner John Y. Brown received, that means that the four ABA team owners that signed the deal with the Silnas valued the visual media rights at about $1 million. That may seem absurdly low in light of the multi-billion dollar TV deals that the NBA has now but during that era the NBA sometimes could not even get the networks to agree to show the championship series live. Magic Johnson's great performance in game six of the 1980 NBA Finals was shown on tape delay.

For the four ABA owners whose teams would be joining the merged league, it seemed like a very meaningless and inconsequential concession to offer the Silnas a small percentage of "visual media" (television) revenues to make the Silnas go away. However, as we have learned in Contracts class and in this class, it is very important to negotiate a definite length of time for a contract. Surely the lawyers involved in the NBA-ABA merger negotiations--including David Stern, who just a few years later became the NBA's Commissioner--knew this as well but they thought that the most important thing was to bring the four ABA teams (and their star players, most notably Julius Erving) into the NBA. The Silna brothers and their colorfully named team just seemed to be a small sideshow. Why not just pay off the Silnas with a small piece of a small TV revenue pie and be done with them?

The exact wording of the key clause is, "The right to receive such revenues shall continue for as long as the NBA or its successors continues in its existence." In other words, the clause lasts "in perpetuity," the words that Ozzie Silna later had stitched on a custom-made Spirits of St. Louis retro cap. Schupak owned a 10% stake in the team and thus he has received 10% of the revenue from this deal.

The deal did not pay off immediately. As part of the NBA-ABA merger, the four former ABA teams did not receive any TV revenue for three years. So, from 1976 to 1978, the Silnas did not earn a dime from the NBA. According to published reports, however, in 1979 the Silnas received their first royalty check in the amount of $200,000. For the 1980-81 season, the Silnas earned $521,749.

By this time, the NBA realized that this deal was a lot better for the Silnas than it was for the league. In 1982, the NBA offered the Silna brothers $5 million spread over an eight year period to cancel the deal. The Silnas proposed that the league pay them $8 million over five years and the NBA refused. At that point, the Silnas had made about $1 million total from the deal. Then, the NBA's popularity exploded.

By the 1986-87 season, the annual payout topped $1 million. By the 1999-2000 season, it was more than $10 million. For the 2010-11 season, the Silnas made $17.5 million. That number increased to over $19 million in 2012-13. Overall, the Silnas received more than $300 million as a result of those little words "in perpetuity."

The Silnas had no overhead costs--no arena to maintain, no player salaries to pay--but every time the TV deals grew larger their profits increased.

That is not all. During the original negotiations, Donald Schupak inserted an intentionally broad definition of visual media revenues, a clause that could make the contract applicable to distribution channels unimaginable in 1976. "I was blunt during these discussions," Schupak explained in 2012. "Rather than narrow the definition of TV revenues, I insisted instead that we add a new sentence [to] emphasize that this was a broad definition that could not be evaded or made obsolete."

Since the contractual language covers all "visual media" revenues, in 2009 the Silnas took the NBA to court over money earned from sources beyond the scope of basic U.S. broadcast TV revenue, including international broadcasts, internet rights and the NBA TV cable network. As a result of that suit, early in 2014 the Silna brothers and the NBA reached a confidential settlement agreement. Reportedly, the Silnas received a $500 million payment from the league in exchange for ending the perpetual payments. The Silnas also will receive additional compensation for various revenue streams not imagined in 1976. The Silnas formed a new partnership with the four former ABA teams. That partnership will supply the Silnas with some TV revenue payments as well, though a buyout clause enables the NBA to end that partnership at any time.

It is not clear why the Silnas agreed to this settlement but the Silnas reportedly lost some money during the Madoff scandal and that could have factored into their decision.

The best practices that we can learn from the Silna brothers' story are (1) Do not agree to a contract that lasts "in perpetuity." The mistake in granting the Silna brothers a share of visual media rights was compounded by the fact that the contract lasted "in perpetuity." (2) Do not rush to make a deal. The four ABA teams that were joining the NBA were so anxious to get things over with that they let the Silnas dictate terms. (3) Clearly specify/define which rights you are signing over and which rights you are keeping and never give away future rights to something that has an unknown value. In this case, the term "visual media" can be interpreted very broadly.

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Notes:

1) You may wonder why the Silnas asked for 1/7th of each of the surviving ABA teams' shares. In December 1975, the ABA owners figured a merger was coming soon and thought that six ABA teams would be allowed and one would be left out. The ABA owners held a meeting and Ozzie Silna wanted to be equitable to the owner who would be excluded from the merger. "The seventh team, I said, should be fully compensated for its players, and they also should receive a share of television money in perpetuity," said Silna. "Everybody was in favor of it, and it was written into the league bylaws at the time. I, of course, had no intention of being that seventh team. I told the owners, 'We're all in this together.' I thought that seventh team deserved the same benefit as the other six. That's how we came up with the one-seventh" figure. However, just a few months later, when the negotiations began, the seventh team had folded and it had also become clear that the Spirits of St. Louis would not be joining the NBA. The Silnas and Schupak applied the parameters they'd set up for the seventh team to themselves. "You try to live by the Golden Rule," Ozzie Silna said. "Some people say it's the best deal ever done. I just looked at it as a way of being fair."

2) Thanks to another bit of foresight by the Silnas and Schupak, they actually received more than 1/7 of each of the former ABA teams' shares of the NBA's TV contract starting in 1995 when the Toronto Raptors and Vancouver Grizzlies joined the league. The Silnas and Schupak anticipated that expansion would threaten to dilute their revenue and so they capped the split of their share at 28 teams. So the Silnas' share is based on a split among a maximum of 28 teams, not however many teams are actually in the league (which has increased from 22 to 30 since 1976).

3) John Y. Brown later bought the Buffalo Braves (the team now known as the L.A. Clippers) and then swapped teams with the owner of the Boston Celtics. After a brief, unsuccessful run as the Celtics' owner, Brown sold the team and went into politics and was elected as Kentucky's governor.

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posted by David Friedman @ 8:15 PM

8 comments

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8 Comments:

At Wednesday, October 19, 2016 10:48:00 AM, Anonymous Anonymous said...

I'm confused. You mentioned only 6 teams instead of 7. After looking it up and seeing that Virginia Squires were the 7th team to finish the 1976 season, what happened to them and their owner?

 
At Wednesday, October 19, 2016 12:23:00 PM, Blogger David Friedman said...

Anonymous:

The Squires had trouble meeting their financial obligations and folded shortly after the 1975-76 season ended. As a regional franchise not based in one city, it is unlikely the Squires would have been included in the merger even if the franchise had survived a little longer.

 
At Wednesday, October 19, 2016 12:40:00 PM, Anonymous Anonymous said...

Why did they fold before negotiations were settled? Were they so much in the hole they couldn't stay afloat for another month or so? They must've known negotiations were coming soon.

Also, since the Squires folded, why did the Silna brothers keep it at 1/7 instead of 1/6? It sounds like the Squires were no longer in the equation.

And why did the 4 former ABA teams form a new partnership with the Silnas? It sounds like they settled for $500 million, and that's that. I guess this new partnership must've been part of the deal.

Very interesting story. I may have heard part of this before, but must've forgotten.

 
At Thursday, October 20, 2016 12:15:00 AM, Blogger David Friedman said...

Anonymous:

Those are good questions. My class presentation was set for five minutes, so by necessity the article did not dive deeply into issues that did not pertain to the contract clause that was relevant to the class discussion.

Here are answers to your questions:

1)The team failed to make a required payment to the league and thus the team ceased operations. The Squires had been cash-strapped for years, which is why they traded away future Hall of Famers Rick Barry, Julius Erving and George Gervin.

2) As mentioned in my article, the original proposal was based on the league having seven teams. The deal worked out pretty well for the Silnas and Schupak.

3) The Silnas lost an undisclosed sum to Bernie Madoff. Plus, with the Silna brothers getting older there may have been some estate planning issues if they did not reach a settlement. Finally, in addition to the lump sum payment the Silnas are still entitled to some media revenues unless the owners execute a buyout clause, so either way the Silnas (or their heirs) will make more than $500 million, in addition to the money that the Silnas received for decades.

One interesting footnote is that the Silnas' dream was always to own an NBA team. Ozzie Silna noted that the value of the ABA teams that joined the NBA increased exponentially since 1976, so he felt like those owners also did quite well for themselves. Of course, the difference is that the Silnas had no overhead costs over the years.

 
At Thursday, October 20, 2016 5:00:00 PM, Blogger Andrew Hennings said...

Great article, very interesting.

 
At Thursday, October 20, 2016 9:16:00 PM, Blogger David Friedman said...

Andrew:

Thank you!

 
At Friday, November 18, 2016 11:18:00 AM, Anonymous Anonymous said...

Is there anything is this agreement that negatively impacts the city of St. Louis, or it's metropolitan area from getting an NBA team? When NBA expansion, or a possible team move(Vancouver Grizzles) is spoken of, St. Louis is hardly ever seriously considered for NBA home.

 
At Friday, November 18, 2016 12:32:00 PM, Blogger David Friedman said...

Anonymous:

The Hawks struggled financially in St. Louis, so the NBA has been reluctant to place a franchise there since the Hawks moved to Atlanta.

 

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