How it Works: The Waiver Procedure and Contract Buyouts

Sanders_Stoudemire

Photo Source: Hoops Habit

Introduction

A buyout is a popular tool front offices use to decrease their team salary and part with a player who is still under a large contract. It’s often used for veterans on a bad team who want to join a playoff team and are underperforming their current salary. The rules are slightly complicated and borrow from multiple sections of the CBA and the NBA by-laws. To get the whole picture of how a buyout works, it is necessary to explain the general waiver procedure and compensation protection. This post will examine those details and provide a clear picture of why and how buyouts work.

General Waiver Procedure[1]

If a team decides to terminate a player’s contract, thereby waiving him, the team must request that Adam Silver request waivers from all other NBA teams. A waiver is essentially a claim from another team that wants to sign that player. After the waiving team contacts Adam Silver with this request, the team cannot change its mind and the request cannot be undone. When the other teams receive this waiver request, they have 48-hours to decide whether to put in a waiver to claim the player’s contract.[2]

Once a team submits a waiver to claim the player, that waiver cannot be withdrawn. If more than one team submits a waiver, then the worse team (by winning percentage) will acquire the player’s contract.[3] If, on the other hand, no teams submit a waiver in the 48-hour waiver period, the player’s contract will be terminated and he will be a free agent. In the event that no team submits a waiver claim and the player becomes a free agent, the waiving team will generally be responsible for the player’s salary remaining on his now-terminated contract. This is because of compensation protection.

Most contracts offer compensation protection and, as such, the contract is referred to as a “guaranteed contract.” Compensation protection comes in five forms: (i) lack of skill, (ii) death, (iii) basketball-related injury, (iv) injury or illness, and (v) mental disability. If compensation is unprotected or the contract is non-guaranteed, a player’s team can waive him and there will be no dead money on their cap sheet.[4] If, however, the player has compensation protections and a team wants to waive him, they will have to decide to either use the stretch provision or pay the full amount of the player’s waived contract in accordance with the original terms of the contract.[5] The stretch provision pays out the remaining guaranteed money on a contract over a longer period of time: two times the remaining years on the contract plus one year. For example, if a player is waived in the first year of a 4 year contract, with $14M due over the last 3 years (split evenly), the $14M will be on the team’s cap sheet as dead money over 7 years at $2M per year. If the team elects not to stretch the contract, the player’s salary will be on the team’s cap sheet as dead money over 3 years at $4.67M per year.

While the stretch provision certainly helps a team maintain as much cap flexibility as possible after waiving a player, it can still be very limiting. Not only does the team have money on their cap sheet that is being paid to a player who is no longer benefiting the organization, but that money will remain on the cap sheet for an extended period of time. And unlike bad contracts for active players on your roster, you simply can’t get rid of dead money via a salary dump trade. The one respite for teams in this situation is the right to set-off.

The set-off right gives teams the ability to offset the money they owe a waived player and the money on their cap sheet in the event that player signs with another professional team.[6] For every year that the team is responsible for the remaining salary on a terminated contract, the team can set-off the amount of money the player is earning on another professional contract, subject to a formula in the CBA. The formula takes the player’s new salary and subtracts the minimum salary for either a rookie (for rookies) or a second year player (for all players other than rookies). If the outcome is positive, the team can offset the player’s dead money cap hit by that amount divided by two. For example, if a team waives a player and has $8M of dead money on their cap sheet in 2015-16 as a result, and that player signs a contract with a Chinese Basketball Association team for $2M in 2015-16, the team can set-off the amount they owe the player by $577,471,[7] and thus owe him only $7,422,529 for the that season. Although this right to set-off does benefit a team in most cases it will be a very limited amount of money, as demonstrated above.

Contract Buyouts

Buyouts essentially solve the problem of teams having to decide between attempting to trade a terrible contract, likely giving up valuable assets in the process, or stretching a player’s full salary over a number of years with the possibility of only a slight break through the set-off right. For the most part, after contracts are entered into the terms are set. In limited circumstances, however, contract terms can be amended to facilitate a trade (i.e. waiving a trade bonus) or compensate the player more (i.e. renegotiating for a higher salary). For a buyout to be possible, teams need to be able to adjust the amount of money they owe a player. Under no circumstances may a team renegotiate a player contract for a lower salary, so the only way to reduce the amount of money owed to a player is renegotiating the guarantees/compensation protection in the contract.

Fortunately, the NBA allows teams to reduce the amount of compensation protection for the purposes of terminating an existing contract. This is the buyout provision in the CBA. Buyouts work like this: (i) a team will request waivers as they would in the general waiver procedure, (ii) once the player clears waivers, all compensation protection on the contract will either be reduced or eliminated, and (iii) the team’s right to set-off is modified or eliminated.

By reducing protected compensation, the amount of money owed to a player and stretched on a team’s cap sheet can be diminished significantly. This can be mutually beneficial to the team and the player. A good example of this is Amar’e Stoudemire’s buyout during the 2014-15 season. Stoudemire was in the last year of his five-year $100M contract and was owed $23.4M that season (all of which was protected). The Knicks were over the luxury tax and among the worst three teams in the league (finishing the season with a 17-65 record). Stoudemire hoped to join a playoff team and potential finals contender.[8] The Knicks and Stoudemire agreed to a buyout, allowing the Knicks to waive Stoudemire and his remaining salary, negotiating the compensation protection down by $2,500,000, thereby owing him only $20,910, 988.[9] As a result, the Knicks cut their luxury tax bill almost in half, paying $8,219,912.50 in tax instead of $14,666,903.75.[10] Stoudemire then signed with the Dallas Mavericks, a team that had one of the best starts of the 2014-15 season.

Another good example of a mutually beneficial contract buyout is the Bucks and Larry Sanders. Sanders made the decision that he did not want to play NBA basketball any longer only one year in to his 4-year, $44M contract extension. With three years remaining and $33M left, Sanders and the Bucks agreed to part ways. They negotiated the compensation protection down from $33M to $13.3M. This enabled the Bucks to stretch that money over 7 years at $1.9M on their cap sheet and Sanders to explore his passions outside of basketball.

The reasons buyouts are relatively rare is that the player has to agree to take less money. Taking $2.5M less on a $100M contract is inconsequential compared to taking almost $20M less on a $44M contract. Players give up their bodies and enormous amounts of time to live up to a contract. Most of the time, even if they underperform a big contract, they probably over-performed their last contract, so players believe they’re owed the money they initially signed for (and rightfully so). By now teams know that anything can happen to a player’s body or mindset and those are factors that have to be weighed when signing any player, especially if that player is on a max or near-max contract. But players also know this and deciding to take less money with even the slightest possibility that they will never get a guaranteed contract again is a big risk that not many would be willing to take.

[1] Amnesty waiver procedures, which I will not explain here, are slightly different but generally follow the same procedure explained here.

[2] Teams actually have to pay an extra fee set by the NBA by-laws ($1,000) to acquire the contract.

[3] For teams with equal winning percentages that both submit a waiver, the successful waiver will be determined by head-to-head matchups. If this is inconclusive, it will be determined by a coin-flip.

[4] All contracts become fully guaranteed on January 10th of the season.

[5] While teams can choose whether or not a player’s waived salary is stretched on their cap sheet, the actual payout of money to the player is automatically stretched.

[6] A professional team means any team, even outside of the NBA or in another country, that pays money to a player for his basketball services.

[7] Or ($2,000,000 – $845,059) ÷ 2.

[8] Barring multiple injuries leaving a team with only 8 active players, a player who was signed as a free agent after clearing waivers can only be included on a playoff roster if he was waived before midnight on March 1st.

[9] According to www.sportrac.com/nba/miami-heat/amare-stoudemire/

[10] Note: The Knicks were subject to the repeater tax rate in 2014-15.

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