By Laura A. Zwicker and Stefanie J. Lipson, of Greenberg Glusker
You are ready to wire billions from your account, you have caps and jerseys for all your friends, but do you really know what you are getting into when you sign on the dotted line for your brand new “Big League Team”? No, we are not talking about player walk-outs, sponsor disputes or even whether your team actually wins. We are talking about the fact that, unlike your tech company or your real estate empire, the league and the other franchise owners are going to have a say in whether your kids can inherit your team, whether and what kind of lifetime gifting and tax planning you can engage in with your new asset and will likely even get to take a look at your otherwise private estate planning documents.
The concept that ownership of a business could include some restrictions on a business owner’s ability to transfer his or her interest is not in any way unique to the governing documents of the major sports leagues. Many business owners want to know that they have a right to buy out their partner’s interest in the business on the partner’s death, rather than becoming a co-owner with their partner’s spouse or children. Other business owners may negotiate structures that freely permit transfers to spouses, children and other estate planning related structures, but provide a buyout right on any attempted transfer to a third party. What makes buying a major league franchise different is that while you might own your entire franchise, you are just one partner in the league. In addition, even the wealthiest, most powerful and business savvy purchaser really can’t negotiate the terms of their interest in the league “partnership.” As one expert in the Sterling trial noted, a major league franchise is like a Faberge egg in scarcity and emotional appeal and this scarcity and emotional appeal gives the leagues leverage in a way that is almost unique in the business world.
Beyond the difficulty the restrictions may pose in marketing a franchise for voluntary sale to a third party, these restrictions may pose even greater difficulties in planning for this asset. Most likely, the new owner’s estate has a value in excess of the current $5.43 Million exclusion from federal estate tax. This means that, within 9 months of owner’s death, the owner’s family will have to pay a 40 percent estate tax on the value of an illiquid asset with a limited pool of eligible purchasers and subject to significant transfer restrictions, the practical application of which may depend on the owner’s relationship with the league management team and with the other franchise owners.
To mitigate the estate tax burden and some of the uncertainty that would be involved with a transfer of the entire franchise at death, our new owner may want to think about engaging in a transaction that would shift some or all of the ownership of the franchise to a trust for children and/or grandchildren during the owner’s lifetime. However, in order to obtain approval for the transaction, the trust which will be the ultimate owner of an interest in the franchise and the transfer itself will be subject to review and approval by the league and perhaps by the other franchise owners as well. This is something that a privacy and control conscious owner would usually be unwilling to tolerate. Further, any change in the trustee of the trust for the children would likely be subject to further league approval, which would expose changes in the circle of our owner’s family and confidants to league, if not general public, scrutiny.
Even if no lifetime tax planning is engaged in, even a transfer to a revocable trust in order to avoid a public court supervised probate on death would be subject to league approval, as would any change in the trustees of that trust. While there is some sacrifice to our new owner’s privacy in such an approval, it is certainly preferable to a public court supervised probate proceeding. In addition, addressing our new owner’s succession plan with the league during the owner’s lifetime may give the owner more certainty that his or her intended beneficiaries will be acceptable to the league than there would be if the succession were addressed after the owner’s death.
In addition to the privacy and succession considerations, our new owner will need to work with an estate planner to determine whether the owner’s family will be able to afford to pay the estate tax on the franchise. It is unlikely to be possible or economically feasible to insure against the estate tax cost using traditional life insurance. Therefore, the funds to pay the 40% tax on the value of the franchise will need to come from a sale of the franchise to a third party, assuming league approval could be obtain in the short time available to pay the tax, from the family’s existing wealth, from new liquidity generated by tax planning with other assets or from the government, in the form deferred payment of estate tax. However, to qualify for deferral of the estate tax, the owner’s family will have to establish to the IRS’s satisfaction that the owner was active in the management of the franchise and may have to subject other valuable assets to an IRS lien, because any lien on the franchise itself would, you guessed it, be subject to league approval.
In the event that there isn’t a third party sale following the owner’s death, the owner’s estate will need come up with a strategy for valuing the franchise for estate tax purposes. While closely held business entities, works of art and unique properties may present their own valuation challenges, professional sports franchises present special valuation difficulties because of the scarcity of teams available for purchase. A valuation expert could look at sales in other leagues and at some of the economic data relating to the franchise to provide an opinion of value, but the IRS would not be unreasonable in taking the position that an appraisal based on the economics of the franchise doesn’t accurately capture the “Faberge” value of the franchise. As a result any valuation of the franchise for gift or estate tax purposes will likely be subject to heightened IRS scrutiny.
The fact that the league and possibly the other franchise owners will be participants in our new owner’s estate planning, the fact that our new owner will not have the final say in who the next owner of the franchise is going to be and the difficulties in planning for the estate tax cost of owning the franchise are not likely to dissuade our new owner from taking on the franchise. However, our new owner’s tax and legal advisors would be remiss if they did not thoroughly advise our new owner about these issues while there was still time for our new owner to decide buy a Faberge egg instead.
Laura A. Zwicker and Stefanie J. Lipson are partners at Greenberg Glusker in Los Angeles. They are both in the firm’s trust and estates practice and advised Shelly Sterling in the development of the family trust as well as the $2 billion dollar sale of the Los Angeles Clippers to Steve Ballmer.
