May 29, 2012

Bizball

Inside the 2012-16 CBA: The Luxury Tax Meets the Draft

by Maury Brown

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This is Part 1 of a multi-part series on the latest Collective Bargaining Agreement

On November 22 of last year, Major League Baseball and the MLBPA did something that the NFL and the NBA could not: reached a new labor agreement without a work stoppage. For those that follow baseball’s labor history, it has become a miraculous run. By the time the current five-year Basic Agreement (read here) expires on December 1, 2016, it will have been 21 years of uninterrupted labor peace.

As mentioned, the league and union for the players made their announcement on November 22 of last year, but that was just a memorandum of understanding, not the finalized agreement.  It took 183 days for the 2012-16 CBA to be released, and with it, we can now begin digging through the 311 pages of details.

This CBA sees a series of sweeping changes from realignment, changes to interleague play, two additional Wild Card teams, and much more. The biggest change, however, comes to how the Rule 4 Draft: a possible International Draft and with details on how those are to be conducted, namely around the allocation of signing bonuses and draft pick compensation.

Draft Pick Compensation Gets a Major Overhaul
The draft will continue to be conducted in June, but the signing deadline will be moved to a date between July 12 and July 18 depending on the date of the All-Star Game.

Getting a leg-up on agents, the league asked for (and got) a provision under which drafted players may now only sign minor league contracts. In other words, Stephen Strasburg-type deals are history. This, of course, hasn’t sat well with player agents. As one agent said to me, “The union threw us (agents) under the bus with this (labor) deal.”

The first big change in draft functionality has already taken place in terms of draft pick compensation for free agents. Moving forward, there will be no more Elias Rankings for A and B Types. Instead, during what is called the “Quiet Period”—the five days directly after the World Series is completed—clubs can make a “Qualifying Offer” to those players on their rosters that are deemed to be free agents.

This “Qualifying Offer” works as such:

During the Quiet Period, the former Club of a Qualified Free Agent may tender the Qualified Free Agent a one-year Uniform Player’s Contract for the next succeeding season with a guaranteed salary that is equal to the average salary of the 125 highest-paid Players each year.

A separate attachment in the CBA describes how that salary average from the 125 highest-paid players is derived:

1, The 125 highest-paid Players initially shall be derived from all Players on a 40-man roster or 60-Day Disabled List on August 31 of the most recently completed season (“Eligible Players”).

2. In determining the 125 highest-paid Players, each Player’s salary for the season at issue (“Salary”) shall be calculated by adding the following: (i) the Player’s base salary for the year at issue as set forth in Joint Exhibit 1 (adjusted pursuant to any salary escalator effective for that season); (ii) a prorated portion of any applicable signing bonus; (iii) a prorated portion of any buyout associated with the first Club or Mutual option year of the Contract (or a deduction of the amount of the buyout if the option was exercised as described in Addendum A); and (iv) any bonuses that were earned by the Player as of the conclusion of the championship season. If any portion of the Player’s earnings in items (i)-(iv) of this paragraph is deferred, his Salary shall be discounted pursuant to the formula set forth in Addendum A.

The player then has seven days to accept or reject the Qualifying Offer. If they reject that offer, the question of draft pick compensation comes into play:

(a) A Qualified Free Agent shall be subject to compensation only if: (i) his former Club tenders him a Qualifying Offer ….; (ii) the Player declines the Qualifying Offer or signs a contract with another Major League Club prior to the expiration of the Acceptance Period; and (iii) the Player signs a Major League contract with another Major League Club that is confirmed by the Players Association and the [Labor Relations Dept. of MLB] LRD before the next succeeding Major League Rule 4 Draft (“Rule 4 Draft”). A Qualified Free Agent who signs a bona fide Minor League contract shall not be subject to compensation irrespective of whether the Minor League contract is subsequently assigned to the Major League Club provided that the execution of the Minor League contract and the subsequent assignment were not the product of an agreement or understanding designed to circumvent Article XX(B)(3) and (4).

The club that signs a player subject to compensation will forfeit its first round selection unless it selects in the top 10, in which case it will forfeit its second-highest selection in the draft. If the player signs with another club as a free agent, the former club will receive a selection at the end of the first round beginning after the last regularly scheduled selection in the round. All former clubs that receive such free agent compensation will select based on reverse order of winning percentage from the prior regular season.

There is a host of miscellaneous provisions as well, such as what happens if a free agent signs a minor keague deal, if a player signed goes on the DL, etc. Start on page 90, for details.

Luxury Tax Meets Signing Bonuses (Rule 4 Draft)
In a nutshell, MLB wanted “hard-slots”—designated figures for the bonuses that each club would have to adhere to. The MLBPA was against this as it posed as a “cap.” The compromise was a soft cap in the use of a luxury tax on the slots.

In the old CBA, the league had a “recommended slot”—a signing bonus designated to a particular draft slot. Clubs didn’t always toe the line on the slots, and that created problems.

For one, clubs that have more revenue to toy with could make offers above slot with greater ease than lower revenue makers. On top of that, some agents either backed clubs into corners or clubs made bad decisions and offered signing bonuses well over slot. Signabilty has become a major issue in the league, as witnessed in the non-signing of Aaron Crow by the Nationals and the near non-signing of Stephen Strasburg by Washington the following year. The luxury tax on signing bonuses is designed, in theory, to allow for competitive balance. It also is a way for the league to police clubs from overspending, and it’s a way for clubs to have a true sense of cost certainty.

Clubs are given a “pool” of signing money that comprises the total aggregate amount across their draft picks. You can sign over-slot in one location and then reduce the signing amount for another pick to offset the over-slot play elsewhere. The key is staying within that “pooled” amount.

There are defined parameters that clubs can budget year in and year out. Here’s how it breaks out:

• The signing bonus pools range from $1.6 million (Angels) to $12.4 million (Twins), which is unique to this year because the new system was layered on top of the old free agent draft pick compensation system for this year.
• The pools are based on the number of picks, including compensation picks, and last season's record.
• The more picks a club has, the larger the pool becomes that the club will have to work with.
• The size of the pools will standardize more from club to club after next year’s class of free agents.
• The size of the pools will be dependent on the number of picks a club has in a given year and where those picks fall within each round. A club with the first pick of the Draft will have the largest pool.

On how those clubs will be penalized, an additional wrinkle is in the mix, which may or may not happen for next season…

Luxury Tax Meets Signing Bonuses (The Possible International Amateur Draft)
It hasn’t happened yet, and it may never. Since negotiations leading up to the 2002 CBA there have been attempts to reach an international draft. The league has wanted it for some time, and according to interviews I did last year with MLBPA Executive Director Michael Weiner, the MLBPA has been as well. The issue has been around the technicalities of making it happen.

The new CBA addresses this… sort of. That is to say, when the new labor agreement was reached, the matter of an International Draft was still being worked through.

Before December 15 of last year, the sides had to come up with an International Talent Committee. As the CBA outlines, “The MLB Executive Vice President for Labor and Human Resources (Rob Manfred) and the Executive Director of the MLBPA (Michael Weiner) (or their designees) shall serve as co-chairs of the Committee, and each of them will appoint three additional members of the Committee.”

With Manfred and Weiner presiding, the committee wound up having New York Mets General Manager Sandy Alderson, MLBPA Director of Player Relations Tony Clark, Tampa Bay Rays Executive Vice President of Baseball Operations Andrew Friedman, MLBPA Special Assistant Stan Javierm, MLB Senior Vice President of Baseball Operations Kim Ng, and MLBPA Senior Advisor Rick Shapiro.

The CBA added that once the committee was created, they had to meet before January 15 of 2012, which they did.

When I spoke with Rob Manfred and Michael Weiner leading up to labor talks, both said that it is the technical issues around making an international draft happen that have proved so vexing. Everything from how to rank players to how to stop “skimming” of signing bonuses needs to be taken on. The new CBA spells out those technicalities by providing a list that the International Talent Committee is charged with addressing. The Committee will be charged with advising the MLBPA and the Office of the Commissioner on the following matters:

1. If there is an international draft, whether international players should be part of a single worldwide draft (including players currently covered by the Rule 4 Draft) or a separate draft (or drafts).

2. The appropriate age at which international amateur players should be signed to professional contracts.

3. If there are to be multiple drafts, whether players from Puerto Rico should remain in the Rule 4 Draft or instead be part of an international draft.

4. The development of appropriate country-by-country plans for playing and development opportunities for players prior to draft eligibility, including expansion of the El TorneoSupremo.

5. The development of appropriate plans to provide undrafted or unsigned players (including players age 18 to21) from Latin America with an opportunity to continue their development, including the creation of a new league or leagues, or the addition of centrally-operated Clubs in the Dominican Summer League (“DSL”).

6. Whether and how regulations should be put in place regarding representation of international amateur players (e.g., “independent trainers” and agents).

7. Improving the education and acculturation programs of Clubs at their international academies.

8. What safeguards should be established in relation to any signing bonus payments made to international amateur players.

9. The laws of the countries from which international players are signed and how those laws should affect the actions of the parties.

10. What actions are necessary in order to achieve the negotiation of a revised agreement between MLB and the Mexican League that allows players greater choice of where to play and promotes a fair and open system of player movement.

11. What actions are necessary in order to achieve the negotiation of revisions to the protocol agreements with the Korean Professional Baseball League, the Japanese Professional Baseball League, and the Taiwan R.O.C. League to accommodate a draft.

12. How Cuban players should be treated under an amateur talent system in light of the legal and political factors that affect their signability.

Here’s what has to happen—shortly, mind you—if an international draft is to take place for the 2013-14 season:

No draft of international amateur players may be implemented in 2013 unless the following conditions are satisfied by June 1, 2012:

1. A new agreement is reached with the Mexican League (consistent with certain provisions in the CBA)

2. The protocol agreements with the Korean Professional Baseball League, the Japanese Professional Baseball League, and the Taiwan R.O.C. are revised  (consistent with certain provisions in the CBA)/

3. A league and/or additional DSL teams to provide playing opportunities for undrafted/unsigned players are organized to begin play no later than June of the year in which a draft covering international amateurs is scheduled to begin.

4. The country-by-country plans referred to in paragraph D.4 above have been completed for the countries of origin of at least 85% of the international players signed in 2011.

5. Appropriate understandings are reached with government officials in the Dominican Republic (and other countries as necessary).

6. Agreement is reached on a procedure for regulating representatives of international amateur players.

If those conditions are met by June 1, 2012, then based on the CBA, “the Office of the Commissioner may give notice that it intends to commence operation of a draft (or drafts) covering international amateur players for the 2013 season and subsequent seasons. Written notice of such intent must be provided to the MLBPA by no later than June 15, 2012, and such notice must include a detailed explanation of the rules and procedures that the Office of the Commissioner intends to use for the draft.”

In other words, there’s an awful lot that has to happen for an international amateur draft. Thus far, there has been no word in the media one way or the other as to whether those marks are being reached. It looks rather daunting for it to occur this year, but stranger things have happened.

Similar to the slotting bonuses that are part of the Rule 4 Draft, there are now constraints on bonuses to international signings via a luxury tax as well. Here’s how the International Draft aspect melds together with the Rule 4 Luxury Tax, based on the language in the CBA (see beginning page 268):

For the 2012-2013 signing period, each Club will be allocated a Signing Bonus Pool of for international draft signings of $2.9 million.

For each signing period following the 2012-2013 signing period, each Club will be allocated a Signing Bonus Pool based on inverse order of its prior season’s winning percentage.

The Signing Bonus Pool will be calculated by assigning four bonus values to each Club, and adding $700,000 to the aggregate sum of those values. The Office of the Commissioner will distribute each Club’s preliminary Signing Bonus Pool and corresponding bonus values by April 1, and final Signing Bonus Pool no later than June 15.

For the 2012-2013 and 2013-2014 signing periods only, a Club’s six highest signing bonuses that are equal to or less than $50,000 will not count toward its Signing Bonus Pool. In addition, bonuses provided to players of $7,500 or less will not count toward a Club’s Signing Bonus Pool.

For signing periods after the 2013-2014 signing period, bonuses provided to players of $10,000 or less will not count toward a Club’s Signing Bonus Pool.

If clubs exceed their slot money, they’ll get hit with penalties via the luxury tax now in place for signing bonuses.

As mentioned, there may or may not be an international draft for the 2013-14 season. The CBA accounts for that by detailing what the Luxury Tax penalties are:

If [an InternationalDraft] will not occur in 2013 and/or 2014 either because the conditions set forth in (provisions in the CBA), or the MLBPA exercised its veto rights…

With the details around whether we will or won’t have an international draft, clubs are presented with the following luxury tax penalties for going over their total amounts:

Clubs that exceed their Signing Bonus Pool in the 2012-2013 signing period and/or 2013-2014 signing period will be subject to the following penalties:

a. 0-5% in excess of Pool—75% tax on all of the Pool overage.

b. 5-10% in excess of Pool—75% tax on all of the Pool overage and loss of right to provide more than one player in the next succeeding signing period with a bonus in excess of $500,000.

c. 10-15% in excess of Pool—100% tax on all of the Pool overage and loss of right to provide any player in the next succeeding signing period with a bonus in excess of $500,000.

d. 15% or greater in excess of Pool—100% tax on all of the Pool overage and loss of right to provide any player in the next succeeding signing period with a bonus in excess of $250,000.

Note: If a Club exceeds its Signing Bonus Pool, and it does not possess the draft picks subject to forfeiture as a result of being penalized in a prior year under the agreement, it will forfeit the designated draft picks in the next draft in which it possesses the relevant picks.

As noted, the penalties are pretty steep, especially if picks are lost. With an increasing emphasis on developing talent, the draft has become arguably the most critical aspect in all of baseball.

Trading Draft Picks (Assignments)
To add an additional wrinkle to the drafting process, clubs can now trade picks through a process the CBA calls “assigning.”  Beginning in the 2013-2014 signing period, clubs may assign (trade) any of the four bonus values that comprise their signing bonus pool in accordance with the following:

1. A Club only may assign the total amount of a bonus value, but not a portion thereof. For example, a Club with an international bonus value of $1 million may assign the $1 million value to another Club, but may not assign only a portion of that value.

2. In any assignment of a bonus value, the Signing Bonus Pool of the assignor Club will be reduced by the amount of the value, and the Signing Bonus Pool of the assignee Club will be increased by the amount of the value.

3. In any signing period, a Club may not acquire via an assignment bonus values that constitute in the aggregatemore than 50% of its original Signing Bonus Pool. By wayof example, a Club with a Signing Bonus Pool of $4 millioncould not acquire via assignment more than $2 millionin additional Signing Bonus Pool capacity. If a Club does acquire via assignments more Signing Bonus Pool capacity than is permitted under this paragraph, its Signing Bonus Pool will be reduced to 150% of its original Signing Bonus Pool.

4. A Club may not acquire bonus values via an assignment after it has exceeded its available Signing Bonus Pool. By way of example, if a Club had $1 million left in its Signing Bonus Pool on August 1, and signed a player for $1.5 million on August 15, it could not acquire additional bonus values after it signed the player on August 15.

5. Cash consideration of any kind is not permitted to be included in a trade involving a Club’s bonus values unless the cash consideration is included to offset the salary obligation of another player included in the assignment (and is greater than such obligations), subject to the Commissioner's approval.

What It All Means
This series on the CBA starts with the changes to signing bonuses around the drafting process because it was the most important issue on management’s side of the table in negotiations. Signability, the ability to bring competitive balance through the draft process, and cost certainty have their fingerprints all over the CBA.

In speaking with executives and agents about the changes, the one thing echoed over and over was that while the changes are some of the most dynamic in league history, the impact is not yet fully known.

“We’re all going to have to feel this out,” said one club executive. “It’s going to take staffs on (league and union side) to get a true understanding of it all, and that’s liable to take a few years.”

As one agent echoed, “We’re going to have to roll with it in the first couple of years. On the face of it, it doesn’t look good for those coming into the league via the draft. We’re going to have to adjust.”

One thing seems clear: when coupled with the luxury tax that has been in place for some time on total player payroll (something that will be covered in the next installment in this series), the league now has set cost containment mechanisms on not one, but two fronts. If MLB can’t get a hard-cap, they’ve at least painted the corners of the plate to place salary constraints wherever possible. In theory, this should further assist the have-nots in the league and continue to place focus on developing talent as opposed to working mostly through the free agency space.

Larger questions loom as to how international signings will function. The details on an international draft are difficult, and its potential implementation could create some thorny issues.

One thing is certain: big changes are afoot with this new agreement. Look for further installments on the 2012-13 Collective Bargaining Agreement in the weeks ahead.

Maury Brown is an author of Baseball Prospectus. 
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