Clawback and its limitations
From the world of professional football …
… comes a tale of contract renegotiation with useful metaphoric lessons about the challenges of harnessing the rogue critter homo developerus into the business of delivering long-term affordable housing, and about the use (and limitations on use) of recapture of money, or clawback as it is known in
Every service contract represents a bargain struck between at least two parties:
- A financial partner, who pays for and consumes the service
- An operating partner, who provides a skill set, a vision, and a willingness to take risk
Every service contract also has a time domain, an interval over which three things happen:
- Services are performed
- Value is created/ provided
- Payment is rendered
No matter how closely one seeks to align these three streams — services, value, and payment — inevitably there will be mismatches. As a result, even if a contract is in equilibrium at the moment of its execution, as it moves through its duration, the net beneficiary shifts based on circumstances. At times the financial partner will have the more beneficial bargain; at times it will be the operating partner. Theoretically, therefore, the only two times a contract may be said to be purely equitable are at its inception– when signed — and its completion – when it is over. In between is a journey.
And what happens when that journey is interrupted — when things go wrong?
Where nothing can go wrong, go wrong, go wrong …
Do the clawback provisions and enforcement contingencies actually work?
Not exactly.
During his college career, Kellen Winslow, Jr. was a supremely talented tight end [No jokes, please, that is the term of art– Ed.] so that when he graduated college, he was a prize draft pick selected by the Cleveland Browns , who signed him to a long-term (six-year) contract. As a lure to sign said contract, and for other financial reasons which need not concern us, the Browns paid Mr. Winslow an enormous signing bonus — analogous for our purposes to a massive cash development fee paid on completion of construction — and Mr. Winslow agreed further to provide services, for attractive but lesser compensation, over the ensuring contract years.
The Browns’ signing of Mr. Winslow made him a financial asset, just as entering into a construction or development agreement with a builder/ developer creates a financial asset for a lender or investor. To protect that investment, the Browns included in the contract a series of provisions designed to deter Mr. Winslow from impairing his performance:
At least twice in Winslow’s contract — in the “optional extension agreement” and in the “signing, reporting and playing bonus addendum” — there is specific language regarding the off-field activities in which the player is precluded from participating. The sections of both addendums are similar and refer to “hazardous activities” that “involve a significant risk of personal injury … including, but not limited to skydiving, hang gliding, mountain climbing, auto racing, motorcycling, scuba diving and skiing.”
One would think, of course, that since Mr. Winslow’s entire monetary value is tied to his unique ability to play football, anyone with an ounce of sense would be careful with that capacity. But Mr. Winslow was stupid and reckless –
But being stupid and reckless are not precluded by his contract, and indeed personality traits characteristic of large crazed young men who play football, and of real estate developers who are always seeking to do the next, biggest, deal. He went motorcycle riding, on his own, doing wheelies:
Winslow was charged last week with disregarding safety …. The charges came after police there reviewed a videotape that showed Winslow, said to be a novice rider, performing wheelies in a parking lot.
And busted up his knee rather spectacularly — so spectacularly, in fact, that neither he nor the Browns are saying.
Because the injuries did not occur in a football situation, the Browns are not compelled to report them, and Winslow and his family have requested that the team not divulge any medical information.
This too is a common reflex action when trouble strikes — conceal it as long as possible, in hopes of sustaining the impression that things are under control. It always backfires — the best strategy is to announce, “Houston, we have a problem,” and then move forward.
“He’s torn his knee pulling wheelies.”
Now, the contract is crystal clear — Mr. Winslow breached it. And the Browns clearly anticipated this risk, so they have an iron-clad clawback provision:
The contract, executed on Aug. 11, 2004, also reads: “It is further understood and agreed that player’s waiver of rights to certain unpaid amounts, and player’s obligation to re-pay certain amounts of [these bonuses] are express provisions of this contract and, but for the provisions herein contained, club would not have executed this contract.”
So the Browns should be clawing back the bonus they paid him, should they not?
Well, in any event, the Browns are proceeding as if they, rather than their player, are the ones with a problem:
While the Browns intend to enforce their financial options, doing so could be a tricky maneuver, in terms of attempting to not alienate a player they still feel is a significant part of their program. The team will seek to avoid acrimony, but that might not be easy, even given the specific language built into the contract.
Why, you ask? Because it has occurred to the Browns that even though they have invested substantial moneys in Mr. Winslow, their goal in this contract has been to secure his services, so any clawback of funds must be weighed against restoring the prospective contract — the contract that consists of the remaining burdens, benefits, and expectations going forward — to equity, equilibrium, and effective incentives.
In short, the contract is busted, and the Browns now need to write a new contract over the palimpsest of the one they wrote and must now expunge from their parchment.
The team has decided, however, to seek financial adjustments to Winslow’s contract, and that move could come within the next few weeks.
In this, the Browns (the financial partner and consumer) have to take into consideration a pile of new information not available to them originally:
- Mr. Winslow, in whom they have invested so much, has already shown himself to be impetuous and contemptuous of agreements that he has made.
- Mr. Winslow is holding several million dollars of the Browns’ money and has performed essentially no services.
- Mr. Winslow, with his ruined knee (yet to be rebuilt), may never be as valuable a player as the Browns originally bargained.
Now for the punch line:
All of the challenges described above mirror perfectly those faced by lenders, investors, and policymakers who seek to harness the strange and half-civilized creature known as homo developerus (the missing link between Neanderthal and Cro-Magnon Man).
One strikes the best bargain one can, and then, if something does go wrong, nine times out of ten it is better to restructure and pull together than engage in recriminations (litigation) that are at best zero-sum (what I win, you lose) and more commonly, negative-sum (we lose all the costs of fighting, which are considerable, and the asset typically wastes away while we do).
And there are other lessons too:
1. Deterrent provisions are useless once they have failed to deter.
2. The most effective place for the financial partner’s money is in the financial partner’s pocket.
The Browns are expected to seek repayment of between $2 million and $3 million. The team will also withhold a $2 million payment due Winslow on July 15, money that is part of his $6 million signing bonus.
So the Browns had the good sense to structure the bonus as a series of staged payments, allowing them to withhold rather than claw back.
3. Clawback against an operating partner is often ineffective because the financial partner needs further services from the operating partner.
4. In workout situations, it’s usually sound psychology to give people a hope, however implausible, that they can recover.
There is a possibility that the Browns would rework Winslow’s contract to afford him the opportunity to earn back some of the forfeited money in so-called “back end” incentives, that would be tied to playing time or performance levels.
5. It is better to work out a problem than dump a troubled asset.
Despite the May 1 motorcycle accident that will sideline tight end Kellen Winslow for the 2005 season, and which adds uncertainty to his football future, the
6. Finally, when facing a seemingly hopeless workout challenge, make Stone Soup!
